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Tokyo, September 2008 Draft

HANS NIEUWENHUIS1

THREE PILLARS OF CONTRACT LAW

Dejima: Japanese merchants bidding on goods offered for sale by the Dutch Nagasaki Museum of History and Culture

Some years ago, when I was eighteen, I read the following story. I must confess, I did not read it of my own free will; I had to read it at school, and not in Dutch or English but in the original Greek version, the Greek written in the fifth century BC. When I was eighteen you could not enter University as a law student unless you had studied ancient Greek for at least five years. The story is told by Herodotus, the Father of History: ‘The Carthaginians also tell us that they trade with a race of men who live in a part of Libya beyond the Pillars of Heracles. On reaching this country, they unload their goods, arrange them tidily along the beach, and then, returning to their boats, raise a smoke. Seeing the smoke, the natives come down to the beach, place on the ground a certain quantity of gold in exchange for the goods, and go off again to a distance. The Carthaginians then come ashore and take a look at the gold; and if they think it represents a fair price for their wares, they collect it and go away; if, on the other hand, it seems too little, they go back aboard and 1

Hans Nieuwenhuis is professor of private law at Leiden University ([email protected]). His main topics are Contract and Tort law.

2 wait, and the natives come and add to the gold until they are satisfied. There is perfect honesty on both sides; the Carthaginians never touch the gold until it equals in value what they have offered for sale, and the natives never touch the goods until the gold have been taken away.’2

Why am I telling you this old story? So much has changed; Carthago, in present-day Tunisia, was destroyed by the Romans. The Pillars of Heracles got a new, Arabic, name: the strait of Gibraltar. And the place where the natives put their gold on the beach would nowadays be somewhere in Ghana. I am retelling the tale told by Herodotus because it is still the best introduction to modern contract law. Beyond the pillars of Heracles it leads us to the everlasting pillars of contract law: autonomy, fairness and good faith. Autonomy; both Carthaginians and natives are free to make contracts like these. They both consider the exchange a non-zero-sum game. The Carthaginians prefer the precious gold to the goods they have available in abundance (probably purple cloth). The natives rather have the purple cloth than the yellow metal which they can collect freely from the riverbed a few miles upstream. Free trade has always had a serious competitor: slavery, the ultimate denial of autonomy. During the 17th and 18th centuries Dutch merchants made huge profits by shipping from the same spot where Carthaginians and natives exchanged gold and purple cloth thousands of slaves (‘black gold’) to America. One slave-boy, Jacobus Capitein, they set free, trained him as a theologian at Leiden University and had him write a Phdthesis proving that slavery does not violate the Christian religion.3 Fairness; ‘the Carthaginians then come ashore and take a look at the gold; and if they think it represents a fair price for their wares, they collect it and go away.’ A fair price; the Greek text has ‘axios’ (‘weighing as much as’). Does the gold counterbalance the cloth? It is important to note that it is the parties themselves who are to decide whether the price is fair (‘if they think it represents a fair price…’). Good faith; ‘there is perfect honesty on both sides.’ Translated somewhat more literally: none of the parties acts unlawfully (adikeein). A very early recognition of the fact that there can be law (and hence unlawfulness) among people who are strangers to each other. Contract and contract law are without any doubt the best means to create nonzero-sums. Whereas Tort Law is the Art of making your own loss, the loss of someone else, Contract Law is the Art of two persons making both a profit. Moreover, contract law is that part of the law which is most easily understood by lawyers and non-lawyers alike. People who do not understand one word of Latin, immediately grasp the importance of pacta sunt servanda, the binding force of contracts. In other areas of the law the situation is quite different. How do you transfer ownership of a slave? Few people would answer: no problem, by means of a mancipatio; you only need five witnesses, a balance and a copper coin. Contract law is the indispensable instrument to facilitate free trade, the free movement of goods, services and capital. In this respect the difference between systems of contract law is a nuisance; it increases transaction costs. What am I willing to pay for the fact that Dutch law will apply to the contract, instead of Italian law with which I am unfamiliar. If Italy and The Netherlands would have the same contract law, these costs 2

Herodotus, The Histories, Book IV, 196; translated by Aubry de Sélincourt. Jacobus Capitein, Dissertatio politico-theologica de servitute, libertati christianae non contraria, Leiden 1742, [UBL 238 E 4:55]. 3

3 would disappear. The advantages of unifying the law are much greater in contract law than, for instance, in family law. If The Netherlands and Italy would have the same law on divorce, the costs of divorcing your Italian wife would still be considerable. It stands to reason that in the European Union with its internal market comprising ‘an area without internal frontiers in which goods, persons, services and capital move freely’ the need for harmonizing contract law is keenly felt. The European Commission has in its Action plan: A More Coherent European Contract Law 4 stressed the importance of the first pillar (party autonomy): ‘Contractual freedom should be the guiding principle; restrictions should only be foreseen where this could be justified with good reasons.’5

The Action Plan almost immediately provoked a reaction from a Study Group chaired by Martijn Hesselink (Amsterdam University). The Group has countered with a Manifesto: Social Justice in European Contract Law emphasizing the need for strengthening the second pillar (fairness): ‘First, at bottom, there is the issue of fairness or social justice. The chosen market order has to embrace and protect a distributive pattern of outcomes that ensures fair treatment for every European citizen, and guarantees that the rules of the market system do not permit exploitation and social exclusion.’6 Today, I would like to discuss some Model Rules of European Contract Law contained in the Draft Common Frame of Reference (DCFR) published at the beginning of this year. These Model Rules were drafted by two groups of scholars coming from a very wide range of European countries, not only countries having a Civil Code (such as Germany, Austria, Italy, Spain, Portugal, France, Belgium and The Netherlands), but also from Common Law countries (United Kingdom and Ireland). The two groups are: a. the Study Group on a European Civil Code, and b. the Research Group on EC Private Law. According to both groups ‘the DCFR is intended to help (…) in drafting any future EU legislation in the field of private law.’7 How does the DCFR deal with the three pillars: autonomy, fairness and good faith? All three appear at once in Article II. – 1:102 under the bold caption Party autonomy: ‘Parties are free to make a contract (…) and to determine its contents, subject to the rules on good faith and fair dealing and any other applicable mandatory rules.’

Article II. – 3:301 continues in the same vein: ‘Negotiations contrary to good faith and fair dealing (1) A person is free to negotiate and is not liable for failure to reach an agreement. (2) A person who is engaged in negotiations has a duty to negotiate in accordance with good faith and fair dealing. This duty may not be excluded or limited by contract.’

4

See the European Commission’s ‘Action Plan on a More Coherent European Contract Law’ of January 2003; COM (2003) final, OJ C 63/1. 5 Brussel 12.2.2003 COM (2003) 68 final, para 62. 6 European Law Journal, Vol. 10, No. 6, November 2004, p. 664. 7 Christian von Bar et al. (editors), Principles, Definitions and Model Rules of European Private Law, Sellier, European law publishers, Munich 2008, p. 30.

4

All this might come as a shock to a common lawyer. He will remember the sharp words of Lord Ackner in Walford v Miles: ‘The concept of a duty to carry on negotiations in good faith is inherently repugnant to the adversarial position of the parties when involved in negotiations. Each party to the negotiations is entitled to pursue his (or her) own interest, so long as he avoids making misrepresentations.’8

Will the proper role of good faith forever remain a bone of contention dividing the United Kingdom and continental Europe? The German comparative law scholar Gunther Teubner certainly thinks so: ‘Good faith will become a strong irritation to the market-driven production regime in Britain if (…) its effect would be to outlaw certain excesses of economic action.’9

On the other hand there are those in the United Kingdom who deny that the introduction of the concept of good faith will cause a strong irritation. Listen for instance to Ewan McKendrick: ‘There are signs that the traditional English hostility towards good faith might be abating. The courts have adopted a more sympathetic stance on a number of occasions. (…) The individual bricks which could be used to create a general principle of good faith and fair dealing can already be identified.10

Good faith, bonne foi, Treu und Glauben; what is it all about? On the continent the role of good faith traditionally was tied, not to the formation of a contract, but to its performance. Prior to 1992 the Dutch Civil Code had a provision, taken from the French Code civil of 1804, which read: ‘legally concluded contracts must be performed in good faith.’11 The German Civil Code (Bürgerliches Gesetzbuch; BGB), section 242 states: ‘An obligor has a duty to perform according to the requirements of good faith, taking customary practice into consideration.’12

In both countries judge made law has broadened the scope of good faith substantially in order to include the formation of contracts. In a landmark decision the Hoge Raad (Supreme Court of The Netherlands) said: ‘Starting negotiations parties enter into a special relationship governed by good faith, requiring that they allow their actions to be determined also by the justified interests of the other party.’13

8

Walford v Miles [1992] 2 AC128 (HL). G. Teubner, Legal Irritants: Good Faith in British Law or How Unifying Law Ends Up in New Divergences, Modern Law Review, 1998, p. 11 e.v. 10 E. McKendrick, Contract Law, Houndmills 2000, p. 259 e.v. 11 Article 1134 of the French Code civil still reads: ‘les conventions légalement formées (…) doivent être executées de bonne foi’. 12 ‘Der Schuldner ist verpflichtet, die Leistung so zu bewirken, wie Treu und Glauben mit Rücksicht auf die Verkehrssitte es erfordern.’ 13 HR 15 November 1957, NJ 1958, 67; Baris/Riezenkamp. 9

5 Good faith may for instance require that a person selling a second-hand car tells the buyer that the car has been involved in a car incident, even if the buyer did not ask specific questions as to the former life of the car. The Bundesgerichtshof (Supreme Court of Germany) took a similar stance: ‘Negotiating a contract, parties have a duty, even if they pursue conflicting interests, to inform each other on those circumstances which could frustrate the purpose of the contract (…) if the other party according to generally accepted views (Verkehrsauffassung) is entitled to expect this information.’14

How wide is the gap between Lord Ackner’s standpoint that each party to the negotiations is entitled to pursue his own interest, so long as he avoids making misrepresentations and the continental view that good faith obliges you to also take into account the interests of the other party? An investigation into the possibility of bridging the Anglo-Continental divide could start from the following test case. A sells to B a mobile crane to be used in the building industry. It is a crane on wheels and it can be driven on the road in order to reach different building sites. The crucial question is: will B obtain a license to drive with this crane on the road? The request for a license was denied because the crane was too heavy and too wide. In the case decided by the Hoge Raad it had been established that A had, in good faith, told B that he would without any doubt get a license. B wants to rescind the contract. According to the Hoge Raad B was entitled to rescind the contract; the rules of good faith imply that you may trust that the statements made by the other party are correct.15 Lord Ackner might object to the lofty tone, but he would in all likelihood have no problem with the outcome. The statement made by A was a misrepresentation, a negligent or maybe even innocent misrepresentation, but nevertheless a misrepresentation. What if we change the facts slightly? Let us assume that A did not make any statement regarding the question whether a license could be obtained, but knew that B thought (wrongly) that the license would be granted. In that case there is no misrepresentation. But should the law honor the wisecrack ‘Ask me no questions; I’ll tell you no lies.’? The Draft Common Frame of Reference contains the following provision: ‘A party may avoid a contract (…) if (…) the other party (…) caused the contract to be concluded in mistake by leaving the mistaken party in error, contrary to good faith and fair dealing, when the other party knew or could reasonably be expected to have known of the mistake’ (Article II. – 7:201).

A common lawyer might frown, reading the superfluous words ‘contrary to good faith and fair dealing’, but apart from that the rule should be acceptable to him. Good faith and fair dealing; ‘Life is a tale told by an idiot, full of sound and fury, signifying nothing.’16 ‘Sound and fury’ is the standard instance of a hendiadys, a two for one; expressing one idea by two words connected with ‘and’. ‘Sound and fury’ for ‘furious sound’. Is ‘good faith and fair dealing’ a sort of hendiadys? With regard to the similar case of ‘redelijkheid en billijkheid’ (reasonableness and fairness), the concept

14

BGH 14 March 1991, BGHZ 114, 90. HR 21 januari 1966, NJ 1966, 183; Booy/Wisman. 16 Shakespeare, Macbeth, Act V, Scene V. 15

6 which in the new Dutch Civil Code took over a large part of the role of good faith, the travaux préparatoires explicitly state that ‘redelijkheid en billijkheid’ is a hendiadys.17 Why is it important to know whether ‘good faith and fair dealing’ is in fact a hendiadys? It matters because if it is, we are left with only two pillars of contract law: autonomy (both parties are free to pursue their own interest as they see fit) and solidarity (both parties must cooperate to ensure that they both get a fair deal from the contract). Such a bipolar model is rather popular among today’s contract law scholars. Chantal Mak uses the Autonomy/Solidarity Continuum as a tool to determine the gradation of autonomy and solidarity in each rule of contract law.18 This continuum is like a line connecting the North and the South pole. Where on earth is Mbandaka? Exactly halfway between the North and the South pole. The Autonomy/Solidarity Continuum can also be used to make claims regarding the direction in which contract law is developing. Thus, Jan Vranken (University of Tilburg) writes: ‘The individualistic approach of contract law has since long been superseded by reality: core of today’s contract law is the duty to take into account the justified interests of the other party.’19

Others, including myself, would challenge his assessment and maintain that party autonomy is still the core of modern contract law. If we see good faith and fair dealing, not as a hendiadys, but as two distinct pillars, we can arrange them, together with the third pillar (autonomy), in such a way that they form a triangle. Each angle provides a view at the two others. The best starting point is good faith, the do’s and don’ts of both parties. In order to answer the question what good faith requires we must invoke the help of the same role model we use in tort law to determine what constitutes negligence: the reasonable person. A person acts negligently if his conduct does not amount to such care as could be expected from a reasonably careful person in the circumstances of the case.20 To discover the requirements of good faith in contract law we have to resort to the same reasonable person. What would he have done when negotiating a contract like this? The reasonable person is guided by a double perspective: how to respect the other party’s autonomy and how to offer him the fairness he is entitled to expect. Would a reasonable person cause the sale of a mobile crane to be concluded if he knew that the other party was mistaken as to the possibility of obtaining a license? Of course not; it would violate the other party’s autonomy. He who is guided by a false impression of things that are of crucial importance to him is unable to make a free, autonomous decision. Would a reasonable seller of bicycles include in his standard contract a provision stating that the buyer is under no circumstances entitled to rescind the contract? Again, of course not. He would realize that a term like that is highly unfair because it undermines

17

Parlementaire Geschiedenis Boek 6, p. 67. Chantal Mak, Fundamental Rights in European Contract Law, Kluwer Law International 2008. p. 206. 19 J.B.M Vranken in Barendrecht et al. (editors), Beginselen van contractenrecht, Deventer 2000, p. 153. 18

20

See Article VI. – 3:102 DCFR.

7 the reciprocal (quid pro quo) character of the contract. If this type of bike proves to be inherently unsafe, the buyer must have the right to free himself of his obligation to pay. The main difference between good faith and fair dealing is that the latter relates to what constitutes a fair deal. It is the content of the contract that counts. The Dutch Civil Code has blacklisted a number of standard terms that would be voidable if they were included in a consumer contract, because their content is deemed to be unfair (the exclusion of the right to rescind the contract for instance).21 On the other hand, violating rules of good faith could easily lead to the rescission of contracts that have a perfectly fair content. Buying an excellent coin of the Roman emperor Caligula, minted in Rome in 38 AD for € 300, might be a bargain with a very fair content, but the buyer is nevertheless entitled to rescind the contract if it were established that he thought that the coin was minted in Lugdunum (Lyon, France) and the seller knew the buyer to be mistaken in this respect. Would a reasonable seller also ensure that the price he is asking is fair? Or is determining the price of the goods subjected only to the rationality of the market, the meeting place where sellers try to sell at the highest, and buyers attempt to buy at the lowest price? The latter is true, even with regard to consumer contracts. A Directive of the Council of the European Communities on Unfair Terms in Consumer Contracts explicitly states that the assessment of the unfair nature of the term shall not relate to the adequacy of the price.22 Protection of consumers against unfair prices is not a task of contract law proper; it is assigned to competition law. Forbidden are all agreements between companies to fix prices (Article 81 EEC). Koga Miyata, in spite of its Japanese sounding name, a Dutch bicycle manufacturer in Heerenveen incurred a very heavy fine imposed by the Dutch Competition Authority (NMa) because it had conspired with other manufacturers (Batavus, Gazelle and Giant) to raise the prices of their bikes.23 Some years ago, when I was sixty, I read the fascinating Autobiography of Fukuzawa Yukichi (1835-1901), founder of Keio University and honored with his portrait on every ten thousand yen bank note.

In his Autobiography Fukuzawa tells us how quickly he learned Dutch, although at first he could not believe that the 26 letters of the alphabet could ever fully represent the 21

Article 6:236. Article 4 of Council Directive 93/13/EEC. 23 NMa zaaknummer: 1615. 22

8 language. He also recounts a very instructive anecdote which is well worth quoting at some length: ‘I was reading Chambers’s book on economics. When I spoke of the book to a certain high official in the treasury bureau one day, he became much interested and wanted me to show him a translation. He said that if translating the entire book was too much, he would like to see a table of contents. I began translating it (it comprised some twenty chapters) when I came upon the word “competition” for which there was no equivalent in Japanese, and I was obliged to use an invention of my own, kyo-so, literally, “race-fight.” When the official saw my translation, he appeared much impressed. Then he said suddenly, “Here is the word ‘fight’; what does it mean? It is such an unpeaceful word.” “That is nothing new,” I replied. “That is exactly what all Japanese merchants are doing. For instance, if one merchant begins to sell things cheap, his neighbor will try to sell them even cheaper. Or if one merchant improves his merchandise to attract more buyers, another will try to take the trade from him by offering goods of still better quality. Thus all merchants ‘race and fight’ and this is the way money values are fixed. This process is termed kyo-so in the science of economics.” “I understand. But don’t you think there is too much effort in Western affairs?” “It isn’t too much effort. It is the fundamentals of the world of commerce.” “Yes, perhaps, went on the official. “I understand the idea, but that word ‘fight’ is not conducive to peace. I could not take the paper with that word to the chancellor.” I suppose he would rather have seen some such phrase as “men being kind to each other” in a book on economics.’24

That ‘certain high official’ of whom Fukuzawa makes a mouthpiece of feudal Japan, would be pleased to see that modern Contract Law does not rest solely on one pillar: kyoso (race-fight). Two other pillars: good faith and fairness lend firm support to an old idea under a new label: solidarity. It is just another word for ‘men being kind to each other.’

24

Fukuzawa Yukichi, The Autobiography, translated by Eiichi Kiyooka, Tokyo 1960, p. 190.