[2nd edition: Case annotated update (April 2005)]
LL.M. of Renmin University of China; E-mail: <email@example.com>.
1. Pacta sunt servanda: A cornerstone of contract law
Pacta sunt servanda (or the sanctity of contract) is a basic and it seems universally accepted principle of contract law: the contract has to be respected. It reflects natural justice and economic requirements because it binds a person to its promises and protects the interests of the promisee. Since effective economic activity is not possible without reliable promises, the importance of this principle has to be underlined.
Pacta sunt servanda is, understandably, a paramount feature of the law of contract. As a matter of principle, parties must adhere to the terms of their contract. This explains, for instance, why specific performance has been adopted under the United Nations Convention on Contracts for the International Sale of Goods (1980; "CISG" or "Convention") as a primary remedy. In principle, from this primacy one could conclude that the CISG drafters were true to their world in implementing the norm of pacta sunt servanda. Unless there are unusual handicaps, parties ideally should do what they have promised. It is indeed a paramount principle in all municipal legal systems.
Pacta sunt servanda enjoys very long national traditions which have been elaborated by the courts and frequently translated into statutes by the legislature. In this regard, it is pertinently noted in Liamco v. Libya:
This principle is still the heart of the matter in modern times for reasons of legal certainty and stability. No doubt international arbitrators also stick, in principle, to pacta. They apply pacta sunt servanda either as "a transnational principle of private law" or as "a cornerstone of the lex mercatoria." Arguably, as held in Sapphire v. National Iranian Oil Company:
However, with pacta sunt servanda kept in mind as a general principle, one should also note that, "practice has demonstrated that on many occasions this principle may lead to the opposite of its aim." It is arguable that the promisor should not be held to his promise when circumstances have changed so fundamentally that a hardship or force majeure event has occurred to him. The main issue here is "the choice to be made between the strict application of pacta sunt servanda and the possible application of the clausula rebus sic stantibus."
As to be further shown below, whatever the significance of pacta sunt servada in legal theory, it may be tempered by the principle of rebus sic stantibus. This is evidenced by the fact that arbitral tribunals in practice and various international organizations through codifications have admitted, albeit in exceptional cases, the doctrine of rebus sic stantibus.
2. Rebus sic stantibus: Doctrine underlying change of circumstances
The term "change of circumstances" is used here to refer collectively to a host of different concepts, applied nationally and internationally, that deal with changes in the economic, legal and business realities underlying a contractual agreement.
The situation existing at the conclusion of the contract may subsequently have changed so completely that the parties, acting as reasonable persons, would not have made the contract, or would have made it differently, had they known what was going to happen. Thus, the majority of modern writers accept the doctrine of rebus sic stantibus. This doctrine has been further translated into the legislation under a host of related concepts. On the national level, these concepts, evolving progressively, include the American commercial impracticability, the English frustration of purpose, the German Wegfall der Geschäftsgrundlage, the French imprévision or the Swiss impossibility, and the like.
On the international level, a number of international awards have also applied the doctrine of rebus sic stantibus as a general principle of international trade. Indeed, a number of international organizations and institutions have attempted to define instances in which the setting aside of a contract is warranted. Among others, reference may be made to the Vienna Convention of the Law of Treaties of 1969 ("VCLT"). Although it is applicable only to treaties governing sovereign States, VCLT has been noted to contain an article (Art. 61) dealing with impossibility of performance, and an article (Art. 62) defining "fundamental change of circumstances" in terms of rebus sic stantibus. In particular, the latter (Art. 62) has been deemed as "a strong argument for the existence of a general legal principle which might also be relevant to transnational contracts with or between private parties." Of more particular relevance, rules dealing with force majeure or hardship have been incorporated into either the Uniform Sales Law, the CISG, or the international "Restatements" of contract law, the UNIDROIT Principles of International Commercial Contracts (1994; "UNIDROIT Principles") and Principles of European Contract Law (1998; "PECL").
An important aspect of the doctrine is that it focuses upon changes that would contradict the "parties' shared expectations" and thereby "defeat their apparent objectives." In this regard, Perillo submits that:
Generally speaking, contracts are the by-products of the parties' will or intention, but that has to be determined objectively. Among other things, the occurrence of a contingency or frustrating event that was unforeseeable at the time of contracting could create circumstances that were not within the contemplation of the parties, and therefore performance exceeds the assent induced and given. Therefore, in case of such changed circumstances, the rebus doctrine has found a widely recognized expression to excuse the non-performance of the contract. This doctrine is available on both a national and an international level, supported by legal writings, courts rulings or arbitral awards, as well as further evidenced by its being incorporated into legislation, conventions or similar instruments.
In general, changed circumstances mainly have two different effects on a contract: "they can render the contractual performance either impossible or (only) more burdensome for a party so as to create a 'hardship' for it." Accordingly, the rebus doctrine is mainly oriented on:
|-||"an overall principle that contracts have to be adapted to changed circumstances," i.e. hardship, on the one hand. Emphasizing the sanctity of contracts does not necessarily mean for its proponents that the parties' agreed arrangements are to be left completely unchangeable. As Zakariya pertinently states: 'Pacta sunt servanda simply means that contracts which have legally come into existence and continue to be in force, must be observed. It means the inviolability, not unchangeability of contracts.'
|-||"the implication of a term that an award of damages would be barred and that the obligations of an agreement would end if there has been a change of circumstances, i.e. force majeure, on the other. As in municipal systems, so in international law it is recognized that changes frustrating the object of an agreement and apart from actual impossibility may justify its termination."|
3. Rebus sic stantibus applied as an exception to pacta sunt servando
One of the most interesting, and potentially most dangerous, inroads into pacta sunt servanda has been the so-called clausula rebus sic stantibus: a contract is binding only as long and as far as matters remain the same as they were at the time of conclusion of the contract. It is obvious that such a proviso, if broadly interpreted, can be used to erode the binding nature of contractual promises very substantially.
Therefore, it is held that: "In international commerce one must rather assume in principle that the parties take the risks of performing under and carrying out the contract upon themselves, unless a different allocation of risk is expressly provided for in the contract (citations omitted)." In particular, "[a]s a general rule, one should be particularly reluctant to accept it when there is no gap or lacuna in the contract and when the intent of the parties has been clearly expressed, as in a Bank Guarantee. Caution is especially called for, moreover, in international transactions where it is generally much less likely that the parties have been unaware of the risk of a remote contingency or unable to formulate it precisely."
Indeed, arbitrators have been rather strict in applying rebus sic stantibus. In this respect, a leading ruling has been found in [ICC Award No. 1512, YCA 1976]:
Similarly, the Tribunal reiterates in [ICC Award No. 8486, YCA 1999] that, the termination (or adaptation) of a contract for unforeseen circumstances (force majeure, hardship, or clausula rebus sic stantibus), "should be allowed only in truly exceptional cases." Otherwise, as the Tribunal notes in [ICC Award No. 6281, YCA (1990)], "any business transaction would be exposed to uncertainty, or even be rendered impossible altogether, whenever the mutual covenants are not performed at the time at which the contract is concluded." Thus, it has been adopted as a rule that:
Moreover, it is to be stressed that, "a change in circumstances will not be taken into account if it occurred during a delay in performance of the person alleging application of the doctrine, this because the principle is based on the 'good faith' concept."
In sum, although the doctrine of rebus sic stantibus has been applied as a general doctrine to deal with changed circumstance. It is limited, however. Tribunals have adopted a reservation that the rebus sic stantibus doctrine, though general in the sense that it is applicable regardless of a clause to the effect, still should be regarded as an exception to the sanctity rule.
4. Concluding remarks
Different legal concepts exist in all legal systems dealing with the problem of changed circumstances and excusing a party from performance of its obligations when a contract has become unexpectedly onerous or impossible to perform. Some systems only accept a narrow range of excuses; others are more generous (e.g., the concepts of imprévision or hardship, force majeure or Wegfall der Geschäftsgrundlage).
The existence of these related concepts evidences, with the fact kept in mind that the approach of municipal legal systems to the problem of changed circumstances varies from country to country, that "rebus sic stantibus, has in its basic form been incorporated into so many legal systems that it may be regarded as a general principle of law." Indeed, international arbitrations have also admitted, albeit in exceptional cases, the doctrine of rebus sic stantibus. This practice has been further codified under the CISG, UNIDROIT Principles and PECL. Thus, it is arguable that:
1. See Dionysios Flambouras in "Comparative Remarks on CISG Article 79 & PECL Articles 6:111, 8:108" (2002); available at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp79.html>.
2. See Dietrich Maskow in "Hardship and Force Majeure": 40 American Journal of Comparative Law (1992); p. 658; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 126400.
3. See Hans van Houtte in "Changed Circumstances and Pacta Sunt Servanda": Gaillard ed., Transnational Rules in International Commercial Arbitration, ICC Publ. Nr. 480,4, Paris (1993); p. 107; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 117300.
4. See Shael Herman in "Specific Performance: a Comparative Analysis": 7 Edinburgh Law Review, Issue 1 (January 2003) 5-26 and Issue 2 (May 2003), p. 196; available at: <http://www.cisg.law.pace.edu/cisg/biblio/herman1.html>.
5. See Hans van Houtte, supra. n. 3; p. 108.
6. See Liamco v. Libya award, April 12, 1977, Yearbook Commercial Arbitration, (1981); p. 101.
7. See A.H. Puelinckxin in "Frustration, Hardship, Force Majeure, Imprévision, Wegfall der Geschäftsgrundlage, Unmöglichkeit, Changed Circumstances": 3 Journal of International Arbitration No. 2 (1986), p. 47; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 128100.
8. See Berthold Goldman in "The Applicable Law: General Principles of Law - the Lex Mercatoria": Lew ed., Contemporary Problems in International Arbitration, London (1986); p. 125; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 112400.
9. See Hans van Houtte, supra. n. 3; p. 109. See also Goldman, who notes that in the sense that this principle is embodied in practically all municipal legislations (however, not without differences as to its strength, and consequently as to its effects), one could contend that this has nothing to do with lex mercatoria. It is to be noted, nevertheless, that very frequently, when applying pacta sunt servanda, arbitrators do not refer to a particular municipal legislation; they see the principle as a general one, which means that it is applied as an element of the lex mercatoria, and therefore, that its actual consequences are not to be taken from any municipal law whatsoever. (See Berthold Goldman, supra. n. 8.)
10. See Sapphire v. National Iranian Oil Company award, March 15, 1963: International Law Review (1967); p. 181.
11. See Dietrich Maskow, supra. n. 2.
12. See Berthold Goldman, supra. n. 8.
13. See Nagla Nassar in "Sanctity of Contracts Revisited", Dordrecht, Boston, London (1995); p. 193; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 105700.
14. See Clive M. Schmitthoff, Schmitthoff's Export Trade, 8 ed. (1986); p. 146.
15. See Ian Brownlie in "Principles of Public International Law", 4th ed., Oxford (1990); p. 620; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 100900.
16. In American law, Section 2-615 of the UCC excuses contractual performance when presupposed conditions upon which the contract is based have not been met. Also, Section 268 (2) of the Restatement (Second) of Contracts deals with the same contingency. Both provisions have departed from the old common law rule of impossibility and have adopted the new test of commercial impracticability. This test evolved from an "all-or-nothing remedy" to a "loss-sharing doctrine". Thus, excuse or partial relief is awarded if the occurrence of a certain contingency has made the performance of a commercial contract impracticable, i.e., unnecessarily burdensome, unprofitable or unfair to one of its parties. The rationale behind this rule is that no one in the business world is expected to work for free, and parties should not be encouraged to take advantage unjustifiably of the misfortunes of their partners; otherwise, the general stability of the institution of contracting would be threatened. It is, thus, thought far better to introduce the "flexible adjustment machinery" of UCC Section 2-615 and Restatement Section 268 (2), instead of the common law test of impossibility.
17. In English law, the doctrine of "frustration of purpose" excuses performance when the circumstances have changed so much that the performance required by the contract is radically different from that which was initially undertaken by the parties. However, though less far-reaching or more strict than its American counterpart, this common law practice on the other side of the Atlantic is not substantially different from that of American courts. More recently, English judges have been generally reluctant to find that a particular contract has been frustrated. English courts have shown a willingness to imply in all contracts a condition to the effect that if the performance of a contract becomes physically or legally impossible, or if possible only in a very different manner from that originally contemplated, then the contract is dischargeable. The frustrating circumstances, however, must have arisen without the fault of either party. Frustration of the contract may be brought on by a variety of situations, including, for example, physical destruction of the subject matter of the contract, or subsequent legal changes, provided the contingency was not within the parties' contemplations. However, mere hardship is not sufficient under English common law to discharge, or even partially discharge, performance. Also, frustration affecting only part of the contract is subject to the normal conditions of frustration, and only arises in connection with severable contracts or where the supervening event is temporary.
18. In German law, the theory of Wegfall der Geschäftsgrundlage (disappearance of the basis of the transaction) covers the effect of changed circumstances on the contract. It ensued from German court practice and "unmöglichkeit", as embodied in Art. 275 of the German Civil Code (BGB), and provides relief for cases where the original economic basis of the contract has changed. When the circumstances have unforeseeably and substantially changed, the foundations of the transaction have been destroyed and the parties are no longer bound to their original contractual commitments. Requesting the original performance of the contract would constitute bad faith (Art. 242 BGB requires that the contract be performed in good faith.). The Wegfall der Geschäftsgrundlage was quite easily applied in the years of galloping inflation after both World Wars. However, it has been less easily accepted with regard to commercial contracts concluded between businessmen. At present Wegfall der Geschäftsgrundlage is applied rather restrictively.
19. French contract law does not provide relief for changed circumstances which make contract performance more onerous but not impossible. The often quoted French doctrine of imprévision is only applied by French administrative courts to contracts concluded with public entities. In commercial contracts, the agreed contract price is not affected by increased costs or currency depreciation. The doctrine of imprévision is developed by the Conseil d'Etat in connection with contracts involving public services, derived from state practice and based only indirectly on Art. 1134 of the French Civil Code (good faith). The Swiss law of contract has much in common with the French law. In addition to drawing on parallel sources, it also provides for very similar solutions. The Swiss Federal Tribunal has admitted that some long-term contracts may be terminated because of an unforeseeable and fundamental change of circumstances on the basis of Art. 2 of the Code civil (good faith). Only changes which would unjustly enrich one of the parties give rise to such relief. Rebus sic stantibus, however, has to be applied restrictively. The impossibility and foreseeability elements of the frustration doctrine make up the core of the French force majeure and Swiss impossibility doctrines. The French and Swiss doctrines are based on only a few statutory provisions. Both systems enjoy a wealth of court practice from which the details of the doctrines of force majeure and impossibility are drawn. Both permit excusing contractual obligations only in cases of impossibility, unless there is a contractual clause to the contrary. Mere hardship is not sufficient to excuse performance. In addition to demonstrating that performance was rendered impossible, one must show that the occurrence of a force majeure event was unforeseen and not a result of either party's fault. Also, the unforeseen event must have been unavoidable in the sense that the party seeking an excusal of performance could not have prevented it. The harshness of this rule is not as severe as it appears, for it is applied in light of the good faith and equity requirements encompassed in Art. 1134 of the French Civil Code and Art. 2 of the Swiss Civil Code. In fact, international tribunals have awarded relief in cases where the facts far from demonstrated impossibility of performance. This also seems to be the position adopted by the national courts of both states. This brings the definition of force majeure or impossibility very near, if not identical, to that articulated in the doctrines of imprévision and wegfall der geschäftsgrundlage.
20. See Berthold Goldman, supra. n. 8; see also Nagla Nassar, supra. n. 13; p. 200.
21. See Nagla Nassar, supra. n. 13.
22. See Norbert Horn in "Changes in Circumstances and the Revision of Contracts in Some European Laws and in International Law": Horn ed., Adaptation and Renegotiation of Contracts in International Trade and Finance, Antwerp, Boston, London, Frankfurt a.M. (1985); p. 25; available at: <http://tldb.uni-koeln.de/TLDB.html; TLDB Document ID: 113700.
23. See Michael E. Dickstein in "Revitalizing the International Law Governing Concession Agreements": 5/6 International Tax & Business Lawyer (1987/88); p. 75; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 121800.
24. See Joseph M. Perillo in "Force Majeure and Hardship under the UNIDROIT Principles of International Commercial Contracts": Contratación internacional. Comentarios a los Principios sobre los Contratos Comerciales Internacionales del Unidroit, Universidad Nacional Autónoma de México - Universidad Panamericana (1998); p. 118; available at: <http://www.cisg.law.pace.edu/cisg/biblio/perillo3.html>.
25. See Nagla Nassar, supra. n. 13; p. 6.
26. See Norbert Horn in "Changes in Circumstances and the Revision of Contracts in Some European Laws and in International Law": Horn ed., Adaptation and Renegotiation of Contracts in International Trade and Finance, Antwerp, Boston, London, Frankfurt a.M. (1985), p. 25; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 113700.
27. See Hans van Houtte, supra. n. 3; p. 115.
28. See Hasan Zakariya in "Changed Circumstances and the Continued Validity of Mineral Development Contracts": Hossain ed., Legal Aspects of the New International Economic Order, London, New York (1980); p. 274; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 118400.
29. See Ian Brownlie, supra. n. 15.
30. See Reinhard Zimmermann in "The Law of Obligations: Roman Foundations of the Civilian Tradition", Munich Cape Town (1990), p. 579; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 109600.
31. See ICC Award No. 8486, Yearbook Commercial Arbitration (1999); p. 167 (also Clunet 1998, at 1047 et seq.; 10 ICC Bull. No. 2, 1999, at 69 et seq.); available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 208486.
32. See ICC Award No. 1512, Yearbook Commercial Arbitration (1976); p. 129 (also Clunet 1974, at 905 et seq.); available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 201512.
33. See Hans van Houtte, supra. n. 3; p. 115.
34. See ICC Award No. 1512, supra. n. 32.
35. See ICC Award No. 8486, supra. n. 31.
36. See ICC Award No. 6281 (1989), Yearbook Commercial Arbitration (1990); p. 98.
37. See Hans van Houtte, supra. n. 3; p. 116.
38. See A.H. Puelinckxin, supra. n. 7.
39. See Nagla Nassar, supra. n. 13; p. 201.
40. See Dionysios Flambouras, supra. n. 1.
41. See Joern Rimke in "Force majeure and hardship: Application in international trade practice with specific regard to the CISG and the UNIDROIT Principles of International Commercial Contracts": Pace Review of the Convention on Contracts for the International Sale of Goods, Kluwer (1999-2000); p. 202; available at: <http://www.cisg.law.pace.edu/cisg/biblio/rimke.html>. (Rimke further notes that: "Although all these concepts are related to each other, since they share important features, the distinction between them is extremely important in drafting choice of law clauses in international contracts.")
42. See Questech Inc. v. Iran, 9 Iran-US Claims Tribunal Report, p. 122; available at: <http://tldb.uni-koeln.de/TLDB.html>; TLDB Document ID: 231400.
43. See Tom Southerington in "Impossibility of Performance and Other Excuses in International Trade": Tuula Ämmälä ed., Private law publication series B:55, Publication of the Faculty of Law of the University of Turku (2001); available at: <http://www.cisg.law.pace.edu/cisg/biblio/southerington.html>.