Paulina Rodríguez*
*Associate in the litigation and arbitration department at Consortium Legal and professor at Universidad Francisco Marroquín (Guatemala).
The Treaty Examiner, Issue 2 (May 2020), pp. 66-70.
It is widely known that parties, through their contracts, can allocate the costs and risks that they are likely to encounter in a specific transaction. The risks that the parties must address will depend on the nature of the transaction. In some occasions the allocation of risks is expressly drafted in the contract, while there are other occasions in which the parties did not agree upon or foresee specific risks. In such scenarios, the law applicable to the contract will help the parties, the judge or arbitral tribunal to allocate the risk and determine which party must assume it.
The present article will address allocation of risk clauses under the 1980 United Nations Convention on Contracts for the International Sales of Goods (CISG) as applied to contracts concluded before and after the COVID-19 pandemic.
Risk Allocation Before COVID-19
Limitation and exclusion clauses are common in international commercial contracts. Such clauses are a way in which the parties allocate risks, in the understanding that if one of the parties breaches the contract, the clause will either (a) exclude their liability or (b) limit it to a specific amount.
Along with other clauses intended to limit risks, such as guarantees, limitation and exclusion clauses used to be the common contractual clauses drafted in commercial transactions before COVID-19.
The most common remedy for breach of contract are damages, which justifies the existence of limitation and exclusion clauses that usually target liability for damages. Because damages are difficult to measure in a precise manner before a breach occurs, the parties may wish to deal with the risk beforehand. The reasons why the parties may want to predict that risk will vary depending on the situation, but most of the time it is to know in advance the amount in payment that a judge or an arbitral tribunal can order.
The limitation and exclusion of liability agreed to by the parties to a contract for the international sale of goods is a matter governed but not settled by the CISG. Regarding claims to compensation for the breach of contractual obligations, primarily regulated by Article 74 of the CISG, parties are free to limit or exclude by agreement the amount that can be claimed and the circumstances under which damages can be claimed.
Commonly, when parties agree on exclusion or limitation of liability clauses, they modify the regime established in the CISG. Parties are empowered to do so under Article 6 of the CISG, which states that the parties may exclude the application of the Convention or derogate from or vary the effect of any of its provisions. This Article allows the parties to modify or derogate the provisions of the convention, including Articles 74 to 79.
Although Article 6 of the CISG gives the parties freedom to derogate remedial provisions, it is important to mention that the obligee must retain at least a minimum adequate remedy; meaning that the limitation and exclusion clauses must not create a situation where performance of the contract becomes optional, subject only to the will of the obligor. That scenario is not possible under CISG since it will contravene both the general principle of reasonableness and good faith in international trade (1).
Limitation clauses
The parties to a contract can express their limitation of liability in different ways: fixed sum, ceiling or cap, percentage of the performance in question, or deposit retained. Parties may limit their liability to a certain amount of money, but also to a certain type of losses: direct damages, consequential damages; and may limit liability to a certain type of conduct, such negligence or fault (2).
Exclusion of liability clauses
Through exclusion of liability clauses, the risk is totally transferred to one of the parties. This type of clauses is more difficult to negotiate since it implies that one of the parties, in case of a future dispute, will not be responsible for any damages.
Risk Allocation After COVID-19
During the COVID-19 crisis, one of the few areas that has not yet fully stopped is international commerce. Although there have been many restrictions in customs and the free movement of goods, international trade has kept on going, even evolving through e-commerce. Therefore, the work for lawyers who draft contracts continues to be challenging each day.
Nowadays, the challenges for the international commercial contracts relies on the foreseeability of allocation of risks. Before COVID-19, price was the main consideration while negotiating the contracts; but now, after COVID-19, the minimization of risk has become the most important aspect to negotiate in the contract (3).
Companies involved in ongoing negotiations are discussing whether to include or exclude pandemics in their force majeure provisions, which in many occasions are boilerplate clauses in many deals. The reason of the inclusion or exclusion of such clauses is the fact that the buyer or the seller my demand to pay more or give up something else for the ability to walk away from a deal in the event of a second wave of the coronavirus or some future viral outbreak. It must be taken in consideration that the pandemic is no longer unforeseeable.
The purpose of this article is not to examine force majeure clauses, which is a topic related to the COVID-19 situation; but what is certain is that in the actual COVID-19 times and in post-COVID-19 contracts, liability clauses will be more present in international commercial contracts and therefore judges and arbitral tribunals will be analyzing more such clauses since disputes will arise.
Nowadays, parties are incorporating so-called ‘corona clauses’ to their contracts, especially in loan agreements and real estate contracts (4). This ‘corona clause’ is the new name for clauses that tend to free businesses affected by viral outbreaks. But at the end of the day, the nature of the ‘corona clause’ is a risk allocation clause equivalent to limitation of liability, exclusion of liability of force majeure clauses.
During the upcoming months and years, there will be disputes arising on what is predictable and foreseeable, but if today’s contracts include “pandemics” or “viral outbreaks”, risk will not only be allocated to buyers or sellers, but also to the lawyers that drafted the contract.
Pre-COVID-19 clauses have led to disputes over agreements struck before the crisis hit. Post-COVID-19 contracts will be more explicit about acts of god and what scenarios can be considered as force majeure events or events that can be considered as a limitation or exclusion of liability.
Gap-filling Provisions under the CISG
As stated before, under Article 6 of the CISG, parties may exclude the application of the Convention or derogate from or vary the effect of any of its provisions. Despite the limitation imposed by the CISG on the contractual liability of the parties, such as the foreseeability rule contained in Article 74, the duty to mitigate in Article 77 and the exemptions due to an impediment in Article 79, there is no provision on the CISG that address specifically the parties’ agreement on the limitation or exclusion of liability for failure to perform the contract (5).
The parties’ agreement on the limitation or exclusion of their own liability falls under the scope of the CISG, since it is a matter connected with the rights and obligations of the buyer and seller arising from the contract and it is related with the scope of the buyer’s or seller’s remedies for breach of contract. Since there is an internal gap in the CISG relating to the type of agreements we are discussing about, the gap must be filled in accordance to Article 7(2), meaning that questions regarding such clauses must be primarily settled in conformity with the general principles on which the CISG is based (6). And only in absence of any general principles, the questions can be settled in conformity with the applicable law or rules of law.
In conclusion, issues regarding pre- and post-COVID-19 contracts can be resolved by the uniform commercial treaties and principles. However, it is important to take in consideration that what must prevail over treaties and international principles is the will of the parties. Contracts are more than words; they reflect the parties’ intent and the costs and risks for the parties involved. That is the reason why every word in the contract must be well thought-out and drafted.
PIE DE IMPRENTA: Juan Pablo Hernández (editor-in-chief), Guatemala, 2 June 2020.
Endnotes
1. CISG Advisory Council Opinion No. 17, Limitation and Exclusion Clauses in CISG Contracts, page 11.
2. See supra note 1, page 4.
3. MILLIGAN, Ellen, et. alt., Corporate Contracts Get a Rewrite for the Post-Pandemic Era, Bloomberg Businessweek, available at: https://www.bloomberg.com/news/articles/2020-05-06/l-brands-wework-fights-point-to-pandemic-premium-in-deals-ahead?utm_campaign=likeshopme&utm_content=www.instagram.com%2Fp%2FCA31cBhnGJ8%2F&srnd=businessweek-v2&sref=xuVirdpv&utm_medium=instagram&utm_source=url_link
4. DOBSON, Amy, Watch out for the “corona clause” being added to real estate contracts, Forbes, available at: https://www.forbes.com/sites/amydobson/2020/03/30/watch-out-for-the-corona-clause-being-added-to-real-estate-contracts/#5c35574e16c5; RENNISON, Joe, “Corona clause” creeps into businesses’ loan documents, Financial Times, available at: https://www.ft.com/content/5ef2d920-686a-11ea-800d-da70cff6e4d3
5. See supra note 1, page 5.
6. Specifically, the principles of freedom of contract and full compensation may be helpful.
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