Discuss about the Case Study for International Commercial Law for Convention Deals.
It is regardless to say that the very nature of future is uncertain. When there exists long term contracts between the parties, there may be situations where prices are suddenly increasing, inflating rising and thereby performance becoming onerous due to changing economic conditions around the globe. However, all such conditions are required to be foreseen by the parties. Contracts can be framed in such a manner by giving provision for the future uncertainties, like by fixing the price and defining performance. Thus, only except of unforeseen situations, the contract shall yield and guarantee performance.
One of the paramount features in law of contract is most considerably, the sanctity of contract. The Latin phrase clearly says that the contract must be respected. Parties are mandated to adhere and abide by the terms of the contract agreed between them, as a matter of principle. Thus, this explains the reason as to why international sales remain unaffected by economic hardship as per the Vienna Convention on International Sales[1].
Under international law, it has become a rule for the arbitrators to consider the terms of contract agreed between the parties as supreme. The contract terms are mandated to be respected by the arbitrator as stated under the Arbitration treaty law[2], arbitration rules[3] and arbitration statutes[4]. Further, the sanctity of contract principle has also been confirmed by the arbitrators.
This main objective of this paper is to critically evaluate the statement “[…] the principle of sanctity of contracts (pacta sunt servanda) as the leading maxim of contract law generally has priority over changes in the surrounding economic conditions.”[5] For this purpose, the paper has been divided into various sections. The first section deals with the principle of sanctity of contract and seeks to analyze the principle in detail with respect to case laws. The second section deals with a principle, which stands contract to that of sanctity, which is flexibility of contract and also examines the grounds for defending the principle of flexibility. In further sections, the paper seeks to examine the interaction between changed circumstances and sanctity of contract and thus focuses on hardship clause, which is provided as a remedy for any change in circumstances. In the last sections, the main discussion shall be regarding the remedies, which the arbitrators or parties may avail in regards to changed circumstances.
Pacta sunt servanda is a Latin phrase, which in English means that the pact or the agreement must be respected. It is a basic principle of civil and international law, which governs contractual relationship between parties. Article 26 of the Vienna Convention on the Law of Treaties also provides for the principle of pacta sunt servanda and states that “every treaty in force is binding upon the parties to it and must be performed by them in good faith”.
In west, two significant principles, namely, ‘pacta sunt servanda’ and ‘the contract is the law of the parties’ protects the fundamental right relating to conclusion of contract between the parties. It is important for the parties to abide by the agreement in all the circumstances. These principles of contract law are not only applicable to contracts governing private persons but also governing state parties. These principles are recognized are eminent rules of private law, which govern the aspects of agreement between the parties and also as rules of law of treaties, which govern the aspects of arbitration among states.[6]
Analysis of various commercial arbitration cases show that in addition to the legal issues raised before the arbitral tribunal, the objective of discussion between the parties is to establish the primacy of the principle of sanctity in commercial arbitration contracts over principle of flexibility as followed in the Western culture.
The tribunal while giving Sapphire[7] award stated that the principle of sanctity is fundamental principle, which the international courts constantly proclaim by holding that it is pertinent to respect every contractual obligation undertaken by the party. Further, the rule of ‘pacta sunt servanda’ governs the basis of each and every contractual relationship in the private international law. [8]
Earlier award of Aramco[9] and of Sapphire were referred in the Topco’s case[10] and it was states that international jurisdiction has never doubted on the existence and implementation of the rule of pacta sunt servanda in international law and thus this maximum must be viewed as a fundamental principle governing the international law. Further, the sole arbitrator in the case of Liamco[11], upheld this principle by stating that international law and practice have widely accepted that unilateral termination of contract is survived by the arbitration clause, which is inserted in the agreement by the parties and this clause continues even after the contract terminates. [12]
The principle of sanctity of contract found its application to equal parties but jurists and scholars have extended the applicability of this principle of the contracts governing relations of states as well as private persons. The principle has been integrated and well extended to the international commercial arbitration contracts. Such contracts are now considered binding on the parties and none of the parties have the right to abrogate, modify or nullify the contract unilaterally.[13]
It has been observed above that the principle of sanctity is well observed by the international law. However, scholars have countered the aspects of absolute sanctity while stressing on the requirement of brining flexibility in terms of legal implications and performance of international commercial contracts. They have generally pointed out on the very nature of such contracts, which influences the scope of national economic development and governmental functions. Most common arguments raised and their respective defenses and discussions in respect of flexibility of the contract principle of sanctity in international commercial arbitration have been analyzed in the sections below:
To defend the flexibility contract principle it has been argued that in reference to international commercial contracts relating to natural resources, these are closely associated with economic development and are underlying instruments of public policy. Thus, in such contracts of natural resources various countries cannot bind themselves in regards to economic welfare of the country since the relationship formed under the contract might derogate with time and affect welfare. Thus, for contracts relating to public interest or welfare, it is pertinent to ensure flexibility principle in application.
Another argument that defends the principle of flexibility, states that international contracts should not be governed by the public international law rather the law of the host state. Since, individuals were not considered subjects of international law; therefore it was valid to deny the status of international to commercial contracts. This argument was raised in the Anglo-Iranian Oil Company Case by The Permanent Court of International Justice.[14]
However, the above argument was countered[15] by stating the view that if state contracts are modified or abrogated, then that shall refer to breach of the international law. It was further stated that the doctrine of flexibility has a fundamental error, which would have been removed if the lawyers of public international law would have give due regard and significance to the teachings, character and role of private international law. In cases where there is no scope for any problem to arise under the customary public international law, it is not possible for any breach of contract to factually occur and thus the principle of pacta sunt servanda goes un-infringed. The private international law of the respective forum governs the contracts. Such law not only has the power to sustain the contract but also modify or abrogate the contractual bond in its entirety.
To defend the principle of flexibility, it has been argued that if pacta sunt servanda being the principle of public international law applies to international contract then there are other principles of international law, particular the principles of changed circumstances, which comprise of expectations to the former principle. Principle of changed circumstances as defined under Article 62 of the Vienna Convention on the Law of Treaties as clausal rebus sic stantibus¸ states that in regards to the inter-state agreements, there is not absoluteness in the principle of sanctity of contract. [16]
Various international jurists have the view that the principle of changed circumstances can be considered as an exception or reservation to the principle of pacta sunt servanda in international law. This view of jurists has now come to be accepted generally in the international law.
Parties may agree to implement a hardship clause in their agreement, when there are any chances that future situations may change. Some of the hardship clauses state that the on occurrence of certain specified situation or circumstance, the contract shall be terminated. However, there are other clauses also, namely the price revision clause or the indexation clause, which state that in change of circumstances even the terms of contract shall change. Further, clauses like that of adaptation clause provide that the parties are ordered to adapt to new circumstances as per the contract terms.
Various authors have argued that hardship clause in a contract pertaining to long-term relations between the parties must be dealt like a custom. In other words, such a clause of hardship must be implied in long term contracts even when not expressly agreed to between the parties. However, if in contractual terms, parties specifically include a clause of hardship, it shall help in proving that no such general customary principle relating to hardship clause exists.[17] Further, the scope and implication of hardship clause varies in various types of such clauses. The application, scope and remedy of each of hardship clauses are different and thus a customary principle cannot be easily based on such varied and diverse hardship clause. Considering this situation, arbitrators have refused to consider hardship clause as customary in long term contracts rather they have focused on strict interpretation of such clauses as per the facts and circumstance of each case. This means that if there is a clause in the contract that mentions specific changes then such clause must be interpreted in a manner that no other change could be considered or taken into account while dealing with the contract.
However, it cannot be said that mere presence of hardship clause shall exclude the entire application of general law relating to changed circumstances. This is so because it is almost impossible for the parties to negotiate and thereafter draft such hardship clause that is capable of covering all possible effects from which performance is likely to be affected. Thus, such changes which cannot be covered under the hardship clause may be applied by integrating the general law on changed circumstances. The arbitrators in the Arbitration Court of the Japan Shipping Exchange[18] stated as follows while recognizing this principle:
“The relation between this Article (renegotiation clause) and the principle of change in situation is such that the present article does not exclude the said principle, but provides for either one of the parties to request the other for consultation to amend the price, even in the instances where the principle of the change in situation does not need to be applied.”
Thus, in case of special circumstances, parties may instruct the tribunal to consider such circumstances that have changed post the dispute between the parties. The Iran-US Claims Tribunal [19]also stated that it is the very duty of the tribunal to consider and taking into account any change in circumstances between the contracting parties.
Most national legal systems have a rule that the binding force of the contract may get affected due to change circumstances. The maximum ‘rebus sic stantibus: when things remain same even the contract remains binding’, ensures possibility of such situations.
Restricted interpretation of the maxim rebus sic stantibus shall be done to limit the huge scope of its analysis. Such expressed contractual terms are excluded that could not be satisfied, like changes relating to failure to perform as per the contractual conditions. Also, the act of God or Force Majeure, is excluded, since it makes the performance of contract completely impossible[20]. The main of this paper shall be to consider and analyze such changes, which make the performance erroneous rather than impossible.
Various legal systems have incorporated the principle of rebus sic stantibus and it is also an important principle of international law. Even the judges of Iran-US Claim Tribunal recognized this principle under the Vienna Convention. Further, the judges stated that with wide implementation of this principle in the national legal systems, it shall not be unreasonable to regard it as a general principle of law.[21]
International treaty law defines the principle of Rebus sic stantibus. The Vienna Convention on the law of treaties, 1969 in its Article 62 defines and explains this principle of rebus sic stantibus. The Article 62 states as follows:
“A fundamental change of circumstances which has occurred with regard to those existing at the time of the conclusion of a treaty, and which was not foreseen by the parties, may not be invoked as a ground for terminating or withdrawing from the treaty unless: (a) the existence of those circumstances constituted an essential basis of the consent of the parties to be bound by the treaty; and (b) the effect of the change is radically to transform the extent of the obligations still to be performed under the treaty.”
The exception nature of this rebus sic stantibus has been demonstrated by the wording of Article 62. It ensures that this principle is considered subordinate to that of pacta sunt servanda and the same has been clearly stated under Article 26 of the Vienna Convention.
It is pertinent for the change in circumstances to be fundamental in nature. The change must be such that the survival of State has been jeopardized entirely. Change cannot be in nature of mere currency reforms or loss in matters of economic interest. In the case of Fisheries Jurisdiction[22], the International Court stated that change must be vital in nature: it should be such that it imperils or prevents the vital development or existence of either of the parties. Further, the change should be such that none of the parties to the contract could reasonable foresee the same.
However, it must be noted that even when the principle of rebus sic stantibus is indentified as a rule of international law by arbitrators and invoked by various parties, relief on such ground has not been granted to the parties. Tribunals and even the International Court of Justice have refused to consider the principle of rebus sic stantibus as a treaty.[23]
Performance when circumstances of contract change are excused under English Law, as per the doctrine of “frustration of purpose”. However, the party who demands excuse in performance under this doctrine must prove that the circumstances have changed radically due to which the performance undertaken as per the contract could not be fulfilled. But, the English judges have shown reluctance in implementing this doctrine to state that the contract has been frustrated.[24]
In regards to international arbitration, implementation and impact of rebus sic stantibus has not been explored. Generally, arbitrators have been strict in implementing this principle to international contracts. Further, arbitrators have concluded that in any case where the mutual convent ants become impossible to perform, the contract shall be rendered impossible. This vitiates the very essence of contract.
Thus, in only handful of cases, this doctrine has been actually implemented into the legal scenario relating to change in circumstances. Rather, arbitrators and tribunals have relied on renegotiation between parties in case of change in circumstances as an effective remedy to such problem. Such renegotiation may be included as a part of contract and state that parties may renegotiate in case of any change in circumstances.[25] Also, on successful renegotiations, rearrangement of contractual relationship may be done. However, it is equally important to identify the situation if such renegotiation fails. The clause dealing with renegotiation must be framed in such a manner that it provides solution to all possible situations.
Conclusion
The above analysis has critically discussed various aspects of the principle of sanctity of contracts. In international contracts, arbitration is the remedy to solve disputes between the parties. Thus, it is important to understand various complexities and rules of international law, which are considered by the arbitrators, tribunals and international courts.
The principle of sanctity of contract or pacta sunt servanda states that the parties must serve the agreement or must fulfill the agreement, which leads to contractual relationship. In other words, it can be stated that the parties in no way can derogate from the agreement and ensure every action with the objective to fulfill contractual obligations agreed. It can be analyzed that this principle is a leading maxim under contract of law, which is also agreed by the arbitrators and used while dealing with international law.
However, it is needless to say that parties under contract may face change in situations, due to which performance of contract gets affected. From the above discussion, it can be concluded that even when arbitrators have accepted the principle of rebus sic stantibus under international law, it has not been implemented into practical situations dealing with contracts. This principle is also considered as subordinate to pacta sunt servanda. Since, it imposes an obligation on the parties to perform. Further, as a remedy to changed circumstances, arbitrators have opted for the remedy of renegotiation between the parties. This remedy also seeks to fulfill the objective of pacta sunt servanda because it holds that in change of circumstances, parties may renegotiate to new agreement but must fulfill their obligations as per the agreement. Thus, it can be finally concluded that principle of sanctity of contract is the leading principle of contract law and is given priority even in change of circumstances or over the principle of flexibility of contract.
References
Article 79 of the Vienna Convention deals with force majeure, excludes “economic hardship”.
European Convention on International Commercial Arbitration, 1961, Article VII.
C.C. Arbitration Rules, Article 13.5; UNCITRAL Rules, Article 33.3.
UNCITRAL Model Law, Article 28(4) already incorporated in many countries.
Klaus Peter Berger, ‘Renegotiation and Adaption of International Investment Contracts: The Role of Contract Drafters and Arbitrators’, Vanderbilt Journal of Transnational Law, (2003) 36, 1347, 1353.
Hamid Reza Nikbakht Fini, State Contract and Abitration, (1990, unpublished thesis, p. 26)
Sapphire Int’l Petroleums Ltd. v National Iranian Oil Co.,[1967].
George R. Delaume, ‘State Contract and Transnational Arbitration’, The American Journal of International Law. (1981) 75, 11.
Arabia v Arabian American Oil Company (Aramco), 27 I.L.R. 117, 168 (1958).
Texaco Overseas Petroleum Co. v Libya (Topco/Calasiatic Case), 53 I.L.R. 389 (1977).
Libyan American Oil Company (LIAMCO) v Government of the Libyan Arab Republic, 17 I.L.M. 3 (1978).
Doak Bishop, “International arbitration of Petroleum Disputes: the development of a ‘Lex Petrolea’”, Cepmlp Journal, (2000).
Wehberg, “Pacta sunt Servanda”, American Journal of International Law, 1959, p.775; J. F. Lalive, “Contracts Between a State or a State agency and a Foreign company”, 13 International and Comparative Law Quarterly, 1964, p.987 Oxford Journal vol. 13 No. 3.
Bing B. Tia, ‘The regime of straits in international law’, Oxford University Press, (1998).
A. Mann, ‘England Rejects Delocalised Contract and Arbitration’, International and Comparative Law Quarterly, (1983) vol. 33. p. 194-195.
Geiger, ‘The Unilateral Changes of Economic Development Agreements’, International and Comparative Law Quarterly, (1974), p. 100.
C.C. award No. 5953 (1989), J.D.I., 1990, 1056 at 1059.
Arbitration Court of the Japan Shipping Exchange, award September 20, 1975, Yb. Comm. Arb., 153 at 154.
Questech decision 9 Iran-US C.T.R., 122-123.
Court of Arbitration at the Polish Chamber of Foreign Trade, award February 11, 1958, Comm. Arb., 1981, 147 at 148.
Questechdecision, 9 Iran – US C.T.R., 122-123.
International Court of Justice, Fisheries Jurisdiction case, ICJ Reports, 1973, 4 at 20.
Yearbook ILC, 1963, II, 208; Yearbook ILC, 1966, II, 257; R. VAN MEHREN and P. KOURIDES, “International arbitrations between state and foreign private parties: the Libyan nationalisation cases”, J.I.L., 1981, 475 at 532.
Lauritzen A.S. v. Wijsmuller B.V., “The Super Servant Two”, 1 Lloyd’s Rep., 1990, 1.
C.C. award No. 4761 (1987), J.D.I., 1987, 1012.
[1] Article 79 of the Vienna Convention deals with force majeure, excludes “economic hardship”.
[2] European Convention on International Commercial Arbitration, 1961, Article VII.
[3] Eg: I.C.C. Arbitration Rules, Article 13.5; UNCITRAL Rules, Article 33.3.
[4] Eg. UNCITRAL Model Law, Article 28(4) already incorporated in many countries.
[5] Klaus Peter Berger, ‘Renegotiation and Adaption of International Investment Contracts: The Role of Contract Drafters and Arbitrators’, Vanderbilt Journal of Transnational Law, (2003) 36, 1347, 1353.
[6] Hamid Reza Nikbakht Fini, State Contract and Abitration, (1990, unpublished thesis, p. 26)
[7] Sapphire Int’l Petroleums Ltd. v National Iranian Oil Co.,[1967].
[8] George R. Delaume, ‘State Contract and Transnational Arbitration’, The American Journal of International Law. (1981) 75, 11.
[9] Arabia v Arabian American Oil Company (Aramco), 27 I.L.R. 117, 168 (1958).
[10] Texaco Overseas Petroleum Co. v Libya (Topco/Calasiatic Case), 53 I.L.R. 389 (1977).
[11] Libyan American Oil Company (LIAMCO) v Government of the Libyan Arab Republic, 17 I.L.M. 3 (1978).
[12] R. Doak Bishop, “International arbitration of Petroleum Disputes: the development of a ‘Lex Petrolea’”, Cepmlp Journal, (2000).
[13] H. Wehberg, “Pacta sunt Servanda”, American Journal of International Law, 1959, p.775; J. F. Lalive, “Contracts Between a State or a State agency and a Foreign company”, 13 International and Comparative Law Quarterly, 1964, p.987 Oxford Journal vol. 13 No. 3.
[14] Bing B. Tia, ‘The regime of straits in international law’, Oxford University Press, (1998).
[15] F. A. Mann, ‘England Rejects Delocalised Contract and Arbitration’, International and Comparative Law Quarterly, (1983) vol. 33. p. 194-195.
[16] R. Geiger, ‘The Unilateral Changes of Economic Development Agreements’, International and Comparative Law Quarterly, (1974), p. 100.
[17] I.C.C. award No. 5953 (1989), J.D.I., 1990, 1056 at 1059.
[18] Arbitration Court of the Japan Shipping Exchange, award September 20, 1975, Yb. Comm. Arb., 153 at 154.
[19] Questech decision 9 Iran-US C.T.R., 122-123.
[20] However arbitrators sometimes bring the former also under the heading of “changed circumstances – rebus sic stantibus”. E.g. Court of Arbitration at the Polish Chamber of Foreign Trade, award February 11, 1958, Yb. Comm. Arb., 1981, 147 at 148.
[21] Questech decision, 9 Iran – US C.T.R., 122-123.
[22] International Court of Justice, Fisheries Jurisdiction case, ICJ Reports, 1973, 4 at 20.
[23] Yearbook ILC, 1963, II, 208; Yearbook ILC, 1966, II, 257; R. VAN MEHREN and P. KOURIDES, “International arbitrations between state and foreign private parties: the Libyan nationalisation cases”, A.J.I.L., 1981, 475 at 532.
[24] J. Lauritzen A.S. v. Wijsmuller B.V., “The Super Servant Two”, 1 Lloyd’s Rep., 1990, 1.
[25] I.C.C. award No. 4761 (1987) , J.D.I., 1987, 1012.
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