Chapter 5: CONTRACT BASICS

CHAPTER 5

Contract Basics

INTERNATIONAL BUSINESS TRANSACTIONS are complicated by the movement of goods and services between foreign jurisdictions with different legal systems. The drafting of a contract, performance or modification of contractual obligations, resolution of disputes, and enforcement of judgments or orders are relatively straightforward in domestic transactions, but they can be tortuous when you face international transactions subject to foreign laws and legal systems with which you are unfamiliar. In addition, many foreign governments actively take part in or become actual third parties to otherwise private contractual relationships. Governments interfere with private contractual agreements for a variety of reasons. What may be consistent with or contrary to the public policy of a government may depend on current priorities for attracting technology or capital, balance of payments problems, or an unstable political regime. Foreign companies may even serve as convenient scapegoats to be expropriated or nationalized, despite previous contractual guarantees. Thus, in order to protect a company’s commercial interests, contracts in countries with this type of instability should be drafted and negotiated by experienced international business managers and lawyers familiar with the country. For a comprehensive view of international sales contracts for the nonattorney, refer to A Short Course in International Contracts by Karla C. Shippey, J.D., also by World Trade Press.

Importance of Written Contracts

At the very least you should have a written contract whenever you pay for goods, especially when you do not take possession of them at the time of payment. Make sure you have documentation for the sale, even if it is just a simple description of goods, quantity, and price. This is usually sufficient for general merchandise if you take physical delivery and ship the goods yourself, rather than having the seller handle packaging and shipping.

Know Your Jurisdiction

Wherever you are doing business you must keep in mind that international contracts must be prepared and negotiated in an entirely different context than domestic ones. A contract in international business is not merely a document setting forth quantity, price, and delivery schedule of the products (although it must surely include such information); it must also take into consideration the local legal system and political and currency risks in the countries involved.

The laws of some jurisdictions require certain contracts to be written in order to be enforceable; others do not. Some jurisdictions also require written contracts for the transfer of certain types of property, such as real (real estate) or immovable property. Observation of other formalities—such as notarization or signatures of witnesses—may be required. In some countries, an individual who works for a corporation may not be allowed to bind that company in a contract without a corporate resolution; in others, anybody who professes to speak for a company may irretrievably commit that company to perform.

Anticipate Problems

For a contract that will be performed over time, such as a series of transactions, you should anticipate potential problems at the outset. Most people enter into an agreement to purchase and sell with the expectation that all will go smoothly and both parties will gain from the transaction. These positive expectations can be realized if your supplier and you provide for contingencies. Even with a simple sales contract, however, you must think about possible downstream problems, and provide for them in your agreement.

What Your Contracts Should Include

When dealing internationally, you must consider the business practices and legal requirements of the countries where the buyer or seller are located. The laws of one or the other country may require specific terms or formats. In some transactions, the laws may even specify all or some of the contract terms. In other countries the contract must be in the local language.

Legal problems occur when you leave terms out of your contract because the gaps will be filled in by application of the law of one or the other country. The result will vary depending on which law is chosen. If terms are vague and open to interpretation, or if any aspect is left to implication or custom, you will have to rely on local law to determine your rights and obligations should a dispute arise. Disputes will be resolved according to the laws of the country with jurisdiction (the country designated in your contract, or the country where both parties have the most significant contacts, or sometimes simply the country whose courts will assume jurisdiction).

Accordingly, the best way to control the results of your contract is to clarify each party’s responsibility in the agreement, and by paying close attention to each contract term. Always be specific. For instance, you may have an agreement that you will buy a certain quantity of a specific product, but how are you going to pick up the goods? Is someone going to box them? Do you want the entire order at once? When are they to be shipped?

Basic Contract Provisions

Your primary objective will be to create a written agreement that clearly states the rights and responsibilities of both parties to the transaction. As such, you should always be certain to come to a definite understanding with the other party

on four basic issues: the goods (including quantity, type, and quality); the time of delivery; the price; and the time and means of payment. In addition, you should include clauses on documentation, forum, governing law, damages, specific performance, and arbitration. ■ GOODS This is where you describe what is being bought and sold. The description must include the number of units or quantity, the type (including model numbers if applicable and or any standard industry specifications), and quality. Quality cannot be stated subjectively, such as “good quality,” but must be stated objectively using applicable industry standard designations. ■ DELIVERY This can be either a ship date or a date of receipt. If it is a ship date, the buyer is advised to have some degree of control over the method of shipping.

If it is a receipt date the seller should be in some control of the method of shipping. ■ PRICE/CURRENCY The price may be a price per unit or a total price, but including both is preferable. The price should also state the currency of the transaction (such as US dollars, Korean won, etc.). The price should also state whether shipping (to a particular destination), insurance, taxes, customs duties, and other costs are to be included. The latter is an important issue and the subject of

Chapter 6: Incoterms. ■ PAYMENT This should state the means of payment—whether prepaid, 120 day credit terms, letter of credit, or any other payment instrument. ■ DOCUMENTATION You must be certain that all documentation (bills of lading, invoices, certificates of origin, etc.) necessary for export from the country of origin and import into the country of destination is listed as a requirement of the contract and for payment. ■ FORUM Forum refers to the place where any dispute will be settled. It is really a matter of convenience and is usually negotiable. When it is not feasible for you to go to the supplier’s country, or vice versa, to settle a dispute, you can jointly designate a third country that would be more convenient to both. ■ GOVERNING LAW The choice of law is critical. It determines not just where you can bring a suit or enforce a judgment, but what rules and procedures will govern the dispute settlement. Where and under what law you file suit will make a difference. Filing suit in your own country, with local counsel familiar with local commercial law and court procedures, will generally produce better results than being forced to rely on the court, counsel, and law of a foreign country.

■ MEASURE OF DAMAGES IN BREACH OF CONTRACT ACTION The measure of damages in a breach of contract action varies from country to country and among legal systems. This can have a tremendous impact on your ability to recover your losses, and on the amount you may recover. Therefore, you should always specify which law, or measure of damages, will apply in such a case and ensure that all parties understand the consequences of this clause. ■ SPECIFIC PERFORMANCE Specific performance is an alternative remedy to monetary damages, and some jurisdictions do not allow this recovery in some or any cases. Specific performance allows an injured party to request a court to compel the breaching party to fulfill the contract agreement. Thus, if you have a contract to buy goods, you can demand those specific goods rather than monetary compensation.

■ ARBITRATION This clause establishes whether both parties agree to arbitration rather than legal action to resolve a dispute. There are advantages and disadvantages to arbitration for both the buyer and the seller. It should not be agreed to without thought.

Don’t Forget!

■ Always include how, where, and in what language disputes will be resolved. ■ Limit warranties or guarantees to conditions under your control. ■ Structure a contract to offset political exposure and incorporate contingency exit strategies. ■ “Boilerplate” or standard contract language should not be used. ■ Some countries do not recognize choice of law and choice of method of dispute resolution in commercial contracts. Such a country may not even enforce a domestic judgment. Do your homework before signing.

Going to Court

It is inevitable that disputes will arise in international transactions. While it is always best to try and resolve such disputes informally, if you are unable to do so you should take steps to protect your rights. There are essentially two types of disputes that can arise: those in which the buyer has a claim against the seller and those in which the seller has a claim against the buyer.

■ BUYER’S CLAIMS AGAINST THE SELLER The goods may not be delivered, or delivery may be delayed. The wrong goods, or goods of a different quantity or quality may be delivered. Proper documentation might not accompany the goods.

The goods might turn out to be defective after you have resold them. In all these cases, you will have a claim against the supplier in which you seek either performance or damages, or a combination of the two. ■ SELLER’S CLAIMS AGAINST THE BUYER A supplier’s claim against you will almost always be for nonpayment of all or part of the purchase price.

Different cultures have different ways of dealing with business disputes. In some countries, a lawsuit is viewed as a personal affront. Engaging in legal disputes, however, is almost always costly, and often results in a compromised outcome for both participants. The courts of many countries are biased in favor of their own nationals, and foreigners rarely, if ever, obtain satisfaction. As such, formal legal proceedings should be avoided if at all possible.

Even if a legal action is ultimately resolved in your favor there are major issues and pitfalls still to be confronted—most importantly, collection of the money awarded or specific performance of the contract terms. This is often impossible, and in any event can take several months or even years to accomplish. In most cases, the amount awarded will not adequately compensate you for the time and expense of litigation. As such it is important to protect yourself to the best extent possible in the initial stages of a business relationship.

ARBITRATION The parties to a commercial transaction may provide in their contract that any disputes over interpretation or performance of the agreement will be resolved through arbitration. Arbitration is where both parties to the dispute agree to have a third party resolve their differences. Arbitration offers neutrality (international arbitration allows each party to avoid the domestic courts of the other) and ease of enforcement (foreign awards can be easier to enforce than foreign court decisions). Many organizations around the world provide arbitration services. Each arbitration association has its own rules of practice and procedure, but most are similar. For example, most arbitration rules provide that each party to a dispute choose one arbitrator, and that the two chosen arbitrators elect a third “neutral” arbitrator with the result decided by a majority (two out of three). In an agreement to arbitrate, the parties have broad power to agree on many significant aspects of the arbitration. At a minimum, the arbitration agreement should contain these elements:

1.An agreement to arbitrate 2.The name of an arbitration organization to administer the arbitration. The

International Chamber of Commerce (Paris), the American Arbitration

Association (New York), and the Arbitration Institute of the Stockholm Chamber of Commerce (Sweden) are three such prominent institutions 3.The rules that will govern the arbitration, and the law that will govern procedural issues or the merits of the dispute 4.The location where the arbitration will be conducted, which may be a “neutral” site 5.Any limitations on the selection of arbitrators, for example, the exclusion of nationals from the countries of the disputing parties 6.The language in which the arbitration proceedings will be conducted 7.The effect of the arbitration decision—binding or nonbinding—on the parties

COLLECTING AFTER AN AWARD Enforcement of arbitration awards is more common than enforcement of court judgments, and most arbitration awards are not reviewed by foreign courts, unlike court judgments from other countries, which are carefully scrutinized. Most countries are now recognizing and enforcing domestic arbitration awards and many will allow cross-border enforcement of awards made in other countries. For example, more than eighty countries have ratified the UN Convention on the

Recognition and Enforcement of Foreign Arbitral Awards. However, a foreign award that violates a country’s laws or public policy is not likely to be recognized or enforced anywhere. Therefore, be aware of the rules governing such matters in both your and your counterpart’s country.