Chapter 11: CONTRACT FUNDAMENTALS IN INTERNATIONAL LEGAL SYSTEMS

CHAPTER 11

Contract Fundamentals in International Legal Systems

BEFORE YOU ENTER into a contract with a person in a foreign country, you should become familiar with that country’s legal system and its laws that will affect your contractual arrangement. You should also gain an understanding of the distinctions between your own country’s legal system and the legal system of the other party’s country. This knowledge can be as important as running a background check on your supplier for two reasons. First, the laws in both countries will determine certain aspects of your contractual relationship. Second, the laws of one country (and not necessarily your own country) may be more favorable to you than those of the other country.

Legal Systems Worldwide

There are four major types of legal systems in the world that provide for commercial law: common law, civil law, Islamic (Shari’ah) law, and communist (socialist) law. Many countries have adopted a combination of these legal systems and in addition have retained some influences from various cultures throughout their histories. For example, Japan looked to Germany when developing its modern laws, and therefore it follows the civil law system although its commercial code shows US influence. Malaysian law is a combination of common law, Islamic law, and Malay principles. The civil law system adopted in Egypt combines Islamic principles with French civil law and some common law rules reflecting a lingering British influence. In Asia, Africa, and South America, the legal system of each country is usually that of its former colonial master—Brazil applies civil law reflecting its Portuguese history, while Singapore applies common law on account of its English heritage.

Common Law

The common law system developed as a court system in England before any statutes were adopted for the country. By the time statutes were drafted, the courts were well-entrenched and a tremendous body of law, common law, had already been established. The statutes served to confirm, codify, limit, and supplement the common law of the courts. As a result, its distinguishing feature is its reliance on precedents established by judges in earlier cases. In other words, the courts in common law countries apply and interpret statutes by following the principles developed in earlier decisions or by extrapolating new principles from the old ones to apply in new factual situations.

The Influence of Local Laws

In most countries, parties are allowed substantial freedom in making contracts, including choice of the law to be applied. However, local laws will apply to restrict your choices and to supplement the agreement with implied contractual terms to the extent that you fail to provide for your rights and obligations. These laws will influence your choices from initial negotiation through enforcement of the contract. For example, you need to know the following details. ■ Which terms of the agreement are controlled by law and which are left to negotiation—you will waste your time and give away your negotiating edge if you negotiate a point already fixed by law, and your negotiated term will be enforceable only to the extent allowed by law. ■ Whether the agreement you have in mind will be valid—if void, it will be unenforceable.

■ Which law would be more favorable to your position—your choice of law should be an informed one.

■ To what extent the law will protect your interests beyond the terms of the contract—if the law is inadequate or silent, you should insist on protective contract terms. ■ What liabilities—civil lawsuits, government-imposed fines, or other penalties—you might incur on account of the other party’s actions or omissions so that you can negotiate protective terms such as for indemnity, proof of authority, proof of quality control, or proof of compliance. ■ What procedures are available to enforce the contract and to recover for losses in the event of breach and to what extent those procedures will be effective remedies.

■ What your liabilities will be if you do not perform the contract.

Therefore, before negotiating a contract, you should be aware of how local laws could affect your contractual arrangement. Otherwise, you may be caught by surprise when you find that performance and enforcement of the terms are not what you expected.

To get a brief overview of the law of a particular country, you might consult the Digest of Commercial Laws of the World (Oceana

Publications) or the International Law Digest (Martindale-Hubbell).

These sources are available in the reference section of most large public and law libraries.

Countries that apply common law to commercial transactions include the United Kingdom, the United States, Canada, Australia, Singapore, the Hong Kong S.A.R., Israel, India, Egypt, Malaysia, and South Africa. In these countries, trials are typically before one judge, and the parties may request a jury. To ensure a fair trial, complex rules and procedures have been developed, and an appeal process is available.

ARBITRATION Arbitration systems are generally well-developed and effective and serve as a means of alleviating litigation delays in the court. Contracts that require the parties to resolve disputes through arbitration will be upheld.

CONTRACTS Contracts for the sale of goods are typically regulated by uniform laws that are similar to the United Nations Convention on International Sales Contracts (CISG). The parties have freedom to agree to any terms desired, provided the terms neither violate public policy nor require the performance of an illegal act.

If contract terms are missing, reasonable rights and obligations will be implied from the law or business practices of the parties or industry. Damages are commonly measured by the rule of “lost benefit of the bargain.” This rule allows a party to claim an amount damages based on the benefit that the party can prove it would have received if the other party had not breached the contract. In most jurisdictions, a party will also be awarded damages for losses that arise from the breach, known as consequential damages.

Civil Law

Most countries that do not apply common law have civil law systems. Civil law is characterized by comprehensive and systematic compilations of statutes, known as codes of law, that govern most aspects of human endeavor. These countries have developed their codes first and then their courts. Therefore, judicial decisions are based on the legal principles set forth in the codes.

Civil law systems use nonjury trials, except in criminal cases, and the courts are typically composed of a panel of judges. In comparison to common law systems, there are few well-defined rules of evidence, and minimal oral testimony or argument is permitted before the court. Most evidence and arguments are presented to the court in writing.

Legal decisions are generally based on one-time interpretations of the codified laws without reference to preceding cases, although in some countries prior case decisions are recognized after the same decision has been made a certain number of times. As a result, the decision in any particular lawsuit is less predictable than it would be in a common law court, which will rely on the preceding case law.

ARBITRATION Many civil law countries have procedures for the recognition of arbitration awards. Efficient arbitration systems are also available in many of them, although there is often a limit on the types of disputes that may be decided by arbitration.

In general, commercial disputes can be arbitrated.

CONTRACTS Commercial contracts (between merchants) usually do not need to be written.

In transactions for the sales of goods, the terms of the contract are often specified by a country’s civil law, although the law allows the parties to agree expressly to different terms. Good faith and fair dealing are usually implied into commercial contracts. The enforcement of oral contracts is difficult in practice because many

civil law courts accept written evidence instead of oral testimony. Negotiation is the preferred method of dealing with disputes or minor alterations in contract terms.

In many civil law codes, rules for calculating damages for breach of contract did not exist. This standard is still not clearly defined in a number of civil law countries. However, courts in these countries tend to be more willing than their common law counterparts to award specific performance in contract actions. This award requires a party to perform a specific action mandated by the court, such as the return of property or remittance of payment. Many of the civil law court systems have welldeveloped enforcement and monitoring mechanisms to make this effective.

Islamic (Shari’ah) Law

In criminal, family, and personal injury matters, Moslem or Islamic countries apply the Law of Islam, originally derived from the Koran and the Sunna. The Koran is believed by its adherents to contain the revelations of Allah to the Prophet Mohammed, and the Sunna is a recording of the Prophet’s later teachings and actions. These sacred volumes do not contain detailed codes, but rather principles and precepts of the Muslim religion. The Muslims do not modify these laws because of their belief that after the Prophet’s death the direct revelations of God ceased and the words of God are immutable.

With some exceptions, most Muslim countries no longer adhere to the strict traditional form of Shari’ah law. Today, its application tends to be limited to family and estate succession law. Even these laws have been codified, so reference to the traditional texts is rarely made except when existing statutes and codes fail to cover a specific situation. To accommodate changes in modern societies and international business practices, most Muslim countries have adopted modified codes based on European legal models, particularly French or Napoleonic Code. A separate division of commercial courts or administrative tribunals usually handles commercial disputes in accordance with civil law concepts. Case decisions are based on the law; case precedents are not binding on later cases.

ARBITRATION Private commercial disputes can be resolved through arbitration in many of the Muslim countries. The arbitration agreement and award will have to be approved by the courts of the country where enforcement is sought.

CONTRACTS Parties are free to contract, provided the terms do not alter any standard legal precepts and practices of the religious tradition of Shari’ah law. Some written evidence of a contract is often required for enforcement purposes, although an oral contract may be proved by a witness. A clause for the application of a governing law other than Shari’ah law will not be recognized. Transactions involving interest may be considered usurious and, therefore, prohibited. The courts will award only actual damages; lost profits and opportunity are considered too speculative. Many contractual terms are limited or unenforceable, including those for repossession of goods on default, retention of title by the seller, remedies, disclaimers, and limitations on liability. Warranties usually follow Shari’ah precepts.

Communist Law

The communist law system is used in the People’s Republic of China, Cuba, the Democratic People’s Republic of Korea, and Vietnam. It originated from the Communist Manifesto of Karl Marx and Friedrich Engels. The Manifesto is a philosophical mandate under which individual rights were subsumed for the good of all society on the assumption that the rights of each citizen inhere in the goals of the state. A code of laws was gradually developed from the Manifesto for the purpose of transforming society into a socialist and then a communist order, at which time the laws were supposed to cease because the new society would function smoothly without the need for rules and regulations.

In the communist system, commercial and foreign trade is primarily operated by the state. Commercial relationships with state-owned entities are heavily affected by whatever government policy is currently in effect, and a modification of contract terms can be required by a sudden shift in state ideology for purposes of implementing a planned economy. To the extent that you are able to trade with private individuals, you will find that individual rights to contract vary depending on state policies as well because the right of society as a whole prevails over individuals.

Private individuals rarely resort to the communist court system for resolution of commercial disputes. The laws applied tend to have a strong ideological content that is unsuitable for interpreting commercial relations. Communist court proceedings are open, direct, and heavily reliant on oral testimony and examination. The rules of evidence are minimal, and prior case decisions carry little weight. The court will consider all evidence presented, decide the relative value and importance of the facts, and make a determination based on general legal principles and communist ideology.

CONTRACTS More and more private individuals are making contracts for the sale of goods in communist countries, but commercial contracts are still primarily made with government agencies. Imports and exports of commodities must be channeled through licensed trading companies. The difficulty of negotiating terms with government agencies tends to limit the freedom to contract. Communist countries that have been heavily trading internationally have developed some private contract law. For example, in China no particular form is mandated for an agreement for the sale of goods, but preprinted forms are in common use for international sales. The law in communist nations is rapidly changing. Most of these nations are in the process of modernizing their economies and have found that they need to conform their commercial practices to today’s international business world. With regard to contracts for the sale of goods, their legal systems are a bit of mixture of civil and common law. When doing business with traders of these nations, it is important to recognize that the unpredictable state of the government bureaucracies makes contractual arrangements inherently unreliable. You should seek to establish relationships with foreign traders of these countries in an effort to stabilize your agreements regardless of the political and economic situation.