European Union: A New European Contract Law For Us All?

Last Updated: 26 October 2011
Article by Jason Rix

The tri-partite pincer movement by Viviane Reding (Vice President of the Commission) from Luxembourg, Diana Wallis MEP (Vice President of the European Parliament) from the UK, and Klaus-Heiner Lehne MEP (Chair of the Committee on Legal Affairs) from Germany looks set to make European contract law a reality soon.

On 3 May 2011, at a hearing organised by the European Conservatives and Reformists, Ms Reding announced the publication of an Expert Group's " feasibility study" on a European contract law for consumers and businesses. It was clear from what Ms Reding said at this hearing that the Commission is almost certain to make a legislative proposal to the European Parliament and Council in autumn 2011. Despite the profound change this new law could herald, there continues to be a lack of engagement by the public and indeed some lawyers on this issue. Perhaps contract law is seen as a dry and remote topic. The concept has been debated for many years but the reality is that this is no longer a hypothetical issue.

In this article, I look at:

  • what the Commission's proposal is,
  • the Commission's case for change,
  • why it matters to business (even though it is described as "optional"),
  • the perceived advantages and disadvantages of the Commission's proposal,
  • what the draft code currently looks like, and
  • what the next steps are.

I also try to capture some of the politics of the debate.

The Green Paper and the "optional instrument"

Officially, the Commission is still considering the original seven different options set out in the Green Paper (ranging from mere publication of the Expert Group's feasibility study through to wholesale harmonisation of all civil law in Europe). In fact, the Commission has already published the Expert Group's feasibility study (thereby implementing option 1), and in its accompanying press release referred to it as "a toolbox for any future EU initiative in the field of contract law" (suggesting the study could of itself fulfil option 2). The feasibility study acknowledges that nobody favoured option 3. The harmonisation options (5 to 7) were seen by most as premature. In practice, the only option that remains is option 4, the so-called "optional instrument", which will create a new, and entirely free-standing, pan-European law of contract. It now seems likely that, despite the objections from business and consumers, the Commission will propose the optional instrument in the autumn.

What is the Commission's justification for the new law? And what do others think?

Ms Reding believes passionately that the optional instrument will protect both consumers and small businesses across Europe. The examples given by Ms Reding as to why we need the law (which also appear in the feasibility study) include: a Mrs Korhonen from Turco, Finland whose daughter, Taru, wants to buy clothing from Paris; as well as a Mr Kowalski, the owner of a small Polish furniture company, who wants to sell his furniture to German and Italian retailers. Mrs Korhonen, it is claimed, does not shop cross-border because she is uncertain about her rights and therefore faces a more restricted choice and higher prices. Mr Kowalski does not want to pay for the legal and translation costs of contracting under German and Italian law. European contract law is touted as the silver bullet.

However, there appears to be a only a small number of vocal supporters of the new law. Consumers (at least as represented by consumer groups), for whom the law was originally intended, do not like the new law because, as it currently stands, it does not offer consumers the same level of protection as that to which they are currently entitled (under Rome I) in particular that consumers should be protected by rules of the country of their habitual residence that cannot be derogated from by agreement. Big business is predominantly opposed because it interferes, or is seen as interfering, with freedom of contract and allocation of risk. Big business dislikes uncertainty: What does "optional" mean? How different from national laws of contract is the new law? The pan-European organisation (UAPME) representing small and medium enterprises (SMEs) is opposed because it believes that contract law is not a major obstacle to trade. One of the outliers is the UK Federation of Small Businesses. They are cautiously supportive of the optional instrument. In terms of Member States, at the latest count, there are 14 responses of which seven are sceptical (including the UK) with the remainder more ambivalent. Poland, which has the Presidency of the Council of the EU from 1 July 2011, is seen as being supportive of the optional instrument (subject to certain qualifications).

Ms Reding does have the support of the European Parliament, the Legal Affairs Committee of which, on 12 April 2011, approved a report that, in the words of the press release, favours the elaboration of an optional European contract law.

One thing all Member States are united on is the need for a full impact assessment. This is nearing completion. It is being undertaken by IBF International Consulting and LEI Wageningen UR. However, the terms of reference for this assessment, drawn up by the Commission, have caused some to question the process. For example, no or little credence appears to be given to option 1 which is characterised as the "do-nothing" baseline against which any potential changes under the remaining policy options and the impacts are to be assessed. In accordance with the so-called "Better Law making principles", the need for a comprehensive and broad impact assessment includes that of not taking legislative action and focusing on practical issues. Additionally, the impact assessment does not appear to extend to the implementation and training costs for judiciary and lawyers, focusing instead on the perceived cost savings of advising on a single law. Costs are a real concern at a time when the UK MoJ is closing courts.

Isn't it optional?

Often, the first questions posed by business when this topic is mentioned are "Does it really matter? Isn't it optional anyway?" The answer to which is "Yes" and "that depends". The mechanics of the optional element of the instrument have yet to be specified. They are noticeably absent from the feasibility study. The Commission states that it will uphold freedom of contract and, indeed, Ms Reding re-affirmed this at the hearing on 3 May. However, there are various proposals that appear still to be on the table which would mean that the new law would not be truly optional. One possibility is that an online consumer would have "a blue button" (ie the European flag) which, if pressed, would allow the consumer to force the new contract law upon a business with whom it is contracting. Alternatively, some have said that it is unrealistic for consumers to be able to decide which contract law should apply to their contracts; the only practical alternative is for businesses to prescribe the choice. There are then more subtle factors that may influence the alleged optionality of the instrument such as: whether parties with bargaining strength will force the choice; whether Governmental bodies and EU organs will insist, from a policy perspective, on the optional instrument; and, whether it will be chosen as compromise between two parties, for example, one who favours French law and the other who favours Polish law. In any event, if it comes into force, everyone (lawyers, the judiciary, consumers and businesses both small and large) will have to understand and consider whether it should, or indeed it is advantageous for it to, apply to the circumstances in question.

Advantages and disadvantages

What then are the pros and cons of the optional instrument? The Commission believes that it will increase cross-border trade. The way that this claim is put is that the average cost to a small business per additional jurisdiction over and above its home jurisdiction is EUR 9,000 for legal and translation costs. This cost is seen as prohibitive. Additionally, says the Commission, consumers are not shopping across borders because they are uncertain about their rights outside of their home jurisdiction. Think back to Mrs Korhonen and Mr Kowalski. Another view put forward by certain online businesses is that some form of European contract law might address the perceived waste of time debating governing law as opposed to focusing on the commercial terms.

Common sense casts doubt on the idea that consumers are most preoccupied by the governing law of a contract at the time when they make a purchase. An IPSO Mori survey commissioned by A&O on this question suggests consumers are far more worried about online security, payment and the ability to return goods.

The objections to the optional instrument are significant. There is a huge uncertainty attached to contracting under an entirely new regime with little or no academic commentary or case law. This has a price which would ultimately be passed on to consumers or would dissuade many businesses from opting to contract under the regime (if it is their option to exercise). It may take years, possibly a generation, before this uncertainty reaches an acceptable level. Moreover, it is far from clear that the already heavily burdened Court of Justice of the EU (ECJ) is best placed to resolve differences of interpretation. It is unlikely that either consumers or SMEs would want time-sensitive matters to be referred to the ECJ with the consequential delay and additional costs. Moreover, as was observed by Bénédicte Chesnelong at the hearing on 3 May, each national court would apply its own traditions in interpreting the new code so that, rather than having a unified system, we would end up with a single code interpreted in 27 different ways.

What about the substance of the draft code?

The draft code, as annexed to the feasibility study, has only just been published. So, it is premature to give a forensic analysis. That said, for the English lawyer, there are a number of areas that leap out. The first is that it is intended to be a free-standing code. Article 1 tells us that "This instrument is to be interpreted and developed autonomously ... without recourse to national laws". An English lawyer or judge cannot look to English case law to understand what is meant by a term. Nor can a German lawyer look to years of clarification on the meaning of "good faith". Codifying contract law is an alien concept to many English lawyers. German or French lawyers may recognise some of the articles as being very similar to those in their own codes.

According to the feasibility study, the code applies only to sales contracts and service contracts associated with sales, such as installation or maintenance, provided by the seller or under the seller's responsibility (eg by a sub-contractor). Article 150 excludes "transport services, training services, telecommunications support services or financial services". Even if the code remains so limited (and the extent of the exclusion is not clear), it does apply to business-to-business, as well as to business-to-consumer sales contracts.

Areas of significance include:

  • Good faith. Article 8 introduces a general, free-standing duty of good faith and fair dealing. The duty may not be excluded or limited by agreement. This is defined (in Article 2) as "a standard of conduct to be characterised by honesty, loyalty and consideration for the interests of the other party to the transaction or relationship in question". This is very different to the position under English law which typically does not recognise good faith unless the parties have agreed to it. Also, it is perhaps wider than the concept of good faith under the French or German codes where it is used to underpin more specific rules rather than standing alone.
  • Duty to negotiate. Article 28 requires that parties must "negotiate in accordance with good faith and fair dealing" and must not "break off negotiations contrary to good faith or fair dealing".
  • Unfair terms. The concept of unfair terms already exists under English and EU law (Unfair Contract Terms Act 1977 and the Unfair Terms in Consumer Contracts Directive). These are typically limited to business-to-consumer contracts. Business-to-business contracts are generally affected when they are on one party's standard terms. Broadly, this dichotomy is maintained. In relation to consumers, under the draft code, a term supplied by a business will not be binding, whether or not it was negotiated, if it "significantly disadvantages the consumer, contrary to the requirement of good faith and fair dealing".
  • Pre-contractual negotiations. Article 57 provides that "In interpreting a contract, regard may be had, in particular, to: (a) the circumstances in which it was concluded, including the preliminary negotiations".

What next?

For all the reasons outlined, I believe this is an important initiative that would benefit from much greater public debate. What, then, are the opportunities to engage?

  • The UK European Scrutiny Committee is scheduled to debate these proposals on 24 May 2011.
  • The European Parliament is scheduled to vote on the proposals on 6 June 2011.
  • Interested parties are able to comment on the "feasibility study" by 1 July 2011.
  • We are awaiting the publication of an impact assessment by the Commission (this may accompany any legislative proposal).
  • The Commission will presumably report more formally on the 320 responses to the Green Paper.
  • The Commission looks likely to make a legislative proposal in autumn 2011.

We continue closely to monitor the developments in this area. I have been lucky enough to attend, at the invitation of the City of London and the Law Society of England and Wales, certain meetings with both MEPs and members of the Commission. We intend to respond to the feasibility study (and are assisting the Law Society with its response) and I would welcome the opportunity to discuss any of the matters in this article either to pass on information or to assist with any response to the proposals.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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