UNIT 2 (2014)Apunte Inglés
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UNIT 2: FREEDOM OF CONTRACT. ELEMENTS OF CONTRACTS.
1.1. Freedom of Contracts Freedom of contract = private autonomy: Parties are free to make a contract or other juridical act to determine its contents, subject to any applicable mandatory rules.
- It has been recognized as a “general principle of civil law” by the European Court of Justice.
It has been seen as protected by art. 16 of the EU Charter of Fundamental Rights (“freedom to conduct business”).
Examples: - Art. 1.1. UNDROIT Principles: “The parties are free to enter into a contract and to determine its content”.
Art. 6 CISG: “The parties may exclude the application of this Convention or, subject to article 12, derogate from or vary the effect of any of its provisions” Art. 1255 Civil Code: “The contracting parties may establish any covenants, clauses and conditions deemed convenient, provided that they are not contrary to the laws, to morals or to public policy”.
Different views of freedom of contract: (1) Legal or moral principle (autonomy of the will): the justification for contractual obligations is found in the free choice (‘will’) of the individuals that enter voluntarily into a contract. Influenced by the liberal philosophical positions of authors such as Rousseau and Kant.
Free development of personality, self-determination, autonomy.
(2) Economic principle (market mimicking): freedom of contract aims at ensuring that legal and commercial institutions are applied in such a manner as to support a free and open market and to facilitate market transactions.
To what extent will unregulated private contracting lead to desirable social consequences? Contract Law rules should be crafted as to create the incentives for the behavior of the contracting partners that would maximize the welfare of the parties affected by the contract regulation, interpretation and enforcement of contracts should take into account that contracts between private parties are cooperative tools that are entered into by the parties in order to maximize their joint surplus from the contractual relationship.
However, it must also be considered that contracts may affect third-parties. For instance, even if two firms are made better-off by a collusive agreement that restricts competition, there are good reasons for the Law not to enforce such an agreement and, on the contrary, not to give effect to the parties’ intentions.
Coase Theorem - non-perfect markets (recall from previous courses the Coase Theorem) There are many problems that affect markets. For example, contracts affect often third parties. Cartel fix prices, that’s positive but negative at the same time.
Economists and other social scientists have highlighted some situations that may support the derogation of the freedom of contract principle. Perfect markets do not exist in practice because of: (a) Harmful externalities to third parties: the harm (dany) to third parties must tend to exceed the benefits of a contract to the parties themselves for it to be socially desirable not to enforce (fer complir) a contract.
Examples: Agreements between competing firms to control prices or exclude entry of a new competitor in a market (e.g. agreements of exclusive dealing).
Agreements with restrains on alienation that have the effect of increasing the parties’ wealth at the expense of prospective acquirers or secondary-markets.
Agreements to commit crimes (you cannot go to the court even you have sign a contract).
Insurance (assegurances) contracts for fines or liability (responsabilitat) arising for crime.
(b) Monopolies or market power (c) Asymmetrical information Contract rules that provide parties with incentives to disclose information.
Rules on mistake Rules on the scope of damages (art. 1107 CC / in common law: Hadley v. Baxendale rule) Minor and incompetents: legal systems may refuse to enforce contracts entered into by minors and incompetents because they may result in losses in their welfare.
(d) Cognitive biases or bounded rationality: o Over-optimism and withdrawal (retirada) of consent o Over-optimism and reduction of liquidated damages (provision included on the contract on what a part of the contract accept to pay something in case he doesn’t obey= clàusula de recisió) o Endowment (dotació) effects and market damages (people tend to value the things they own higher to the same thing of another person, eg. If I want to sell my mobile phone, I’ll put a price, if I want to buy this mobile phone, I’ll put a lower price to it. It happen the same in case of damage, eg. If somebody break your mobile, you’ll ask for high price and he other will only pay for the market value).
(e) Also, the issue of “commodification”: it describes the assignment (assignació) of economic value to something not previously considered in economic terms.
In order to avoid such phenomenon, sometimes legal systems set forth rules on inalienability.
o o Grounds (causa): paternalism, culture, religion, politics.
Examples: sales of human prgans, prostitution, surrogacy agreements… Typical arguments: - Sale of human organs might be undesirable because: o Some individuals will sell their own organs (such as kidneys) without realizing the harmful consequences for themselves. Enforcing the agreement may make the contracting parties worse off due to a problem of lack of information.
o Some individuals will not receive the care they need. Enforcing the agreement may make the contracting parties worse off (en pitjor situació) due to the contract-induced behaviour.
o The very existence of a market for human organs might be conceived by some citizens as eroding norms of respect for human life.
The general consequences of freedom of contract in Contract Law: According to the principle of freedom of contract, parties are free to: - Decide whether to enter into a contract and establish binding legal relationships or not - Choose among the different contracts supplies by the legal system (typical contracts) and modify or fine-tune the different default rules established in the law in order to adapt them to their own interests therefore parties may exclude the application of many legal rules. So, the parties are free to choose the type of contract they want between those allowed (ex. buy or rent).
- Created new contracts according to their own interests (atypical contracts: not regulated by the law) (1) Freedom to enter into a contract Exceptions: - Invalid consent: absence of will (eg. Mistake, Fraud, Coercion/Duress) - Monopoly or market failure due to high transaction costs (eg. Nexpresso, competition is no allowed) In traditional common law, for instance, some business are designated as common carriers and are obligated to enter into exchange on standard terms with anyone who wishes. Modern statues have expanded such duties in a variety of ways: for instance, the essential-facilities doctrine in antitrust law requires vertically integrated firms to make certain stages of production available on a contractual basis to their non-integrated competitors.
E.g.: compulsory licenses, “Fair, Reasonable and Non-Discriminatory Terms” (FRAND), Essential Facilities Doctrine, Refusals to deal.
- Non-Discrimination: it limits the right to choose a contractual partner in some settings.
o Council Directive 2004/113/EC, of 13 December 2004 Implementing the Principle of Equal Treatment Between Men and Women in the Access to and Supply of Goods and Services, 2004 O.J. (L 373) 37.
o Hotel Owners’ Right to Ban Persons from Hotel Premises o o o Bull and Bull v. Hall and Preddy  EWCA (Civ) 83 (Eng.): Peter and Hazelmary Bull, the owners of a small bed-and-breakfast decided to exclude homosexual couples from rooms with a double bed on the ground that they regarded such behavior as immoral and contrary to their religious beliefs. They also opposed all sexual intercourse outside marriage.
Eg. Gay couples not allowed in the hotel decision: allow them, because it’s a minority.
Judgment of the Landgericht Frankfurt (Oder) (Regional Court) of 22 June 2010: The plaintiff was a leader of the National Democratic Party of Germany (NPD), a radical right wing fascist party. In September 2009, the plaintiff’s wife booked a four-day holiday for her and her husband via a travel agency. Before the holidays, the hotel (the Defendant in the case) informed the plaintiff by letter that he was banned from the hotel’s premises. After the plaintiff demanded an explanation for the ban, the hotel management informed that his political beliefs were not in-line with the hotel’s aim to guarantee an enjoyable holiday experience for all guests.
Eg. Nazi politician not allowed in the hotel decision: the hotel can ban he, because he can cause a negative effect to other costumers.
Court of Appeals Madrid, 6.5.2009 (AC 176/2009; J: Lorenzo Pérez San Francisco): Air-company IBERIA S.A. followed a policy according to which deaf passenger could not travel alone but with an accompanying individual.
The Court of Appeals held that this refusal to sell individual tickets to deaf passengers was discriminatory and ordered IBERIA no pay nominal damages to the victims. According to the Court, this policy was excessive to attain the goal of facilitating communication between the crew and the passengers in cases of an emergency.
Eg. Deaf (sordos) people cannot travel alone decision: this policy has to be eliminated.
Court of Appeals La Coruña, 15.5.2009 (AC 507/2008; J: Rafael Jesús Fernández-Porto García): Insurance company “Sanitas, Sociedad Anónima de Seguros” refused to provide health insurance to a minor with Down syndrome. The Court of First Instance held that this refusal was discriminatory and ordered the company to pay a 6.000 Euro damages award. However, the Court of Appeals accepted Sanitas’ appeal and vacated the judgment. According to the Court of Appeals, the refusal was grounded in the facts that clients with Down syndrome are more likely to develop some sort of illnesses and other conditions that may be costly for the company.
Eg. Refuse to provide health insurance to a minor with Down syndrome decision: policy justified because it has ground.
- Quasi-contracts: an obligation that the law creates in the absence of an agreement between the parties. It is usually invoked in situations where unjust enrichment, which occurs when a person retains money or benefits that in equity belong to another, would exist without judicial relief two parties don’t negotiate a contract, but for some circumstances, there is an obligation (e.g.: you repair the door of your neighbour, because it has been broken in a robbery and he is no there. He has the obligation to pay it when he comes back) Unjust enrichment, management of another's affairs (negotiorum gestio), or payment of a thing not due (indebiti solutio).
- Outside contract law: Necessity (rewards for rescue); takings of property.
[Recall from previous courses the distinction between property rules and liability rules by Calabresi/Melamed] (2) Freedom to modify the content of contracts provided by the legal system Mandatory rules (“normes imperativas”: norms included in the legal system that cannot be modified by parties) Default rules (“normes dispositives”: rules supplied by the legal system that can be modified by the parties) Some rules of contract law supply default terms that are subject to contractual override; other rules of contract law are mandatory--they can't be modified by the contract.
Example of mandatory rule: Articles 7.1 and 1258 Civil Code create a duty to act in good faith. These are mandatory rules, because such duty cannot be disclaimed by a contractual provision.
Example of default rule: Article 1465 Civil Code: “Delivery expenses of the things sold shall be borne by the seller, and transport or freight expense shall be borne by the purchaser, unless parties agree otherwise”.
It isn't always clear whether a given rule is one or the other: the usual tipoff is language like, "unless the contract provides otherwise" or "absent an agreement to the contrary." Default rules reduce transaction costs: Drafting a complete contract would almost always (perhaps always) cost more than the contract is worth a complete contract is unfeasible and they never exist in reality. We only have “incomplete” contracts. Default rules may be used to complete “obligational gaps” in the incomplete agreement.
They can be understood as a public good supplied by the State.
But, there’s a problem: paternalism. Why to use one default rule and not the reverse? - Majoritarian perspective: to establish the usual behavior as default.
Informational penalties (Ian Ayres and Richard Gertner, “Filling gaps in incomplete contracts: an economic theory of default rules”, 99 Yale Law Journal 87 (1989).
Increase of social welfare (benestar): (a) Libertarian paternalism. “Nudges”: Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness, Yale University Press, 2008.
(b) Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?”, Science, 21 November 2003: Vol. 302 no. 5649, pp. 1338-1339 (www.dangoldstein.com).
Organ donations in countries with an opt-out system (default rule: every citizen is a donor unless she has opted out) are substantially higher than in countries with an opt-in system (default rule: only citizens that have opted in by agreeing to be donors are considered donors).
(3) Freedom to create new contracts “Numerus apertus” (limitation in the number of property laws they can create) vs. “Numerus clausus” in property rights.
Atypical contracts in Spanish Law: - Sponsoring and merchandising agreements Franchise (franquícia) agreements Limits to private autonomy: an agreement cannot violate (art. 1255 Civil Code) - Mandatory norms o Legal systems comprise mandatory rules and default rules. Default rules apply when the parties have not established an alternative norm into the agreement. As we have seen, they basically serve as a transaction cost reduction mechanism.
Example of mandatory norm: Minimum-price fixation in distribution or technology transfer agreements: “the restriction of a party’s ability to determine its prices when selling products to third parties, without prejudice to the possibility of imposing a maximum sale price or recommending a sale price, provided that it does not amount to a fixed or minimum sale price as a result of pressure from, or incentives offered by, any of the parties”.
Consequence of infringement of a mandatory rule: invalid agreement or invalid term in the contract? Article 6.3. “Acts contrary to mandatory and prohibitive rules shall be null and void by operation of law, except when such rules provide for a different legal effect in the event of violation”.
Usual term included in contracts: severability or “salvatorius” provisions A provision in a contract which states that if parts of the contract are held to be illegal or otherwise unenforceable, the remainder of the contract should still apply. Sometimes, severability clauses will state that some provisions to the contract are so essential to the contract's purpose that if they are illegal or unenforceable, the contract as a whole will be voided.
Consequences: 1- all the contract invalid (very serious infringements of norms) 2- the provision in the contracts that infringes a norm is invalid, but the rest of the contract will be valid.
3- in some cases some mandatory norms establishes an alternative solution (e.g.: this provision is invalid, but here is a substitute/solution) 4- the mandatory norm being infringed refers to an essential element of the contract, so all the contract loses validity.
- Morality: Repugnance in contracts (e.g. dwarf-tossing; some forms of prostitution).
o William Shakespeare, The Merchant of Venice: a promise to cut a pound of flesh of the debtor if a loan is not repaid to Shylock.
(https://www.youtube.com/watch?v=gtYGzr8Nx-8) - Public policy (“ordre públic”): body of principles that underpin the operation of legal systems in each jurisdiction; contracts to perform an obligation in a foreign country but with legal effects that should occur in Spain.
o E.g: sale of organs; gestational surrogacy.
Mandatory elements of contracts Art. 1261 Civil Code: a contract does not exist unless it comprises the following elements: - 1. Consent by the parties (see Unit 3) - 2. Definite and legal object what you promise to the other party - 3. “Causa”: Legal cause or socioeconomic purpose of the agreement - [Formalities] in some cases some formalities would be required.
Article 2: 101 PECL - Conditions for the Conclusion of a Contract “(1) A contract is concluded if: (a) the parties intend to be legally bound, and (b) they reach a sufficient agreement without any further requirement.
(2) A contract need not be concluded or evidenced in writing nor is it subject to any other requirement as to form. The contract may be proved by any means, including witnesses”.
Article II. – 4:101 Draft Common Frame of Reference: Requirements for the conclusion of a contract “A contract is concluded, without any further requirement, if the parties: (a) intend to enter into a binding legal relationship or bring about some other legal effect; and (b) reach a sufficient agreement”.
Considertation: Is similar to “causa” in Common Law, they are the promises both parties eschange (in Common Law is one of the main requirements).
“Causa” - No legal definition in the Spanish Civil Code.
o Article 1274 CC: “En los contratos onerosos se entiende por causa, para cada parte contratante, la prestación o promesa de una cosa o servicio por la otra parte; en los remuneratorios, el servicio o beneficio que se remunera, y en los de pura beneficencia, la mera liberalidad del bienhechor”.
- - Luis Díez-Picazo: “the concept of causa, within the theory of contract, is for sure one of the most obscure, misleading, and difficult to apprehend institutions in civil law”.
Most legal systems do not use this institution to discipline contracts.
European harmonization projects and trends show how causa or similar institutions in other legal systems (consideration in common law) are not considered as requirements of contracts.
Many legal scholars in Spain advocate for the elimination of such requirement.
Socioeconomic purpose that the parties aim to attain when concluding the contract.
Roles of “causa” in Spanish Law: a) Assessing that the contracting parties actually had a purpose when concluded the contract.
Article 1275: “Contracts without a cause or with an illicit one do not create legal effects…” Lack of cause absolute simulation (simulación absoluta) The contracting parties just created an apparent contract but they lacked any intention to be bound legally by the agreement It happends when the parties have no finality when entering the contract. For instance: A is the owner of a dwelling in Barcelona where he has his residence. In order to escape potential liability and the risk of losing the apartment to creditors, A enters a sales contract with his daughter B. The agreement includes a price which is actually never paid by B to A. A still lives in his apartment and B has no possession whatsoever of the dwelling.
False cause relative simulation (simulación relativa) The contracting parties create an apparent contract in which they pretend to attain a purpose that is not the actual one that would lead them to be bound legally by the agreement. For instance: A is the owner of a dwelling in Barcelona and wishes to donate it to his daughter B.
Donations in Spain are subject to a tax that is higher than the one established for sales. In order to avoid paying the higher tax, A and B draft a sales contract which is included in a public deed (“escriptura pública”) and pay the lower tax for sales there is a true “causa” they avoid, they use a different kind of contract with a different “causa” (not true).
Consequence: the true cause shall prevail, and therefore the courts should deem the agreement a donation.
Article 6:103 DCFR –Simulation “When the parties have concluded an apparent contract which was not intended to reflect their true agreement, as between the parties the true agreement prevails”.
However, in the last years the Supreme Court has held that the deed used to include the sales contract cannot be understood as a valid substitute for the donation deed. Therefore, since the donation deed is a mandatory formality for a donation to be valid, the agreement would not meet all the legal requirements and therefore would not produce legal effects (see, for instance, Judgment of the Supreme Court of January 11th2007 (RJ 2007/1502).
In the past the public deed of the sale is valid for the donation, nowadays it is no valid, it cannot be a substitute.
b) Assessing that the purpose that was aimed by the contracting parties was licit.
Article 1275: “Contracts without a cause or with an illicit one do not create legal effects…” Limitations to freedom of contract.
c) Assessing that the purpose that was aimed by the contracting parties merited to be honoured by the State.
Some authors have highlighted that some promises, despite being licit and consented by the parties, shall not be enforced by courts. Examples: domestic relationships, friendship and other social promises.
Which contracts have to be respected by a court? Some authors believe that “causa” may be used to establish which kind of contracts have to be enforced by courts.
Fomalities in expressing consent In general, formalities are normally not required. It’s not an essential requirement.
Article 11 CISG “A contract of sale need not be concluded in or evidenced by writing and is not subject to any other requirement as to form. It may be proved by any means, including witnesses”.
Art. 1278 of the Spanish Civil Code “Contracts shall be binding no matter the way in which the contract was formalized, provided that the essential conditions for its validity are met”.
Freedom from formalities is a good general starting point from an economic perspective: If a contract is mutually agreed, it is because it increases contracting parties’ welfare and therefore, the Law should not erect barriers (formalities are barriers to enter a contract, and that’s not positive), except when justified on other grounds, to prevent these welfareenhancing interactions from taking place.
However, in most legal systems a non-trivial set of contracts require certain formalities. Some contracts require a public deed: prenuptial agreements; donations of real property; sales of real property; mortgages, corporations and limited liability companies usually also require public deeds.
Other agreements have to be made in writing (publishing contracts).
Consequence of failure to comply with formalities: invalidity of contract; but in some cases just a remedy to summon the other party to put the agreement in writing (e.g. publishing contracts in the Copyright Act).
Many formalities are required only when one of the contracting parties is a consumer: - The requirement that the contract is made in writing with one copy for the consumer (door to door sale contracts, time sharing contracts).
- The requirement of a minimum content, informative of contractual rights of consumer (consumer credit, distance sales).
- The right of withdrawal, thereby the consumer can walk away from the contract within a legally specified time from signing the contract (door to door sale contracts, time sharing contracts, distance sales).
Roles of formalities: - Increase the level of information of contracting parties.
- Offering opportunities for reducing biases: time would be needed before the formality is completed and the contracting party may decide to step back (similar to cooling-off periods).
- Reductions of costs in future litigation: written contracts can facilitate evidence about the existence and validity of consent; the content of the contract agreed between the parties… if we have a written contract, judges have access to it and it will be easier in case of litigation.
- Increased information for third parties. Mortgage agreements registered in public register and that’s a protection for third parties, because they have the possibility to know the apartment is affected by a mortgage.