Excerpt from John O. Honnold, Uniform Law for International Sales under the 1980 United Nations Convention, 3rd ed. (1999), pages 56-62. Reproduced with permission of the publisher, Kluwer Law International, The Hague.
§ 57 Paragraph (1) of Article 3 deals with the Convention’s applicability to contracts for the supply of goods to be manufactured or produced; paragraph (2) deals with sales contracts that include the supply of labor or other services.
"(1) Contracts for the supply of goods to be manufactured or produced are to be considered sales unless the party who orders the goods undertakes to supply a substantial part of the materials necessary for such manufacture or production.
"(2) This Convention does not apply to contracts in which the preponderant part of the obligations of the party who furnishes the goods consists in the supply of labour or other services."
§58 A. Goods To Be Manufactured
Paragraph (1) states the necessary premise that a modern sales law must include transactions which call for the manufacture or production of goods and then addresses this question: Does the Convention extend to contracts in which the party who receives a finished product supplies all or part of the necessary materials?
Example 3A. Owner, in possession of unfinished textiles ("grey goods"), makes a contract with Finisher providing that Finisher will bleach and dye the goods and return them to Owner.
By virtue of paragraph (1) of Article 3, this contract does not fall within the Convention. The same is true even if the contract states that [page 56] the goods are owned by Finisher during the processing and are thereafter sold to Owner for an agreed price. Regardless of the form of the contract, the "unless" clause of paragraph (1) is decisive: The party who ordered the goods undertook "to supply a substantial part of the materials necessary for" their manufacture or production.
Questions of degree inevitably arise along the borders of the statute. Some of these question can be suggested by an example.
Example 3B. Purchaser contracted with Manufacturer for the supply of stainless steel and agreed to supply the chromium, a necessary ingredient; the value of the chromium supplied by Purchaser comprised 15% of the total value of the materials used in manufacturing the stainless steel.
The fact that the chromium was necessary for the production does not itself lead to the exclusion of this transaction; exclusion results only when the purchaser supplies "a substantial part of the materials necessary" for production. We may assume that the weight or volume of the chromium would not be "substantial" in relation to all of the necessary materials but this should not be decisive: The only commensurable relationship is one based on value. How big a proportion of the value of all the materials is "substantial?" Paragraph (2) refers to "the preponderant part"; a "substantial" part would be less than preponderant. It seems that a tribunal might well conclude that 15% is "substantial" but the evaluation of such questions of degree is difficult to predict. The parties to such an international transaction would be well advised to solve the question of the Convention’s applicability in their contract.
Assume that Purchaser did not supply chromium or other materials but did supply valuable technical services and "know-how" that had "substantial" value in relation to the total value of the materials. No provision [page 57] of CISG excludes this transaction. Art. 3(2) excludes transactions only on the basis of services provided by the seller. At the Vienna Conference a proposal to exclude transactions on the basis of expert services supplied by the buyer was rejected. See O. R. 243–244; Docy. Hist. 464–465; Schlechtriem, 1998 Commentary 40.
(1) Decisions that apply the Convention, on the ground that B did not supply a "substantial" part of the materials, include: HUNG. Arb. Ch. of Comm. & Ind., VB/94131, 5 December 1995 (B supplied only 10% of goods needed for production); GER. OLG Frankfurt a M., 5 U 164/90 17 September 1991).
(2) CISG did not apply: AUS. OGH (Sup.Ct.) 27 October 1994, CLOUT 105, UNILEX D.1994-27. FR, CA Chambéry, 93-648, 25 May 1993, CLOUT 157, UNILEX D.1993-17. See also: Bonell/Ligouri, ULR (1996-1) 150–151.
§60 B. Contracts not Confined to the Supply of Goods
Example 3C. In an international contract Supplier agreed to deliver and install manufacturing machinery in Purhcaser’s factory and also to provide technicians to operate the machinery for the period of one year. The value of the machinery was $1,000,000 and the value of supplying the technicians was $200,000.
The above contract would not be excluded from the Convention by Article 3(2) since the "supply of labour and other services" did not comprise "the preponderant part of the obligations of the party who furnishes the good." The opposite answer would result if the contract called for services with value in excess of $1,000,000. For example, Article 3(2) could exclude a contract to repair a complex machine if the cost of labor is greater than that of the replacement parts.
Does the Convention apply not only to the part of the contract dealing with the supply of goods but also to the part dealing with the supply of services? The answer should be Yes. Article 3(2) applies only when the parties deal with both goods and services in a single contract. When there are significant relationships between the two aspects of the contract the Convention should apply to the entire contract. If this is not the case, the [page 58] arrangement should be treated as two contracts and the Convention would apply only to the contract for goods. Because of the relationships between the supplying of goods and services it would be important for a single set of rules to apply to the entire contract. When a controversy arises, the most troublesome problems, not regulated by the contract, are likely to relate to remedies for breach—particularly the question whether the breach justifies avoidance of the entire contract. A unified approach to such problems may be necessary for the effective application of the Convention’s provisions to the transaction in goods; pursuant to Article 3(2) the value of goods would at least equal and in most cases would exceed the value of the services. Many of the provisions of the Convention are concerned with the physical aspects of goods—transport, damage, destruction, deterioration. Services do not generate these problems, but the irrelevance of these provisions of the Convention should not present difficulties. And the Convention’s general approach to interpretation and enforcement of the contract would be useful for the entire transaction. (The Convention’s unitary approach to the contract and its remedies was introduced in the Overview in Ch. 1 at §2 and Ch. 2 at §§24–27.)
Decisions that apply CISG since S’s services were not a "preponderant" part include: ICC Arb. (Paris), No.7153/1992, 26 August 1992; FR, Grenoble, RG 93/4897, 26 April 1995, Roque v. Le Sarl. CLOUT 152, UNILEX D.1995-14. Contra: Service was "predominant; CISG not applicable: GER. OLG Köln, 19 U 282/93, 26 August 1994 (contract for market research embodied in report). See: Bonell-Ligouri ULR 152, n. 28-31 (citing cases and articles).
§60.2 Severability. Professor Schlechtriem suggested that domestic law should decide whether a transaction involving both goods and services is one contract governed by the Convention or is two contracts with the service aspect governed by domestic law. 1986 Commentary 32. This conclusion is entitled to great weight. The present writer has held a different view but would now be inclined to agree with Schlechtriem if the approach of applicable domestic law to the question of "severability" is sufficiently flexible to give decisive weight to the question mentioned above: Will "severing" the contract prevent the effective application of the uniform international rules to the transaction in goods? If a Contracting State applies domestic rules on "severability" that ignore the effective application of the Convention to a transaction that combines goods and services that State would scarcely be honoring its obligation to give full effect to the rules governing international sales or to the mandate of Article 7(1) (§§85–86, infra ) that in interpreting the Convention "regard [page 59] is to be had to its international character and to the need to promote uniformity in its application. " See Khoo, B-B Commentary §3.1, p. 43. Article 3(2) is based on the premise that the Convention will apply to some transactions that embrace both goods and services; decisions as to which transactions will be covered can not properly be made solely on the basis of principles of domestic law.
In discussing Article 2 at §56, supra, we saw that construction of an immovable building was not a sale of "goods". Even when contracts for industrial works call for the buyer to supply the land and building, some of the equipment may become a permanent part of the building while other equipment may be free-standing and readily removable. "Turn-key" contracts may also include the supplying of "know-how" and services in placing the plant in operation.
Such complex contracts should (and often do) designate the applicable law. See Art. 6 at §75, infra. If the contract is silent, deciding whether the Convention governs any part of the transaction calls for applying by analogy the Convention’s provisions on mixed contracts in Article 3, supra, and also consideration of the parties’ implied intent (Art. 8, §§104–111, infra ) in the light of the (1) suitability of the Convention’s provisions to the contract as a whole and (2) the feasibility of "severing" the contract to make the Convention apply to only part (§60.2, supra).
In some situations tribunals may find that provisions of the Convention are helpful in solving comparable problems that fall outside its scope. Such voluntary borrowing of solutions from specialized statutes has been useful within domestic legal systems. For example, in the United States the Uniform Sales Act (1906) and it successor, Article 2 of the Uniform Commercial Code (1954), state that they govern "sales" of [page 60] goods, language that literally would exclude the burgeoning field of supplying goods through leasing (hiring or rental) arrangements. However, courts faced with the question whether the user (lessee) of the goods was entitled to legal protection when the goods were defective found that the "sales" statutes dealt with a comparable problem and relied on these provisions; this approach was not in obedience to statutory command but in observance of the principle that similar problems called for similar solutions. The extension of "sales" rules to "leases" of goods has necessarily been selective; for example, some of the "sales" rules dealing with remedies for breach are inappropriate to transactions in which the user’s investment is limited to rental payments. Problems such as these led in 1987 to the addition to the Uniform Commercial Code (UCC) of a new Article 2A. Leases, immediately following Article 2. Sales.
"Lease" or "Sale": Form or Substance. Some transactions labelled "lease" in substance are sales—subject to a security interest. Whether the CISG applies to these transactions should depend on substance rather than form; "chameleon leases" may be subject to CISG if they satisfy the other requirements for applicability—e.g., Article 1. Penetrating such disguises in the setting of the UCC is discussed in White & Summers (1995) 21-3.
Tribunals, of course, are under no international obligation to use the Convention’s provisions for transactions that lie outside its scope; such "borrowing" depends on principles of domestic jurisprudence and a decision whether rules designed for domestic transactions are as suited to international transactions as the Convention. In a larger sense, careful analogical extension of these and other international rules can make a measured, albeit modest, contribution to the reestablishment of an international law-merchant.[page 61]
Measured analogical use of the Convention’s provisions can also relieve pressure for doubtful interpretations extending the Convention’s scope. In discussing Article 7(2), §§96–102, infra, we shall consider the Convention’s invitation to use "the general principles on which it is based" to govern questions which, although "not expressly settled" in the Convention, arise out of matters "governed by" the Convention. This provision calling for analogical extension of the Convention’s substantive rules to avoid "gaps" in the uniform rules transactions that fall within the Convention’s scope is profoundly different from principles for interpreting provisions (e.g., Articles 1–6) which govern the Convention’s outer boundaries.
As the language quoted from Article 7 shows, its call for a broad analogical approach to the Convention’s substantive provisions "governed by" the Convention does not apply to provisions such as Articles 1–6, which define the area that the Convention does not "govern". Nor does the Convention contain any provision authorizing analogical extension of its outer boundaries. Indeed, in framing the Convention such a proposal would have received short shrift and for good reason: Doubt about the Convention’s outer boundaries generates uncertainty as to nearly every substantive issue that can arise in an international sale.
These factors suggest that provisions defining the Convention’s outer boundaries should be interpreted to achieve maximum certainty. On the other hand, as we shall see, Article 7(2) (buttressed by Articles 8 and 9, §§104–122, infra ) calls for a more flexible approach in the development of rules to govern transactions that reside within the Convention’s domain.[page 62]
FOOTNOTES: Chapter on Article 3
1. This article was derived, after redrafting, from Art. 3 of the 1978 Draft. These proceedings at the Vienna Conference are recorded in O. R. 241–245, 270–271, 84–85; Docy, Hist. 462–466, 491–492, 656–657. Cf. ULIS 6, ULF 1(7). Proceedings in UNCITRAL: II YB 41, 56–57, VI YB 90–91, 110–111, 51, VIII YB 28, 38; Docy. Hist. 46, 62–63, 215–216, 235–236, 242, 321, 331.
2. The comparable categories in various legal systems are analyzed in Lorenz, Contracts for Work on Goods and Building Contracts, VIII Int. Enc. Comp. L. Ch. 8 §§2–5.
3. ULIS 6 made exclusion from the Law depend on the supply of "an essential and substantial part of the materials." In UNCITRAL the reference to "essential" was deleted. But cf. Kahn, Rev. Int. Dr. Comp. 951, 955 (1981). The drafters of the French version had difficulty with the concept of "substantial" and used the phrase "une part essentielle." The Spanish version states "una parte sustancial." Schlechtriem, Com. (1998) 39.
Art. 6 provides that the parties "may exclude the application of the Convention...." The Commentary to Art. 6 considers the converse—agreements that the Convention will be applicable —and concludes that in cases like Example 3B, such an agreement probably would be effective. See Art. 6 infra at §78. Cf. Schlechtriem, 1986 Commentary 36: suggests that Article 6 authorizes parties to make CISG applicable although Art. 3(2) would exclude the contract. The discussion of Article 6, §§78–83, infra, suggests a similar result based on applicable domestic law.
4. W/G 2 paras. 61–67, II YB 56–57; UNCITRAL X (1997) Annex, I, para. 43, VIII YB 28; SR. 2 paras. 30–82; SR. 4 paras. 4–10 Docy Hist. 62–63, 321. As a result of the basic rule of Art. 3(1), supra at §57, labor costs in manufacturing the machinery would be irrelevant; such costs are not the "supply of labour or other services" under Art. 3(2).
5. See UNCITRAL Legal Guide on the Drawing Up of International Contracts for the Construction of Industrial Works. United Nations. U. N. Sales No. E.87. V.10 1988); Kritzer Manual Ch. 26.
6. Honnold, Sales 137–146; Stone, The Common Law in the United States, 50 Harv. L. Rev. 4, 12–14 (1936).
7. This difference is reflected in both case-law and in Article 2A—Leases which was added to the UCC in 1987. The 1988 UNIDROIT Convention on International Financing Leasing (Ottawa, May 28, 1988) responded to the special role of institutions that finance leasing transactions.
8. Cf. Berman, The Law of International Commercial Transactions ( Lex Mercatoria ), 2 Emory J. Int. Dispute Resolution 235, 298–310 (1988); B. Goldman, Lex Mercatoria, 3 Forum Internationale (1983). Cf. Goldstajn in Dubrovnik Lectures 55, 85–93. The present writer’s commitment to the development of international lex mercatoria has not yet prepared him to join in proclamations that the New Dispensation has fully arrived. See Langen, Transnational Commercial Law (1973).