Chapter 8.

Key Transactional Aspects of Business Operations

8.1. Contract Law and Commercial Law
Contract law is a basic element of any legal system. The legal enforceability of certain promises forms the backbone of an economy. There are several key aspects of contract law in general: formation of contracts; validity of contracts; interpretation of contracts; performance, non-performance and termination; remedies for breach of contract. Also, there are some special features of the laws governing commercial contracts such as contracts for the sale of goods and services.

8.1.1. Contract Formation

In most legal systems and in recent multilateral agreements dealing with contract law principles, the formation of a contract requires two elements: an offer and an acceptance of that offer. For example, Mr. Smith says to Mr. Rogers I will sell you this book for 50 dollars and if Mr. Rogers replies to Mr. Smith I accept your offer, then a contract is formed. However, in many cases two people will not speak this way. They will not make their offer and acceptance so obvious. Therefore, rules have been developed to determine when the behavior of one person constitutes an acceptance. In general, an offer has been made if one person indicates to another, with a reasonable degree of clarity, either by spoken or written words or by behavior, that he or she is willing to enter into a binding agreement that requires to do a particular thing in return for another one that will be done by another person. Thus, an offer has almost certainly been made if Mr. smith, while wearing a venders permit and standing at a booth marked Books for Sale, holds up a book to Mr. Rogers as he walks by and says 50 dollars? and shows a questioning look in his eyes. Unless a reasonable person would know that Mr. Smith is just joking and that no offer was intended, an offer has been made.

It is easy to imagine cases, in which reasonable people might have different interpretations of Mr. Smith behavior. If he were not standing at a book selling booth but instead he were engaged in a conversation with Mr. Rogers while walking down the street and he might hold up a book and say 50 dollars? as an abbreviated way of saying any number of different things: Can you believe I spent 50 dollars on this book? or Do you think I should sell this book to my neighbor for 50 dollars? or something else. In such case, it will be difficult to determine whether an offer has been made or not. Similar rules apply to the acceptance. In general, an offer has been accepted if the person to whom the offer has been made (the offeree) has indicated to the person making the offer (the offeror), with a reasonable degree of clarity, either by spoken or written words of by behavior, that the offeree is willing to do the thing requested by the offer. Thus, Mr. Rogers can accept an offer made by Mr. Smith by using several means by saying OK or by moving his head or hands signaling that he is willing to pay 50 dollars for the book. However, it is not completely clear sometimes whether an acceptance has been made. In such a case it must be decided by application of legal procedures. A court will usually examine all the circumstances closely to see how the general rule stated above should apply in a particular case. Detailed rules often exist regarding things such as: duration of an offer (how long it is valid for a person to accept it); withdrawal of an offer (when an offer, once made, can be withdrawn) or of an acceptance; the degree in which an acceptance must match the terms of an offer in order for a contract to be formed and the effect of rejection of an offer. These rules vary from one legal system to another and they often vary depending on whether the contract is for the commercial sale of goods or another kind of contract (a contract for providing services, a contract for the sale of land etc.). In many legal systems, particularly those influenced by English common law, another element called consideration must be shown to exist before a contract is formed. In English law, consideration is anything of value (item or service) which each party to a contract must agree to exchange. In other words, a contract must be met with or supported by consideration in order to be enforceable.

The rules in US law are closely related but slightly different. In that system, consideration is something done or promised in return for a contractual promise. In order for a contract to be binding (consideration shown), three elements must exist: there must be a bargain regarding the terms of an exchange; there must be a mutual exchange; the exchange must be of something having a certain value. The consideration procedure is quite complicated. Thus, it is absent from many legal systems.

8.1.2. Contract Validity

If an offer has been made and accepted, then a contract exists. Often, the law requires that a contract, once made, must be performed in accordance with its terms. However, this general rule is subject to exceptions. A contract is not valid and therefore not fully binding, if one of the parties did not have the proper legal capacity to enter such a contract. Specific legal rules usually govern what persons can have legal capacity. These rules are designed to protect different groups of people whose maturity or mental abilities are considered inadequate to require them to be bound by contractual promises that they make. Similarly, a contract is not enforceable if there has been some serious misrepresentation associated with its conclusion. For example, if Mr. Smith wanting to sell a house to Mr. Rogers hides from him the fact that the roof leaks and tells him that that everything is fine and Mr. Rogers accepts the deal and finds out after that that there is a problem with the roof, he will not be required to pay the purchase price. Also, a contract may be declared unenforceable if duress was involved in the contract formation. Duress refers to the situations, in which persons could be forced to enter into a contract, meaning unwillingly. For example, physical or physiological violence exerted over an individual in order to determine him or her to enter a contract will nullify such a contract. In some cases, a contract will not be enforced if, at the time it was concluded, its terms were so unfair as to make it unconscionable (in whole or in part) to hold one party to the agreement. 3

The fundamental principle on which contract law is based is the freedom of contract, meaning that persons are free to enter whatever agreement they want. Therefore, in many legal systems, the authority of the court to declare a contract unenforceable on account of unconscionability will be very limited. However, modern economic life involves many situations in which the bargaining power between the parties is unequal, leading to great temptation on the part of some contracting parties to impose bargains on weaker parties, agreements that are unfair in every aspect. Thus, the freedom of contract doctrine should be completed by rules that will safeguard the rights and obligation generated by a contract.

8.1.3. Contract Interpretation

Many contracts are made without much formality or attention to detail. People enter into hundreds of contracts in a year buying groceries, taking a taxi etc. Most of those contracts are unwritten. Sometimes, even when written, a contract can never specify precisely what every term means and how it is to be construed in every conceivable circumstance. As a result, questions sometimes arise about what the parties agreed to or what they should be deemed to have agreed to. In short, questions arise about how to interpret and apply the contract provisions. There are several theories of contract interpretation, especially in the case of written contracts. Under one theory, a judgment about how to apply a contract should be made by examining only the words of the contract itself without any regard to other evidence that might show what the parties intended in the particular circumstances that have prompted a conflict. Under another theory, a judgment about how to apply a contract should be made after reviewing not only the text of the contract but also all other relevant information, such as the behavior of the parties, including prior courses of dealing up to the time the contract was made. Under a third theory, the well-being of the parties and even the values and priorities of the community as a whole should be taken into account when interpreting and enforcing a contract.

Sometimes important terms of a contract are added by judges or through legislation. For example, this is the case of the warranty when specified terms must be added to the contracts used for the sale of goods or provision of services. Some terms of the contract are implied and they should not be specified in writing. For example, the law imposes in many legal systems a duty of good faith and fair dealing in the performance of any contract.

8.1.4. Contract Performance, Non-Performance and Termination

Once a contract is formed and it is valid, it has to be performed according to its terms as properly interpreted. What should happen if one of the parties to the contract should not perform or only performs part of the obligations that were undertaken in the contract? Special rules govern such situations. In some cases, partial performance by one party has the result of reducing the obligations of the other party. In some cases, a total non-performance by one party is excused under the doctrine of force majeure. The doctrine provides that if a circumstance that occurred in spite of the partys will (act of God) made performance impossible, the non-performance will be excused. If there is no excuse for non-performance by one party, the situation will trigger the availability of remedies to the other party to the contract. Sometimes, the non-performance gravely affects the contract and, as a result, it brings the contract to an end. Thus, a fundamental breach of contract usually relieves the other party of all obligations under the contract, giving that other party the right to sue for compensation (monetary damages). Also, the contract can be terminated by mutual consent of the parties.

8.1.5. Remedies for Breach of Contract

A fundamental breach of contract triggers the right of the non-breaching party to sue for monetary damages. This is the term used in many legal systems when referring to financial compensation owed by one party to another. The right to financial

compensations can occur in other circumstances as well when one of the parties does not fulfill the contract obligations as agreed. Detailed rules apply to the calculation of proper financial damages to be paid to the non-breaching party, especially if the non-performance caused other injury or economic loss to the other party. These rules will vary from one country to another. However, in many cases the method of calculating the financial damages is the one called expectation measure of damages. The method requires three steps: determining the financial value of the obligations that had to be performed, determining the financial loss resulted from the non-performance, awarding the sum of money resulted from the difference between the two values. In some cases, it might not be possible to use this method. Thus, another method that can be used is the method called reliance measure. Thus, the aim is to restore the injured party to the economic position that that party had at the time when the contract was formed. Another method is restitution and it is used to prevent the breaching party from being unjustly enriched. Detailed rules also govern the requirements of mitigation that is, to what extent a party to a contract should take steps to minimize the loss occurring as a result of another partys non-performance. The remedy of monetary damages is the typical remedy used by European Civil law countries. However, besides the remedy of monetary damages, another type of remedy called specific performance exists. This remedy is well-know to English common-law, as a heritage from 14th and 15th centuries. The remedy of specific performance instead of merely compensating the nonbreaching party, actually forces the breaching party to go forward with the performance of the contract even though that party does not wish to do so.

8.1.6. Commercial Contracts

Definition of commercial contracts differs among legal systems. Commercial contracts are agreements that are governed by the commercial legal rules. They are usually perceived as contracts for the sale of goods or services used by merchants. 6

However, commercial contracts encompass different other agreements such as licensing, franchising, transfer of technology contracts, consulting, mandating (representation contracts) etc. In comparison with the ordinary contracts, commercial contracts have special features that need to be addressed with special legal rules, distinct from the ones governing contracts in general. Thus, commercial rules are subject to separate laws and codes in many countries and also at international level. Property and ownership is one particular concept that is particularly addressed by commercial law. Rules governing the sale of goods usually clearly specify the point at which the ownership interests in the goods sold pass from the seller to the buyer. This is important for several reasons. One of them relates to risk: the parties need to know when the risk of loss or damage passes from the seller to the buyer. Another reason concerns the financing of a sale of goods. In some cases, the buyer will not have the money to pay for the goods and will need to obtain a loan from a bank. The bank will require the buyer to give a security interest in the goods until the buyer has repaid the loan. If the buyer fails to repay the loan, the bank will seize the goods and the situation will generate a splitting the property rights over the goods. Another special feature of commercial contracts relates to the variety of forms that sales can take. The simplest sale would involve immediate exchange of goods for the price. However, sometimes the sale of goods takes place in several installments and payment is made on each installment. More complicated than that, payment can take place on an entirely different schedule. Thus, questions can arise regarding the respective rights and duties of the parties as well as the rights of third parties involved in the transaction (e.g. the bank providing the loan for the buyer). One last issue that relates to commercial contracts refers to specific elements that must exist in order for a sale contract to be legally formed and binding. The usual terms will include: a description of the goods, the price, the quality of goods sold, the time and place of delivery and also, the time, the place and the form of the payment. These requirements are stated internationally by United Nations Convention on Contracts for the International Sales of Goods.

8.1.7. Electronic Commerce

The technological revolution dramatically influenced commercial activities. Many business and individuals use computers and other electronic equipment to transmit messages, to place orders, to conduct financial transactions. Thus, the law needs to keep up with these changes. However, the law fails to do so. There are theoretical and conceptual difficulties posed by the recent development of electronic commerce. Also, there are numerous practical difficulties in applying specific, traditional rules of contract law to electronic commerce. For example, many national laws require that the contracts should be in writing in order to be enforceable. Many times however, electronic commerce is not documented in any physical document. Also, there are national rules that require that certain contracts must be signed in order to be enforceable. At the international level, UNICITRAL (the United Nations Commission on International Trade Law) approved in 1996 a Model Law on Electronic Commerce that can be adopted by nations. In addition to UNICITRAL initiative, the International Chamber of Commerce (ICC) has also promulgated a set of legal principles for digital signatures, known as the General Usage of International Digitally Ensured Commerce (GUIDEC). This set of rules can be regarded as an improvement on the UNICITRAL model law because it provides more detail. More recently, the 2005 United Nations Convention on the Use of Electronic Communications in International Contracts is designed to enhance legal certainty and commercial predictability in cases where electronic communications are used in international transactions. However, until today, the treaty has relatively few parties.

8.2. Resolution of Commercial Disputes

Several key provisions need to be included in commercial sales contracts. Dispute resolution is not one of them but it is often needed in order to solve potential conflicts that might arise under the contract.

Dispute resolution provisions are especially important in international commercial contracts, that is, contracts for the international sales of goods. Most transactions gave birth to an international commercial arbitration system that originated in medieval Western Europe during the growth of the mercantile trade between nation-states. The reasons for commercial dispute resolution have remained the same for centuries and they mainly try to: handle disagreements between parties, preferably in a less formal and sometimes less expensive way than that provided by applicable procedures in a court of law; choose a neutral forum to solve the dispute; obtain a ruling against the losing party that can be enforced both nationally and internationally; provide flexibility and confidentiality to the proceedings.

4.2.1. Choice of Law, Forum and Procedures

Three closely related topics bear on dispute resolution and on the drafting of appropriate contractual provisions. The first is choice of law. The general trend is to permit parties to choose the set of legal rules that will govern their contractual relation. This is particularly important if the parties are coming from different countries. The second related topic is choice of forum. This refers to the court or other adjudicative body to which any dispute is to be submitted. This provision is of vital importance in the case of international sales of goods or other type of contracts that have an extraneous element. The third issue concerns alternative dispute resolution. In most countries, the parties may choose to handle disputes through commercial arbitration or other means of dispute resolution that are less formal and less public than the court system usually is. The full range of alternative dispute resolution procedures available in sales contracts includes the following: commercial arbitration, conciliation, mediation, negotiation. These terms and concepts differ from one country and language to the next. Here is one set of commonly accepted definitions of these four procedures:

arbitration

a procedure that is similar to public, formal litigation but that is handled largely outside the court system and thus it is subject to much greater input by the parties as to the identity of the arbitrators; the rules the arbitrators should use in determining the rights and obligations of the parties; the procedures that the arbitrators should follow in coming to a decision and announcing it; the language and the location where the arbitral proceedings will take place

conciliation

a procedure that is more informal than arbitration or litigation and that involves a person (conciliator) who reviews the claims of both parties to a dispute and offers solutions that will focus on the repair of the damage and not on the allocation of the blame a go-between procedure in which a person acts as a vehicle for communication between the parties, so that their differing views on the dispute can be understood and reconciled, the parties will be responsible for their reconciliation and not the intermediary person

mediation

negotiation

direct discussion between the parties without the involvement of a third party with the hope that the business decision makers can resolve the dispute without any formal or external proceedings

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