1. Introduction to Spanish contract law (2016)Apunte Inglés
Apuntes del profesor Carlos Gómez.
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IBE, 1st year - 3rd Term
Business law II
Introduction to Spanish contract law
CONTRACTS ...................................................................................................................... 2
Why do we need contracts? ......................................................................................... 2
Mandatory rules ........................................................................................................... 4
Paradox: aleatory view of negotiations ........................................................................ 5
BASIC INSTITUTIONS OF SPANISH CONTRACT LAW ......................................................... 7
Implied contracts .......................................................................................................... 7
Invalid contracts ........................................................................................................... 7
Private information....................................................................................................... 8
Expectations ............................................................................................................... 10
Efficient breach of contract ........................................................................................ 12
WARRANTIES IN CONSUMER SALES ............................................................................... 13
Pacta sunt servanda.................................................................................................... 13
Solutions ..................................................................................................................... 14
IBE, 1st year - 3rd Term
Business law II
In the course we’re going to deal with contacts, since they contain the rules to make
exchanges of assets possible. We will be focusing in contracts, tort and property. This
is why we will study private law.
1. Contract: deals with voluntary transfers 2. Tort (liability): deals with involuntary transfers 3. Property: deals with the protection assets They are the main field of study for us this trimester. They all refer to assets which have an economic value.
CONTRACTS Contract: Relationship between two parties that agree on something about an economic issue. So, it is an agreement with an economic interest, an agreement for exchange of assets. If there’s a lack of either agreement or exchange it’s not a contract (for example, a tort is an exchange without agreement). The sales contract is the easiest one to understand.
Why do we need contracts? Contracts have been present in all cultures since always. We need them because sources are scarce, so with them we want to ensure efficiency and trust each other.
They might be scarce because they are not available or because we have seen that it is more efficient to specialize and then exchange. Specialization wouldn’t be possible without contracts.
Contract law shouldn’t be concerned wi th outcome: we don’t care if parties are better off or not after the contract. They are mostly concerned with the exchange progress. Spanish civil code doesn’t mention the fairness of the contract to make it valid (you can pay the double of the actual price if you want to UNLESS THERE’S ABUSE In any legal system (a more or less efficient one) we want we want clear rules and contract law should have the following functions: 1. Contain opportunism1 in non simultaneous exchanges 1 Ex ante (adverse selection) and ex post (moral hazard, hold up) - see Economic Business I (Topic 4) 2 avillagrasa IBE, 1st year - 3rd Term Business law II Make possible specific investments (avoid Holdup problem) PROTECT PARTIES IN THE PROCESS When we have simultaneous exchanges everything is easier. We can think of a store, for example: if I don’t pay, I'm not going to get the asset.
Non simultaneous exchanges are more sophisticated because they allow for specification. This is why advanced economies have more complex contracts.
2. Fill in the gaps of the contracts Contracts are always incomplete. This means that we can’t include all the possible scenarios, dangers, etc. However things are clearer than without the contract. We don’t include everything because it is not rational 2 to include things that may happen in a very little probability because that would change the conditions. For example I may become insolvent and not able to pay, but if I include that probability the other party will want me to pay more HIGHER RISK = HIGHER PRICE 15.04.16 3. Reduce transaction costs It lowers the cost that the parties have to agree on to make the contract. The contract law system will reduce transaction costs if it makes it easier to make a contract. This is because in the majority of contract law systems, contract rules contained in civil codes are mostly default rules (they are not mandatory, only applied if there isn’t agreement). Parties can make the contract anyway they want and only use default rules if they can’t agree over something, thus allowing to reach the highest efficiency.
Why do we need default rules? i. They make possible to reduce the costs of bargaining.
ii. Make possible to fill in the gaps of an incomplete contract. They make contracting easier.
iii. They disclose (revelar/divulger) relevant information. This means that they we will bargain on issues that might be silent if not. Solve issues and make them clear.
Ex: What if the default rule says that I have to deliver the article to your house but that’s very costly for me? Then I can bargain/disclose.
4. Welfare-enhancing contracts // welfare reducing contracts3 The objective would be to promote welfare enhancing contracts and avoid welfare reduction. We should be better off after a contract but in reality is not 2 An action is rational as long as we are at the point where including more things are not providing any more benefit (Mg cost = Mg benefit).
3 This is debated 3 IBE, 1st year - 3rd Term avillagrasa Business law II always like this. Anyway, it is impossible to be 100% efficient (eliminate welfare reducing contracts).
The greater the protection of the non simultaneous exchanges is, the better the legal system is assumed to be.
Freedom A key word in private law is freedom. This refers to contractual freedom (autonomía privada/de voluntad): to be able to agree on as many issues in the contract as possible.
It implies: 1. Entering/Contracting: Free to enter into a contract (contracting). If there isn’t freedom then it’s not going to be legal.
Ex: You don’t have to contract a loan if you don’t want to.
2. Bargaining: The result of negotiation is the contract itself.
Ex: You want me to give you money, so I can decide to give you money or not, and if I decide to give it to you, I can give it for free (as a present) or not (a loan).
Mandatory rules Freedom of contract only exists when the asymmetry between parties is not huge. If there’s a big asymmetry, we will work under mandatory rules.
There’s no contract without freedom but sometimes the situation is difficult and you don’t have a choice.
Ex: you are free to sign a contract with your electricity supplier (the contact is already made no freedom of bargaining). However, if you don’t accept, you will not have light.
An example if this is contract law when we buy things, like the number of years of guarantee we have to be provided. They are used when one party doesn’t have any bargaining power (there isn’t any other option or he doesn’t have enough knowledge).
Freedom is not universal Any economy and so any legal system don’t allow parties to contract on everything.
There are some limitations, we exclude some assets from the freedom of exchange.
This is because it would generate differences and injustices.
Ex: There’s no market for becoming a IBE student (I can’t pay to be one), or there isn’t (or shouldn’t) market for the decision of a judge (sobornar). Freedom is mainly restricted for public goods, but also for humans (I can’t buy a person or his organs).
4 avillagrasa IBE, 1st year - 3rd Term Business law II The law determines the borders of the contract 1. Contracting on everything promotes inequality 2. We realized that some contracts entail negative externalities to 3rd individuals.
The market and contracts work because they are not universal 21.04.16 An agreement (contract) is an offer that has to be accepted. We will say that the contract starts when conditions (offers) are accepted.
This implies that everything that happened before the agreement (bargaining, negotiation...) is not longer important from a legal point of view. Therefore, everything that happened before the agreement is out of the scope of the legal system unless they became part of the contract.
Paradox: aleatory view of negotiations What if I’m telling you that the ring is made out of gold but that’s false? If you accepted to buy the ring (there’s an agreement) what happens? We have a problem because I accepted the offer but I lied. However the lie was made before the contract, during the negotiation, so it shouldn’t be under the scope of contractual law. The system doesn’t want the people to lie, so the seller will only be liable if I buy the ring and then I discover that that was false I’m liable only if I contract with someone and after he discovers the truth.
In general terms there’s no liability before the contract (I can lie) but there is after the contract. This is because it is better to assume that everyone can freely enter to a contract. Imposing liability before the contract might limit the freedom of negotiation and would prevent people to enter in negotiations.
The freedom of bargaining or aleatory view of negotiations is limited by: a. Mandatory rules: part of the content of the contract is imposed by the law. An example is consumer law. When we make a contract the law has already established a rule. You can contract and give more but not less. For example guarantees (you can give more but not less), conditions of financial agreements, etc. Mandatory rules impose contractual contents, so we avoid negotiation in these questions. This is made to protect the consumers/weaker party from the asymmetry of information. They have negative aspects too, as 5 avillagrasa IBE, 1st year - 3rd Term Business law II they limit the contractual freedom, so there might be fewer transactions. Other bad aspects of the obligatory 2 years guarantee 4are: 1. Sellers lose the ability to signal the quality of their products. However they can extend the guarantee. They lose the differentiating traits.
2. The guarantee has a direct consequence on the price, as the products with less quality are cheaper to make. This is not good from the individual point of view since it doesn’t allow the consumers to buy a cheaper product without guarantee if they are not interested in it (maybe they only want a PC for 6 months). You can’t decide to buy or not protection.
3. Sellers might sell products that will work only as long as the guarantee has to be enforced i.e. the product will only work for 2 years.
Mandatory rules solve the paradox we’ve seen before because the w eaker party is protected.
b. Pre-contractual liabilities: in some circumstances legal systems (mostly European ones) state that there should be pre-contractual liabilities. People should enter to the negotiation with the intention to contract. There’s the general duty of negotiate in fair terms. I’m not entitled to deal with someone just to prevent the other part in the negotiation to avoid him to negotiate with my competitor. Also I can’t deal if my intention is to harm the party. If we negotiate we might not reach and agreement (that’s normal) but if the other party discovers that the other party didn’t have legal intentions (wanted to make the contract) the system is prone to impose pre-contractual liability for considering that he wasn’t dealing in fair terms.
4 European law 6 avillagrasa IBE, 1st year - 3rd Term Business law II BASIC INSTITUTIONS OF SPANISH CONTRACT LAW Implied contracts As we have said the contract starts after it has been accepted. However it is not always very clear to see when this acceptance has happened. This is when we assume that there are implied contracts.
Ex 1: Imagine that your neighbour is in a trip without communication. Then for some reason the lock broke and you decided to change it to prevent anyone to enter to his home, paying for the reparation costs yourself. Can you claim the cost of it to your neighbour? Now think it in this way: what if you don’t repair the neighbour’s lock? He is going to come back and say “why didn’t you fixed? I would have paid you the cost”.
Under Spanish law if someone has made you a favour and acted rationally (not being rational is buying a gold locker, for example) we consider it to be an implied contract.
Anyway, it is difficult to assess. This is why we follow the following criteria to determine when there has been an implied contact.
Ex 2: You are in a cafeteria and you’re very relaxed and chill. Then a violinist comes and starts to play your favourite songs. You’re enjoying a lot. After half an hour the violinist asks you if you have enjoyed and you say yes. Then he asks you to give him 13€. Do you have to pay? NO The difference between the 1st and the 2nd example is that in the 1st one you couldn’t decide. However, in the 2nd example the violins could have reached an agreement (entered in a contract). The cost of negotiation was as with any other cases.
Implied contracts are only valid if the real contract was impossible to make. There’s no contractual relationship ex post if it could have been made ex ante (if you are conscious to contract you have to accept the conditions explicitly).
Invalid contracts The contract has to be a result of the acceptance of the conditions (by both parties), except if you weren’t able to (see locker example). If you haven’t entered into a contract not freely (I had a gun in the head or I was drunk) I can go to the court and make the contract not valid (void).
Contracts made by incompetent people or minors are neither valid nor enforceable. At least you should be able to go to court and make it invalid.
7 avillagrasa IBE, 1st year - 3rd Term Business law II Because of this some contracts have to be made before the notary, to make sure that the parties understand what are they doing and are conscious (understand the terms and conditions of the contracts as well as the risks).
Examples of it are the preferentes or the cláusula suelo case. However there’s a border “thin as the skin of my teeth” between the real knowledge and the one you needed.
For example, the preferentes case wouldn’t have been such an issue if we hadn’t been in crisis. Also it is difficult to determine if it was true that people didn’t know what they were doing.
The thing is that if you consider that you didn’t know what you were doing you can go to court and then the judge will decide to believe you or not (a lawyer had more information about preferentes than an old individual).
22.04.16 There’s a big border between the contract and the negotiation. This is the traditional view, which implies the aleatory view of negotiation. Parties can agree many things during the negotiation but at the end only the aspects included after the contract has been accepted can be legally enforced. Most of European courts have made exceptions to this way of understanding, as they understand that, under some circumstance the border “disappears”. This means that the negotiation process itself should also be taken into account. This is the negotiating in fair terms thing.
This idea opens a debate over the impact that information given by the parties during the negotiation process should have in the contract.
Ex: Imagine you have a jewellery and you have a ring with a fake diamond. Then someone comes to buy a ring and chooses the fake one. I decided to sell it to you as if it was real (at the same price as the real one). After some time the client discovers the truth. Does he have a claim against me? Yes. What would I have done knowing that the diamond was false? We can argue that we didn’t have information and make the contract void, as we entered in the contract by mistake.
If one of the parties lied in the negotiation process we can consider that we are in a contract made without acceptance, and so make it void.
Private information Sometimes part of the information is private. This means that the information is hidden. The issue is how much do I have to disclosure information during the negotiation process. If legal answer was that I have to disclose it, if I’m not saying some relevant information during the contract, afterwards the other party can claim that he entered in the contract by mistake.
8 avillagrasa IBE, 1st year - 3rd Term Business law II Ex 1: Imagine that an investor finds out that there’s oil underneath a farm after contracting a company to make a geological study that cost $1M. Then he negotiates with the farmer and set a price higher than the market price. The farmer is happy because he thinks he has made a good deal. Then the investor finds the oil and becomes rich and the farmer wants to claim for compensation as the price of the land was lower than the price of a land with oil (and the investor hided the information).
Can the farmer claim compensation (saying that he entered in the contract by mistake)? If the investor lied when the farmer asked why he was so interested I have a legal claim. If the farmer didn’t ask, since he didn’t lied, would he have a legal claim? It’s complicated.
In both cases (the ring and the oil) there’s hidden information. The question is at which extent we have to share the information.
Ex 2: You buy pure diamonds to a jeweller because you know that in the following weeks the price are going to increase a lot, and you plan to resell it. Do you have to specify why do you want the diamonds? No.
A real case: Tobacco in Louisiana There was a war and the tobacco ships were stuck in the harbour without possibilities to ship. Then the day before the pace was signed the brother of the ambassador of Louisiana (who knew that they could start shipping and selling again) bought all the ships for almost nothing (the merchants valued the ships very cheap because they didn’t see possibilities of shipping). Then the merchants sued the brother of the ambassador for hiding the information.
It is not easy to state until when we have to share information, as it has several clear implications: 1. Sharing information has impact in contract 2. If the business is successful everybody wants to be businessman but before no one is willing to take the risk. This means that when things go well we want to claim but if things go bad we don’t want to.
3. Information has cost Private information: Information that only has one of the parties. The party has the information for free or at a very low cost and for the other party having this information would be either impossible or very costly. In either case, the cost of the last party is higher than the cost of the other party. It has to be shared.
Public information: No duty to share public information. Public information is the information that has the same cost for both parties. Both parties can have the same information at the same cost.
See it with the examples: 9 avillagrasa IBE, 1st year - 3rd Term Business law II 1. Diamond: the jeweller can know if the diamond is false in less than 5 minutes just by looking at it or with the machines he has, while the buyer should buy a machine or pay someone to value him costing him money and time.
2. Oil: the farmer could have contracted the Canadian company to make the study at the same cost as the investor. The information had the same price for both.
The fact that the farmer didn’t have the information doesn’t mean that it’s private, as it reachable at the same cost as the investor. Then it is considered to be public information, therefore, you can’t claim anything. Even if the investor lied to you it was public information so you have no claim.
No insider (CEO) is allowed to use the information they have for their profit. This means that if the CEO knows that the shares are going to increase and buys to shares to shareholders this is invalid (it was private information). However, if the investor t hinks that shares are going to increase their value he can buy them because he’s using public information.
28.04.16 Expectations In the middle of the formation and the performance we have to know exactly which the implications of the contract are, what they meant when they did the contract. We have the interpretation.
We should assume that usually rational parties enter into a contract in order to get something. This something should be more valuable than the negotiation process itself (it makes no sense to negotiate if at the end I’ll be worst off). Therefore, we should assume that they enter in a contract to benefit from the output of the contract.
Contracts are commitment devices. They are the mechanism used to enforce a contract. This commitment relates with some specific result that the parties expect to get. The contract allows the parties to have some expectations. They are not simply hopes but something based on rights that I have and legally enforced duties.
Dealing with the expectations is the main issue for contractual law (because of the interpretation problem).
The correct way to compensate the party who suffers the breach (incumplimiento) of the contract is not only giving back what was accorded but also compensation. This is giving the harmed party the asset itself but also the expectations that he had.
The objective for the remedies is to make the harmed party be as good as if the contract has been correctly performed.
10 avillagrasa IBE, 1st year - 3rd Term Business law II The thing is that the injurer shouldn’t bring me back to my initial situation. In the legal system view the injurer should put the other party in the same position as if the contract had occurred.
If you don’t give me the car after I paid you, the correct compensation is either that I receive a car or the value of the car in money and expectation damages. If I get the car or my money back I would be as good as I was before the contract, so the seller has to give me something else to make me be as good as I expected to be.
Some countries allow the party that can be breached (the buyer) gives them the power to enforce the contract. So, even if the party breaches the contract I have the right of it to be enforced (I’ll get the car anyway). In other systems we also get money for the inconveniences and the specific performance.
Solutions 1. Specific performance: The specific performance remedy understands that the best way of fulfilling contractual expectations is to make it enforceable even before the contract has been enforced, in addition to the inconveniences compensation (prejudices). This means that the victim is entitled to ask for specific performance (get what was stated in the contract) and a monetary compensation.
2. Payment of damages: The party in blame for not accomplishing the contract can just “get away” by giving the other party the money corresponding to the expectations he had. The compensation (in the car example) should make me as happy as I would be if the contract had been correctly performed.
Civil law vs. Common law In the civil law systems the mainly used remedy is the specific performance one, if specific performance can be given. They non-performer party has the obligation to deal with the consequences of the contract.
In common law systems the victim can’t ask for specific performance, so the injurer gets free just by paying money, damages. This happens unless if the injurer is insolvent or the victim can’t be well compensated. The non-performer avoids the consequences of breaching the contract by paying money.
Liquidity damages Liquidity damages (cláusula penal) are the agreements made in the contract that state what is going to happen if the contract is not performed.
In both systems we can agree on other consequences in the contract. For example in civil law we can say that if the contract is not performed we will be compensated with a certain amount of money. This is allowed because nobody knows better than the parties themselves the best way they can be compensated.
11 avillagrasa IBE, 1st year - 3rd Term Business law II In theory by making more costly the no-performance than the cost of performance we’re incentivizing the parties to commit with the contract. However, the problem in courts is that the judge might underestimate your expectations. Because of this we can’t say in all cases that it makes the cost of no-performance greater than the cost of performance. However, it should reduce the no-performance.
Efficient breach of contract We’re in a situation where not performing is less costly than performing. For example, if I have to deliver the goods but doing so costs more that what I’m going to be paid.
A wants to sell his house. A values my house by 100.000€ and he has an offer by B of 110.000€ and he sells it to him. But then C comes and tells A that it’s his dreamt house. A tells C that the house has already been sold but C offers me 500.000€. What should A do? A would want to sell to C instead of B, as he would be richer. Nothing should prevent A to sell to C because it is more efficient for him.
Anyway, it would depend on the type of remedies given (specific performance or ...). If there’s specific performance (which is a bad solution in this case) the party (A) can’t avoid the contract. However, if there isn’t, A can compensate B with damages and contract with C. How is this efficient? Back to the example: If A can compensate B, he can pay B and make him and himself better off, as B gets +110.000 (maybe even 220.000€), A gets +320.000 (value of his house + B’s compensation) and C gets his dreamt house.
Because of the previous example, in general there’s the idea that damages is a better solution than specific performance, which prevents some efficient contracts. However there’s a debate and one of the main arguments against is fairness. Because if we use contracts to have more confidence in other parties, we shouldn’t have efficient braches of contract (what would future As do?). It could cause opportunistic behaviour.
Common law is usually considered to be more effient. However it doesn’t take into account that contract should be used to stop opportunism an d make contracts commitment devises.
On our example with specific performance it is difficult to A to escape from the contact with A, which in this sense is a limitation in efficiency. But in the other hand, specific performance doesn’t prevent the contract because if C is interested in the house, he’s going to buy it either to A or to B. The only thing that happens is that surplus is shared differently.
The only problem deals with transaction costs. In this case the transaction costs are equivalent, so the legal system shouldn’t allow to efficient breach.
12 avillagrasa IBE, 1st year - 3rd Term Business law II 12.05.16 WARRANTIES IN CONSUMER SALES Pacta sunt servanda Real case: Peanuts from Iran Ex: a Texas company buys peanuts from Iran. Once it receives the peanuts it sells them in the US market. Let’s suppose that the agreed price is 20$/T in the 1st year. The Texan company makes a contract to buy 5T and they have agreed in the place of delivery, way of delivery, etc. Since it is rational to think that the contract is going to be accomplished (I will get the 5T of peanuts for 20$/T) I also have made contracts with other companies in the US, for example with a catering. Obviously the contracts with other US companies depend on the accomplishment of the contract (quantity and price).
After some time, the war of Iran starts and now the Iranian company can’t cross the Suez channel because it is closed. Now they need to take a longer trip (through Africa) to arrive to US. Because if this, the costs of the Iranian company are higher (transportation=50$) so the price agreed is not enough to cover the costs. The Iranian company is not longer interested in the contract because it is losing a lot of money. So, does the Texan company have a legal claim against it if the Iranian company breaches the contract? If the Iranian company stops providing the peanuts the Texan company is going to have a problem because it can’t accomplish its other contracts.
The Texan company can say to the Iranian one that the increase in transportation price is their problem and that it shouldn’t bother it. So if it decides to go to court it can also ask for compensation. So, in summary, the Iranian company has to deliver the peanuts even if it is losing money.
The Iranian company then has to compare the expected damages (the amount it would have to pay if they go to the court) and the costs of transportations. There’s a problem in, for example Europe, where the seller should be given a monetary compensation but also the asset.
13 avillagrasa IBE, 1st year - 3rd Term Business law II Solutions Pacta sunt servanda The contract is mandatory: the parties have to accomplish the contract always (it’s your problem if you can’t). The fact that “this is your problem” is usually considered to be unfair. Situations like the one of the peanuts can be referred as: a. Frustration of the contract b. Commercial impracticability c. Hardship Rebus sic stanibus: According to this doctrine we state that the parties enter in the contract assuming that nothing will suddenly change and that everything will stay the same way as it was when the contract was made.
Rebus sunt servanda The contract is mandatory as long as there’s a big change that the parties couldn’t have foreseen when making the contract. It applies only in when there was symmetry in the contract and the case was unforeseeable. This leads to the problem of saying what can and can’t be predicted: at which “amount” of probability we can apply it.
Actually this doesn’t have a clear solution (remember that the complete contract doesn’t exist).
What would happen if the problem was on the Texan side? What if all the clients of the Texan company go bankrupt? What if it’s banned to sell Iranian peanuts in the US market? What if the market price lowered and it wasn’t profitable to pay 20$? If we could breach the contact when an external factor changes the circumstances and affects us negatively we would put in risk the Pacta sunt servanda (contracts prevent opportunism). Because of this there’s a problem on how to solve these cases.
We’ve been 300 years trying to figure out how to balance th e unfairness of the pacta sunt servanda and the possibility of generating opportunism of the rebus sunt servanda.
Economic view The problem is a problem of information because nobody was able to know, to anticipate that there would be a geopolitical conflict and that it would affect the transportation price. The problems are: 14 avillagrasa - - IBE, 1st year - 3rd Term Business law II Asymmetric information problems: One of the parties knows something that the other don’t. This is like the ring example (fraud) or the oil land (the information was public so it wasn’t a fraud).
Symmetric information problem: Both parties have the same information when they contract. In the peanuts example none of the parties had any information.
Since there isn’t a clear way of solve this parties would have to negotiate before going to court. The renegotiation doesn’t mean that we reach a new agreement but it implies that the parties have to cooperate to find a solution. However, this is a very incomplete solution.