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Reproduced with permission of 18 Journal of Law & Commerce (1999) 191-258

excerpt from

Transcript of a Workshop on the Sales Convention:
Leading CISG scholars discuss Contract Formation,
Validity, Excuse for Hardship, Avoidance, Nachfrist,
Contract Interpretation, Parol Evidence, Analogical
Application, and much more

Transcribed and edited by Harry M. Flechtner [*]

[Hypothetical case

I. INTRODUCTION

On November 13, 1998, the Center for International Legal Education of the University of Pittsburgh School of Law and the Law Faculty of Meiji Gakuin University (Japan) sponsored a workshop and roundtable discussion on the United Nations Convention on Contracts for the International Sale of Goods ("CISG").[1] The workshop was held in the Rare Books Room of the Library of the University of Pennsylvania Law School, which provided generous support for the program. The purpose of the workshop was to bring together two groups of academics interested in the CISG scholars of substantive international sales law, and researchers in the field of computer artificial intelligence whose work focused on the CISG. Participants included leading CISG scholars from the United States, Japan and Europe, several of whom had been instrumental in the drafting and promulgation of the CISG, and pre-eminent scholars [page 191] of artificial intelligence and the law from Japan and the U.S.[2] Professor Hajime Yoshino of Meiji Gakuin University and Professor Harry Flechtner of the University of Pittsburgh co-moderated the program. The other participants in the workshop were Professor John O. Honnold of the University of Pennsylvania, Professor Kazuaki Sono of Tezukayana University (Japan), Professor Peter Schlechtriem of the University of Freiburg (Germany), Professor Curtis Reitz of the University of Pennsylvania, Professor Joseph Lookofsky of the University of Copenhagen (Denmark), Professor Shigeru Kagayama of Nagoya University (Japan), and Professor Kevin Ashley of the University of Pittsburgh.[page 192]

(...)

SCHLECHTRIEM: In the process of developing and elaborating the Convention, its boundaries cannot be overstepped. I think my hypothetical case can illustrate one of those boundaries. . . .[page 220]

Hypothetical Case by Professor Schlechtriem

In May, 1998, the English shipping company Seastar Cruises ordered a cruise ship of 60,000 tons from the Netherlands shipyard Rotterdam Shipbuilding (buyer). Rotterdam invited a number of European manufacturers of diesel engines to negotiate for supplying the engines for the cruise ship. The invitation was accompanied by descriptions of and specifications for the engines, approximate delivery dates, and a general price framework. A German engine manufacturer, LMU (seller), responded to the invitation by communicating its interest in a contract, and the buyer and seller agreed to negotiate the details of an order for the engines. A letter of intent signed by the CEO's of both enterprises provided that each side would supply two teams to conduct the negotiations: one team, comprised of engineers and an authorized board member, was charged with negotiating the technical aspects of the engines' power, weight, consumption, inspection periods, etc. . . .; the second team, made up of financial and business experts and an authorized board member, was to find agreement on non-technical matters such as the exact time for delivery, the terms of payment, letter of credit requirements, and first payment guarantees for conforming deliveries.

The teams of engineers representing buyer and seller started to negotiate on June 25, 1998. As they reached agreement on specific points, the agreements were recorded in documents until they had reached agreement on all technical issues. On July 15, these documents were merged into a "memorandum of understanding" and signed by all members of the respective teams. The financial and business teams began negotiating on June 27, 1998 and followed the same procedure -- they recorded agreements on specific points and then, on July 10, incorporated these agreements into a comprehensive memorandum of understanding signed by all team members from both sides. Under the original letter of intent signed by the CEO's of buyer and seller, the two memoranda of understanding were to be merged into a single document that would be signed by both CEO's in a formal ceremony. The final signing ceremony was planned for August 15, 1998, to be followed by a celebration by all members of the negotiating teams.

On August 10, 1998, however, buyer was informed that Seastar Cruises, the company for whom the cruise ship was to be built, was in financial straits, and that a bankruptcy proceeding was imminent. Buyer therefore asked seller to delay the planned signing ceremony for several days. On August 15, 1998, buyer informed seller that the deal for the [page 221] ship engines was off because Seastar Cruises was bankrupt and had annulled the shipbuilding contract.

Seller asks for an expert opinion as to whether he can claim damages from buyer for his lost profits from the deal, or at least for the expenses seller incurred to the point of cancellation.

SCHLECHTRIEM: The case is very simple. The parties contracted for an engine to be used in a ship that the buyer intended to build for a shipping company. Buyer sent out invitations for those interested to submit offers -- but the first part of the problem doesn't need intensive discussion; it's very clear. The first part is an application of Article 14. In the second part, offers were submitted and the parties started to negotiate the details of an order. And now we come to the first interesting point: a letter of intent was signed by both CEO's defining how to proceed in these step by step, point by point negotiations. What is the character of this letter?

REITZ: What is the legal effect?

SCHLECHTRIEM: Yes, what is the effect of the letter of intent in such situation. Is this a contract to contract? How would you characterize it? And would you treat it as governed by the Convention? I would bring it under the Convention, and I would say it's a contract to contract in good faith.

HONNOLD: Are you going to leave that or come back to it?

SCHLECHTRIEM: I will give an overview of the entire problem, and then return to particular issues. The parties came to an agreement on all important points by using two negotiating teams comprised of experts -- one team for the business side of the deal and one for the technical side. These two teams each produced a memorandum of understanding signed by all team members. That raises the issue whether there is a contract at this point, and what is the legal significance of the final ceremony, provided for in the very first document between the parties, in which the CEO's of the parties would sign a written contract and then have a nice party. Is the contract not concluded until the final signing ceremony, or is it already formed when the negotiating teams signed the memoranda of understanding? The answer, I think, depends on the intention of the parties. They could have meant -- and this is quite likely on the facts of my case -- that a binding contract would be concluded when the negotiating teams signed their memoranda of understanding, because at that point you have a meeting of the minds and agreement on all points. The rest they might have intended merely as a formality. On the other hand, of course, the parties may have agreed that a formal instrument [page 222] must be signed in order to form the contract. In that case, the signing ceremony to take place on August 15 would conclude the contract, and everything before would be mere preparation.

HONNOLD: Are you going to come back to that point too?

SCHLECHTRIEM: Yes, I will later on. Suppose you decide that, by the understanding of the parties or under their contract to contract, a binding agreement could be concluded only by the final signing ceremony on August 15. Then what happens if one party walks out before the ceremony occurs and says, "I won't go through with the transaction"? I think that takes us to the question of the limits to which we can develop the Convention. Now we have a question of pre-contractual liability for breaking off negotiations at a certain point. Can there be liability in damages to the other party for the expenses so far incurred, or for even more? This, I think, is outside the boundaries of the CISG. We cannot develop the European culpa in contrahendo idea, the pre-contractual liability doctrine, as a uniform doctrine inside the boundaries of the Convention. But we will probably return to this point later. I can explain then why I'm negative about the prospects of including this idea of pre-contractual liability -- in cases involving the breaking off of negotiations that have reached a certain point, for instance -- as part of the development of uniform rules inside the boundaries or limits of the Convention. That was my overview. Now I'm willing to defend and discuss my ideas.

FLECHTNER: Do you want to go back to the first issue -- the contract to contract, the letter of intent?

SCHLECHTRIEM: The letter of intent? Fine.

HONNOLD: May I ask a question?

SCHLECHTRIEM: Yes, please.

HONNOLD: I would suppose in general you might be right about the significance of the meeting of the parties, but do you suppose the ultimate analysis would depend on the practices of the parties and the practices of the trade involved? [The impact of CISG Article 9 on practices and usages will be considered at the end of the present hypothetical case.]

SCHLECHTRIEM: Certainly that has to be taken into consideration. Let me add one point that I had been saving to rebut criticism, but so far that hasn't been necessary: If I say that a contract can be concluded without a clearly identifiable offer and acceptance, what would be the basis for developing the Convention to permit formation without offer and acceptance? I think the basis would be Article 6. Under Article 6, party autonomy allows the parties to deviate from all provisions and all rules [page 223] of the Convention, and, therefore, they can also deviate from the prescribed method of forming a contract by offer and acceptance. They can, by entering into a contract to contract, agree on a different path to formation of the contract. That would be the basis in the Convention to reach the desired result -- to have contract formation without offer and acceptance, but by this process of negotiating and agreeing on every point, step by step.

REITZ: Is the Article 6 argument that the formation provisions of the Convention are being deviated from, but not the rest of the Convention. The rest of the Convention still applies?

SCHLECHTRIEM: Yes. It's up to the parties to decide from what provisions of the Convention they want to deviate. In my case, they only wanted to deviate from the offer and acceptance rules of Part II of the CISG. Let me try to forge a link to the discussion of this morning, when we discussed the question of contract formation by shipping goods, and whether shipment was to be regarded as an acceptance despite the fact that no notice of the shipment had been communicated to the offerree. Even if you are reluctant to treat this as governed by Article 18(3), there could still be an understanding of the parties that in a situation involving a counter-offer it would not be necessary that notice of acceptance of the counter-offer be given -- thereby deviating from Article 18(1). So under the Convention, parties are free to make their own rules as to formation of contracts.

FLECHTNER: May I play the lawyer, as you did this morning?

SCHLECHTRIEM: Yes, please.

FLECHTNER: Isn't there a circularity problem here in the sense that, for Article 6 to apply, the parties have to agree to derogate from the Convention's formation rules, yet the issue here is whether they have agreed at all? How can you find an agreement to derogate without having first found an agreement?

SCHLECHTRIEM: This is familiar logical problem. It is a common conflict of law issue where you have a choice of law clause and you have to decide whether the choice of law clause is valid. Under which law do you decide whether the law clause is valid? The common sense answer -- although it violates logical thinking -- is that the law designated in the choice of law clause should apply to answer the question whether the choice of law agreement was valid. And I would give the same answer here.

FLECHTNER: So you like the common sense answer despite the mild violence it does to logic? [page 224]

SCHLECHTRIEM: Yes.

LOOKOFSKY: When you don't have a classical offer and acceptance, is the question of whether a contract has been concluded under Article 23 in fact a matter which is governed by but not settled in the Convention? Isn't that another way of presenting your argument?

SCHLECHTRIEM: It's a problem that was not addressed. Whether it was overlooked or not I can't say because I do not know the thoughts of the delegates.

LOOKOFSKY: To carry this a step further, Article 23 says a contract is concluded at the moment when an acceptance of an offer becomes affective. You're saying, that's one way, but not the only way, of doing it. And under Article 7(2) we could say that the question of whether a contract for the sale of goods is concluded by other methods is a matter governed, but not settled by the Convention. We can look to general principles of the CISG to determine ways other than through offer and acceptance in which contracts can be concluded.

SCHLECHTRIEM: Right.

YOSHINO: Are you going to give us a general theory of contract formation, which is independent of the offer and acceptance regime?

SCHLECHTRIEM: I'm not going to give a general theory, but I just want to point out that different methods of forming contracts are allowed under Article 6, if the parties are in agreement.

YOSHINO: When you cite Article 6, your argument about formation of contract is grounded in the CISG. But I think in general, offer and acceptance is not required to form contracts. Today we have discussed several contract-concluding processes that do not directly correspond to the offer and acceptance process. Therefore, we could devise a theory of contract formation under which one can conclude a contract, for example, by cooperative working as in your case. It is clear that everyone can make his own rules as a result of party autonomy. Thus, we could have a general theory of formation of contract that allows a contract to be formed without an offer or acceptance. What is your opinion of that?

SCHLECHTRIEM: You can develop such a general theory on formation of contracts, but before I would dare to do so I would first want to collect all the situations where a contract appeared to be formed without offer and acceptance. I've given an example of one such situation here, where the parties agreed to negotiate point by point, step by step. Another situation where offer and acceptance does not seem to work is where the contract is fully negotiated but not yet formed, and then the representatives of the parties sit around a table and a document is passed [page 225] around and everyone signs. It would be silly to say the first signature is the offer and the next signature is the acceptance. You have to abandon the model of offer and acceptance.

I am far from claiming to know all the situations which could be covered by a general theory of contract formation outside the offer-and-acceptance model, but a third situation involves crossing offers. Suppose the parties have already had contacts, and they know what they want, and each sends a letter at the same time: one letter says, "I'm willing to deliver this," and the other indicates a willingness to buy the same thing. These crossing offers should constitute a contract. Article 23, however, creates a problem for formation of contract by any means other than offer and acceptance. Under that provision, you have to determine when exactly the contract came about.

It might also be important for particular conflict of law rules to determine where the contract was concluded. We generally say it is concluded where the last creative communication became effective. If acceptance is effective upon receipt, then the contract was formed at the place where the acceptance was received. But then you have a famous English case adopting the dispatch theory, under which the place of formation is the place where the acceptance was dispatched. As to that, I have another idea not yet fully developed. I'm reluctant to say this, but I think Article 23 should have been omitted. You don't find it in the Uniform Law on Formation [ULF], (the predecessor UNIDROIT treaty on contract formation), and for a good reason.[6] The reason is that the answer to the question where and when a contract was formed really depends on the reason we need to know the time and place of contracting. Suppose, for instance, a provision of tax law requires a determination of the time that a certain contract was concluded. The meaning of the time of contract formation in the context of a tax regulation could be quite different from the meaning of the time of contract formation in connection with another regulation. So rather than looking to Article 23 to determine the time and place of contract formation, I would look to interpreting the regulation that necessitates determining the time or place of formation. I think determining the place of contract formation for conflict of law purposes, for example, can be entirely different than determining the place of formation for purposes of other regulations. [page 226]

LOOKOFSKY: I didn't mean to imply that we should use the principle in Article 23 to determine whether a contract had been formed in an example like yours. I think the principle we should use has already been mentioned, and that's the question of whether the parties intended to reach an agreement or not. We have that principle in Article 14. So maybe we could begin to construct a general principle from that. To use Article 7(2) we are going to have to find some general principles. You're indicating what some of them might be, and you're cautious. And I think I agree. But there is an expression of a principle in Article 14 that we might be able to develop into a general principle -- that the intention of not just the offeror but of both parties is decisive.

SCHLECHTRIEM: Yes. The intention to be bound.

HONNOLD: My book played elaborate disrespect to the concept that a contract could be made only by a formal offer and acceptance. Memory being what it is at my age, I'm going to have to look back and see whether I took account of Article 18, which suddenly leaped at me during our discussion. Article 18(1) says, "[a] statement made by or other conduct of the offerree" -- conduct "indicating assent to an offer is an acceptance." I think that language is pregnant with meaning.

SCHLECHTRIEM: And the same applies to the offer, too.

HONNOLD: You may never know who is the offeror and who is the offerree when they're going back and forth, saying this or that. You can't identify number one or number two.

YOSHINO: I'd like to ask Professor Kagayama to explain his views concerning formation of contract and party autonomy, which I think are very similar to the views of Professor Schlechtriem.

KAGAYAMA: Freedom of contract means that a party can choose how to proceed. In this case, the parties wanted to form the contract with the signing ceremony.

SCHLECHTRIEM: That depends on what they meant by that ceremony -- whether it should constitute the point of contract formation, or just a ceremony celebrating that they had already reached agreement through the efforts of their two negotiating teams.

KAGAYAMA: The two parties agreed that the contract was not concluded until the signing ceremony occurred.

SCHLECHTRIEM: I do not think so. My own solution to the case would be that this last ceremony was not a special kind of formal requirement necessary for the final formation of an agreement, but it was just what is not uncommon in large transactions -- when everything is settled and everyone is in agreement there's a kind of celebration where [page 227] both parties come together. But the celebration does not create the contract, and it does not have to occur for the contract to be concluded.

KAGAYAMA: This question is governed by Article 6?

SCHLECHTRIEM: Article 6 is the basis for the deviation from the normal formation procedure under the Convention involving offer and acceptance. In my problem, the parties agreed to negotiate point by point, and in the end, when there is an agreement on all points, the negotiating teams sign a memorandum of understanding without regard to whether there was an offer and acceptance.

KAGAYAMA: The UNIDROIT Principles of International Commercial Contracts may be relevant here.

SCHLECHTRIEM: The Principles have a provision saying that a contract can be brought about by means other than offer and acceptance.

KAGAYAMA: And you agree?

SCHLECHTRIEM: Yes, of course.

LOOKOFSKY: I'm just going to get the last part of the problem into the discussion as well. Let's assume that the contract has been formed.

REITZ: Are you at the letter of intent stage?

LOOKOFSKY: No, I think we're at the memorandum of understanding stage. It was there, I believe, Professor Schlechtriem, that you said there was a CISG contract.

SCHLECHTRIEM: Yes.

LOOKOFSKY: I think we should come back later to the question whether the letter of intent was also a CISG contract. I'm not sure about that.

SCHLECHTRIEM: I also think we could come back to that.

LOOKOFSKY: Yes, but just the point I wanted to get to now was this: if there was a contract because the parties intended there to be the contract, then I suppose you will award the seller full damages for breach of contract because there is no excuse here valid under the CISG for non-performance.

SCHLECHTRIEM: Yes.

SONO: Professor Schlechtriem, now that I understand your view that the signing ceremony was a mere formality and that a contract was formed before the ceremony occurred, may I ask a question? In your hypothetical there were two teams, and each team negotiated. First one term agreed on a memorandum of understanding, and then the other team agreed on another memorandum. Then on the fifteenth of July, these two memoranda of understanding were to be merged into a single [page 228] document, and then the formal signing ceremony would occur. But the two memoranda of understanding from the negotiating teams each related to different aspects of the transaction which were distinct from one another. How can those two memoranda of understanding, relating to two different aspects, be regarded as a contract between the parties?

SCHLECHTRIEM: The two parties intended it to be so.

LOOKOFSKY: But we all know that when the lawyers from each side get together they could easily destroy this deal when it was time to merge the memoranda.

SCHLECHTRIEM: Yes, of course. The procedure used by these parties is not a foolproof one. If I had been called in before the parties signed the letter of intent describing the negotiating procedure, I would have advised them to make it clear that they intended to be bound upon the execution of the second memorandum of understanding, and also to make it clear that the signing ceremony was just a formal act to celebrate the completion of the deal. But in the real world, when a letter of intent like the one in my hypothetical is signed, the people involved are so happy to be near a deal that, even if you were sitting next to them whispering into their ears to be sure to include such a clause, they would ignore your advice in order to avoid having to open new negotiations. That is in fact what I experienced in the actual case -- there were lawyers saying, "Be careful, make it clear that the last memorandum of understanding binds the parties to a contract."

HONNOLD: Could one of the parties walk away from the transaction between the time the two memoranda of understanding were signed? Could one party say, we won't go ahead with the deal?

SCHLECHTRIEM: They certainly could, and by doing so the party could prevent the formation of the contract. Whether that would create pre-contractual liability is an issue outside the ambit of the Convention, I think. As for that question of pre-contractual liability, although I'm afraid there might other opinions, I think you have to revert to domestic law. I promised to explain why I think we cannot develop that under the Convention.

HONNOLD: When are you going to do that? I need that information.

SCHLECHTRIEM: Well, I will try to get the exact page citation to the third edition of my commentary. [Laughter.] The reason why I'm reluctant to develop uniform rules for this issue on the basis of Article 7 of the Convention is that the various legal systems of the world differ considerably in their approach to the question of pre-contractual liability.[page 229] Systems like the French and Italian, which have a general tort clause providing that you have to pay damages for any losses caused by your fault. They can cover these situations by saying it's a tort to break off negotiations at a certain point. Other systems, like the German system, don't have a general clause creating tort liability for purely economic loss, which is the issue here. They have to develop quasi-contractual tools for these situations. The so-called culpa in contrahendo doctrine is just that kind of quasi-contractual tool designed to overcome the shortcomings of our tort law, which doesn't cover, as I understand it, purely economic loss.

HONNOLD: I am right with you in thinking that you cannot get culpa in contrahendo out of the Convention, even though -- as you may know I'm very strong for developing the principles of the Convention. But I don't think you have enough principles in the Convention dealing with culpa in contrahendo to provide a scaffolding for the development of that doctrine. I'm anxious to see how you write your views up.

SCHLECHTRIEM: I shall write them up as I have tried to explain them here.

HONNOLD: That's fine.

SCHLECHTRIEM: In order to develop uniform rules on a question, it first of all must be a matter governed by the Convention. I think everything at happens before the conclusion of the contract -- although you could try to read the Convention more broadly -- isn't really governed by the Convention.

HONNOLD: I think you're saying something like what I was trying to suggest. You need some kind of structure -- some sort of a baseline or springboard.

SCHLECHTRIEM: Yes. Even if you're very liberal and say the Convention extends to the pre-contractual period, you still need to identify a principle that could be the basis for developing rules. Those steps are very uncertain and dangerous.

HONNOLD: I agree.

LOOKOFSKY: I think one of the appealing aspects of considering this question to be governed by but not settled in the Convention is that you don't need much of the scaffolding you were talking about. It seems to me that the American U.C.C. cases that try to determine whether a contract has been made or not, even though something is missing, rely to a large degree on whether the parties intended to make an agreement at that point, and there's not much more to it. There isn't really a lot more theory, at least in the cases that I'm familiar with. In other words, if we [page 230] try to stay within the Convention and to avoid going to domestic law on this issue, what are we missing? Is there something lacking that we need? I don't see that a lot is missing, if we follow this approach. On the other hand if we talk about whether other issues are within the scope of the Convention, then we may start to disagree. I think, for example, that perhaps I disagree with both of you on the question of product liability. I don't feel that the Convention has all the product liability scaffolding necessary so that it should absorb tort claims. I would rather see competing rules in some situations.

SCHLECHTRIEM: That would be a topic for an additional seminar.

LOOKOFSKY: Definitely another seminar.

SCHLECHTRIEM: And I would enthusiastically participate.

LOOKOFSKY: But right now I'm just comparing the product liability issue to the question of pre-contractual liability you raised. Here I see fewer problems.

KAGAYAMA: In this case neither party committed a culpa [wrongful act], did they?

SCHLECHTRIEM: Well, you could see a culpa in intentionally breaking off negotiations without just grounds.

YOSHINO: If the buyer had gone into bankruptcy, clearly the buyer would be responsible for breaking the negotiations. But here, it is the buyer's customer that has gone into bankruptcy.

SCHLECHTRIEM: That's a good point. You are pointing out, Professor Yoshino, that it is not the fault of the buyer that his customer went bankrupt, and, therefore, his breaking off negotiations might not constitute fault in the sense of culpa in contrahendo, making him liable for the breaking off. That's a very good point, and it shows again what was mentioned about the need for principles to develop rules on pre-contractual liability. Of course, we would need to know more facts. Without more facts, I would think it is the buyer's risk whether his customer will take the goods he is ordering. If he doesn't want to take that risk, he should insert a clause providing that his obligation to purchase is conditional upon his customer's financial ability or willingness to take the ship.

REITZ: Could that be implied?

SCHLECHTRIEM: Well, that depends on the circumstances. I don't mean to sidestep difficult questions, but I think it's really a matter of the circumstances.

REITZ: On the facts, it appears to me that this subordinate contract for engines is clearly made with knowledge of the cruise ship contract. [page 231]

SCHLECHTRIEM: Yes.

REITZ: And the engines were being purchased specifically and exclusively for that cruise ship. There is a linkage there that I think would give rise to a frustration-type defense.

SCHLECHTRIEM: But didn't the buyer assume the risk that he might not be able to use the machines he ordered? If he doesn't want to take that risk, he must put in a clause that allows him to cancel.

SONO: Does it depend on the kind of risk we are talking about? If the engines could only be used for the particular ship of the buyer's customer, and could not be used for any other purpose, perhaps then a condition should be implied.

SCHLECHTRIEM: I would think just the opposite. What would the seller do with the engines if there were no other use for them?

SONO: That's true for the buyer also.

SCHLECHTRIEM: Yes, but that's a risk he's taking in buying such a machine.

LOOKOFSKY: Is this argument any different if we are talking about the culpa in contrahendo situation as opposed to the situation where we found the parties had a binding contract?

SCHLECHTRIEM: It's an issue that arises on both sides of the line. If you say it's not entirely the risk of the buyer, then it might be justified for the buyer to break off the negotiations at the last point before the contract was concluded. And, therefore, there would be no culpa. But at least under German law, if it's your risk, then you don't have a justified reason for breaking off negotiations.

LOOKOFSKY: If we are on the side of the line where a contract has already been formed -- that is, if we say that the memoranda of understanding conclude[d] the contract -- then I would expect you to make the argument that under Article 7(2), the so-called frustration of purpose cases are subsumed or preempt by Article 79, and that if there's no excuse under Article 79, then there's no excuse at all. I agree with that. But I understand you to say that it might be somewhat different if we are prior to the binding contract stage. And the extent of the damages could also be different.

SCHLECHTRIEM: Yes.

REITZ: The Article 79 issue is subject to Article 6. And in particular fact situations there can be an implied derogation from Article 79.

YOSHINO: As regards the culpa in contrahendo issue, Professor Kagayama can introduce you to a Japanese case which relates to this issue.[page 232]

KAGAYAMA: Professor Kagayama first quoted Article 2.15 of the UNIDROIT Principles of International Commercial Contracts, which provides as follows:

"(1) A party is free to negotiate and is not liable for failure to reach an agreement.
"(2) However, a party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party.
"(3) It is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party." [7]

The Japanese Supreme Court has decided a case applying very similar principles -- the Decision of September 18, 1984, Conf. Hanrei Jiho No. 1137, p. 51. In that case, a dentist (buyer and defendant) wanted to open a clinic, and, therefore, entered into negotiations to conclude a contract for the purchase of space in a suitable building. During the negotiations, the buyer specified the space needed for the dental clinic, gave the seller plans for the layout of the space, pointed out that the existing space lacked the electrical capacity required for the clinic, and implicitly authorized the owner to change the design and construct facilities suitable for the clinic. After six months, however, the buyer broke off negotiations because he had decided that the space available in the seller's building was too small.

The Japanese Supreme Court held that the buyer was liable to the seller for losses caused when the seller changed the design of the space and incurred construction costs, because the buyer had not acted in good faith in negotiating the contract.

The holding is similar to the position of the UNIDROIT Principles, and the case is similar to your hypothetical case, Professor Schlechtriem.

SCHLECHTRIEM: They are similar.

YOSHINO: If the buyer rather than the buyer's customer had gone bankrupt in your hypothetical, Professor Schlechtriem, the cases would be almost the same.

SCHLECHTRIEM: Your reference to the UNIDROIT Principles, Professor Kagayama, helps me give an answer to your question, Professor Reitz, concerning whether the bankruptcy of the buyer's customer would give the buyer a defense. The "Hardship" provisions of the UNIDROIT Principles, which were drafted along the lines of the German [page 233] law, I believe, and which deal with hardship interfering with the performance of a contract, have a good description of the risks that a contracting party assumes. Article 6.2.2 of the Principles says that "hardship" occurs "where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished and" -- now comes an important limitation -- "(b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract."[8] I think the possibility that the customer of the buyer would become bankrupt is something that could reasonably have been foreseen by the buyer himself, and he should have inserted a clause into the contract, or into the first instrument the parties executed to allow him to get out of the negotiations at the last point.

FLECHTNER: Suppose it had been the seller of the engines who had learnt about the shipbuilding opportunity with Seastar and had realized it was a chance to promote use of its engines, and it was the seller who contacted Seastar and then structured the transaction so that the seller sold the engines to the buyer and the buyer sold the ships to Seastar. Would you that change your opinion?

SCHLECHTRIEM: Yes, because then I would regard the possibility of Seastar's bankruptcy as part of the seller's risk. He wanted to have this end-customer, and he had negotiations with the end-customer. In that situation, I would think that he shouldered at least part of the risk that the end-customer might go bankrupt.

FLECHTNER: So it's the party who dealt with the party that went bankrupt, had the relationship with the party that went bankrupt, who bears the risk of the bankruptcy?

SCHLECHTRIEM: That's right. In the variation you propose, the involvement of the buyer Rotterdam Shipbuilding would be a sort of accident. The Seastar Company could have bought the engines directly from the seller, and then it would be clear that Seastar's bankruptcy would be a risk of the seller.

REITZ: We have, at least in some parts of U.S. commercial law, a notion that when a circumstance like this arises, it is not an excuse in the sense that it would allow the disadvantaged party to walk away scot free, but it is sufficient to terminate the contract without liability for expectation losses -- only restitution damages would be required, or at least some [page 234] limited remedy based on allowing cancellation of the contract in mid-performance. Is that possible under the Convention?

SCHLECHTRIEM: I wouldn't think so, if we were talking about a contract that was not concluded. It would be possible under the UNIDROIT Principles.

REITZ: Suppose the contract was concluded, and some performance has taken place, but it is not fully performed. Then the contract is terminated, and the ultimate result is the cruise ship is not going to be built.

SCHLECHTRIEM: In its "Hardship" provisions, the UNIDROIT Principles adopted the solution that first the parties have to renegotiate. There is nothing really to renegotiate in my hypothetical situation. If the parties don't reach an agreement, they can turn to the court and the court can adapt the contract to the changed circumstances, or it can terminate the contract. I would think that is can terminate the contract and award compensation for certain reliance losses to the other party. The court can find an equitable solution.

REITZ: But could that be done under the Convention?

SCHLECHTRIEM: I have to give one of my doctoral candidates that issue, and after the doctoral thesis we will hope to know better. [Laughter.] Actually, I think doing that would stretch the Convention very far, although perhaps not too far. This point was also on my mind during out discussion this morning. You have to picture for yourselves the delegates at the 1980 Vienna Conference. They were from different legal systems, with different preconceptions and convictions. When we talked this morning about a specified price as requirement for contract under the Convention -- this was in particular the idea of the French, and they were adamant about including a requirement that an offer must specify a price. In the meantime, the Supreme Court of France has given up that requirement. The same observation might apply to this doctrine of adapting contracts to changed circumstances, in particular in these hardship cases. The French are adamantly against any interference with contracts based on a change of circumstances.

REITZ: Pacta sunt servanda.

SCHLECHTRIEM: Yes. There is a French case from the beginning of the nineteenth century where an entrepreneur promised to keep a channel free, to dig it out whenever it silted up, for 50 francs a year, and he was held to that contract a hundred years later. No change of circumstance or re-evaluation of the terms of the contract was considered. But in that regard the attitude of the French seems to have become more liberal, because my French colleagues at UNIDROIT agreed to the "Hardship" [page 235] provisions of the Principles, against the deeply held convictions of the French legal community. So perhaps we are moving to a situation where the majority of Contracting States would have a rule of hardship and of adapting contracts. There is, of course, a very strong reluctance to entrust judges with making contracts, and I think this may exist in your country too, Professor Reitz. So I hesitate to predict that in the near future there will be a favorable atmosphere for such a rule. But if there was movement toward such a rule among Contracting States, then I think it would be possible to develop a similar doctrine under Article 7(2) of the Convention by saying there is a gap in the CISG with regard to hardship rules. Then the gap could be could be filled by invoking the general principles of the Convention, and those general principles include good faith and fair dealing, and this requires that both parties try to adapt the contract in event of unforeseeable developments.

REITZ: I'm really pushing on how far your Article 6 arguments goes in circumstances other than formation.

SCHLECHTRIEM: Well, that wouldn't be an Article 6 question. That would be Article 7(2).

REITZ: It could be that also.

SCHLECHTRIEM: I would say Article 7(2) because my argument is based on the idea that there is a gap in the Convention. That could be disputed, of course, because at the time of the drafting of the Convention the hardship problem was regarded as covered by Article 79. That's my impression.

REITZ: And adaptation of the contract was not included as part of the Convention at that time?

SCHLECHTRIEM: Correct.

SONO: Would you find adaptation to be part of the Convention now?

SCHLECHTRIEM: I would be liberal in finding gaps, then finding general principles of the Convention, and then filling the gaps by rules derived from the principles.

HONNOLD: May I add a footnote to the argument I was making earlier in support of your views against a Convention rule on culpa in contrahendo? I mentioned that I thought there wasn't enough of a springboard in the Convention for such a rule. I would now add the suggestion that, in this setting, there is not enough of a springboard to create the kind of uniformity that the Convention was designed to produce. It's an area that is too amorphous to think that a few lawyers' views would produce [page 236] a basis for the kind of uniform rule that a world-wide body of people -- 53 countries now -- would be obliged to follow.

SCHLECHTRIEM: Yes, it is a bit forward perhaps to say that not all 53 Contracting States or jurists from 53 Contracting States must be of the same opinion.

HONNOLD: No, not at all. But you have to have a basis for uniformity.

SCHLECHTRIEM: Are you aiming at a rational basis for a rule for adapting contracts, adjusting to changed circumstances in hardship cases?

HONNOLD: No, I was just talking about matters that seem to be external to the Convention.

SCHLECHTRIEM: With regard to the problem of hardship and adjustment of contract, I think I could argue, first of all, that it's a matter governed by the Convention -- a disturbance in the performance of the contract brought about by certain events not fully covered by Article 79. Of course, that view could be disputed.

HONNOLD: I confess, I wasn't addressing that hardship argument. I was thinking about something else.

SCHLECHTRIEM: Yes, the pre-contractual liability argument. But if you ask me whether there is somewhere in the Convention the principle of adjustment or adaptation of contracts, I would put forward a very provoking argument. I think the remedy of price reduction in Article 50 of the Convention is a kind of adjustment of the contract to reflect a disturbed balance between performance on one side and obligation on the other side. The defects in the goods, or the non-conformities of the goods, constitute a disturbance of the equilibrium or balance of the exchanged performances. That is why we defended price reduction -- as a just instrument for adjusting the disturbed balance of performances. Of course the Common Law countries who are not familiar with the price reduction remedy regard it as something entirely different -- as a kind of damages set-off against the purchase price. But if you can accept the notion that it has an entirely different function and aim, then it could be -- it's a bit speculative, of course, but in a workshop like this you should allow such speculation -- then you could use this principle as a springboard to develop a general rule of adjustment in hardship cases.

HONNOLD: The interesting facts of our Hypothetical Case stated: Seastar ordered a cruise ship of 60,000 tons from Rotterdam (R). Of course, CISG does not govern the purchase of a ship: Article 2(d). However, the dimensions of this transaction may be relevant to the relationship [page 237] between Rotterdam (R) and the construction and purchase from LMU of the ship's engines, one of the vital steps necessary for R's construction of a large ship. The facts do not state whether Seastar and Rotterdam had agreed on the price for the ship, either prior or subsequent to the negotiations between R and LMU concerning the specifications of the ship's engines, and the cost of their construction. Normal business prudence would suggest that R would not venture large expenditures of construction costs without arrangements for payments by the buyer, Seastar. Similarly, under prudent business practices, it would be surprising if R could come to a final agreement with LMU on final costs, and payments for the ship's engines, before R had a binding agreement with Seastar with respect to total costs and procedures assuring payment.

In litigation or arbitration, against this setting it would seem useful to call witnesses, experienced in transactions of this character and magnitude, for information whether arrangements by the two mixed teams normally would be final, or whether the agreed periods between July 10 and August 15 would normally be available for consideration by the chief executive officers of the two parties, especially examination by R's officers of the financial responsibility of Seastar for outlays of this magnitude. Information by this examination that Seastar was on the verge of bankruptcy would, of course, have presented R from finalizing a contract with LMU, and precluded a claim by LMU for breach of contract. Whether LMU would have a claim against R for a share of the expense of the preliminary studies would, as earlier discussions have shown, depend on prior agreement by the parties or, in some jurisdictions, domestic law.

Now, contrary to the above views, let us assume that the preliminary studies are binding. In this setting the following might arise. Seastar's bankruptcy would prevent R from building the ship for Seastar. May LMU build the engines, at R's expense, although R would have no use for engines made to these specifications? Some of the early discussion, above, seemed to suggest that this might be possible. Would not such needless waste be barred by CISG 77: "A party who relies on a breach on contract must take such measures as are reasonable in the circumstances to mitigate the loss. . . ."[page 238]

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FOOTNOTES

* Professor of Law, University of Pittsburgh School of Law. J.D. 1981 Harvard Law School; M.A. 1975 Harvard University; A.B. 1973 Harvard College.

1. United Nations Convention on Contracts for the International Sale of Goods, Apr. 11, 1980, S. Treaty Doc. No. 98-9 (1983), 19 I.L.M. 668 (1980) [hereinafter "CISG" or "Convention"] (entered into force on Jan. 1, 1988), available in 15 U.S.C.A. app. at 49 (West Supp. 1996), 52 Fed. Reg. 6262-80, 7737 (1987), U.N. Doc. A/Conf. 97/18 (1980).

2. For further information on the participants, please see "About the Participants in the CISG Workshop" at pages 194-95.

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6. Convention Relating to a Uniform Law on the Formation of Contracts for the International Sale of Goods, done at the Hague, July 1, 1964, 834 U.N.T.S. 169, 3 I.L.M. 864 (entered into force Aug. 23, 1972) [hereinafter "ULF" or "Hague Convention"].

7. See UNIDROIT: Principles of International Commercial Contracts, Principes d'UNIDROIT Relatifs aux Contrats du Commerce International (International Institute for the Unification of Private Law ed., 1994), 34 I.L.M. 1069 [hereinafter UNIDROIT].

8. Id.

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