The binding force of International Treaty is on account of the fundamental principle known as Pacta Sunt Servanda

“The binding force of International Treaty is on account of the fundamental principle known as Pacta Sunt Servanda”. Explain.

1. Introduction:

The sanctity of contract is one of the most fundamental principles of law (I). However, the interaction between the sanctity of contract and changed circumstances has to be investigated. This paper will therefore focus a hardship clause which provide for a change in circumstances (II). It will then briefly consider to what extent arbitrators – amiable compositors – may grant relief because of changed circumstances (III). It thereafter will examine whether arbitrators who are not amiable compositors and who cannot apply a hardship clause, are entitled to grant relief because of changed circumstances (IV). Finally, the remedies available in a case of changed circumstances will be analyzed (V).

he sanctity of contract is, understandably, a paramount feature of the law of contract. Pacta sunt servanda[1]:the contract has to be respected. As a matter of principle, parties must adhere to the terms of their contract. This explains, for instance, why economic hardship does not affect international sales under the Vienna Convention on International Sales.

Arbitrators have to apply the terms of the contract which parties have agreed upon. Arbitration treaty law, arbitration statutes as well as arbitration rules confirm that the arbitrator has to respect the contract terms. Arbitrators have frequently confirmed the sanctity of contract.

For disputes with a state or state entity as a party, arbitrators often a pacta sunt servanda. This may not surprise as contracts concluded with such parties are generally submitted to rules of international law, which includes the principle of pacta sunt servanda. In the Sapphire v. National lranian Oil Companyaward, for instance, the arbitrators expressly stated: “It is a fundamental principle of law, which is constantly being proclaimed by international courts, that contractual undertakings must be respected. The rule pacta sunt servanda is the basis of every contractual relationship.”

2. Contractual Provisions:

Parties, who are aware that the context of the contract may change, can agree on a hardship clause in their contract. Some of these clauses provide the contract will terminate when a specified change in circumstances has occurred. Other clauses, such as indexation clauses or price revision clauses provide the contract terms will be automatically changed if such circumstances arise. Finally, some clauses, adaptation clauses, merely order the parties to adapt the contract terms to the new circumstances.

Some authors have argued that the widespread use of hardship clauses in long-term contracts has created a custom: the hardship clause must be implied in the contract even if it was not expressly included by parties. However, the fact that parties sometimes include a hardship clause in the contract may prove that no general customary principle exists. Moreover, there is such a variety in these hardship clauses with regard to their scope, application and remedy, that it is difficult to base a customary principle on them.

However, the mere presence of a hardship clause should not in itself exclude the application of the general law on changed circumstances. It would be too cumbersome if parties were obliged to negotiate and draft hardship clauses covering all possible events which may affect performance. Consequently, the general law on changed circumstances remains applicable to all changes not covered by a hardship clause. This principle has been recognized by arbitrators from the Arbitration Court of the Japan Shipping Exchange, who stated[2]:

The relation between this Article (renegotiation clause) and the principle of change in situation is such that the present article does not exclude the said principle, but provides for either one of the parties to request the other for consultation to amend the price, even in the instances where the principle of the change in situation does not need to be applied.

3. Enforcement of International Law:

Rebus sic stantibus is a principle of international treaty law. The 1969 Vienna Convention and Law of Treaties, Article 62, states:

A fundamental change of circumstances which has occurred with regard to those existing at the time of the conclusion of a treaty, and which was not foreseen by the parties, may not be invoked as a ground for terminating or withdrawing from the treaty unless: (a) the existence of those circumstances constituted an essential basis of the consent of the parties to be bound by the treaty; and (b) the effect of the change is radically to transform the extent of the obligations still to be performed under the treaty.

The wording of Article 62 demonstrates the exceptional character of rebus sic stantibus. It is subordinate to the more general principle of pacta sunt servanda, as set out in Article 26 of the Vienna Convention.

The change in circumstance has to be fundamental. It has to jeopardize the survival of the State. Simple loss of economic gain or currency reforms is insufficient. As the International Court stated in the Fisheries Jurisdiction case, the changes must be vital: they have to “imperil the existence or vital development of one the parties”. Moreover, the change in circumstances has to be unforeseeable.

In fact, although parties have often invoked rebus sic stantibus before international tribunals, such parties have never been granted relief on these grounds. The International Court of Justice or other tribunals have always refused to apply rebus sic stantibus to a treaty.

4. Enforcement of National Law:

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, more recently, English judges have been generally reluctant to find that a particular contract has been frustrated.

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. Paragraph 242 of the German Civil Code (BGB) requires that the contract be performed in good faith. However, 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. 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.

5. Recognition:

Sometimes the contract obliges parties to renegotiate when circumstances have changed. If these negotiations are successful, the contractual relationship is rearranged.

However, what happens when these negotiations fail? Most renegotiation clauses are silent on this point. Arbitral practice is very scarce. For instance, arbitrators of the Arbitration Court of the Japan Shipping Exchange refused to terminate the contract in such event, similarly, an I.C.C[3]. Award, rendered in 1974, indicated that a clause to renegotiate does not give a party the right to terminate the contract when negotiations fail. Termination would only be possible if the other party unreasonably refused to accept the proposal to adapt the contract. Eventually, arbitrators would have to decide whether such refusal was unjustified and constituted a breach of contract giving rise to its termination. Arbitrators thus decided that a Libyan general contractor committed a breach of contract when he failed to participate in the renegotiations on price increases with his Italian subcontractor in spite of his contractual commitment to do so.

6. Contract Adaptation:

Under certain legal systems, such as public international law or English law, a judge or an arbitrator does not have the power to adapt contract terms to changed circumstances or to substitute new terms more suitable for the changed situation. However, under some legal systems, such as the German, the Dutch or the Japanese, the judges or arbitrators are empowered to adjust contracts to take into account the changed circumstances.

Further, some renegotiation clauses state that arbitrators have to adapt the contract to changed circumstances in the event that the parties are unable to reach an agreement on contract amendment. Such clauses sometimes provide rather vague standards that the arbitrator has to apply: he should have “due regard for the interests of the other party”; he should respect “l’esprit de collaboration et de répartition équitable des résultats“; he should do whatever is possible “pour rétablir la position relative des parties“. Such clauses sometimes specify the binding force of the arbitrator’s decision: it may either be finally binding or subject to both parties’ approval (In the latter case, the contract is terminated when both parties do not agree with the arbitrator’s proposal).

7. Arbitration Practice:

Contract allocates risks among the parties. When the contract is drafted in precise terms but does not provide for a remedy when circumstances are changed, it may be assumed that the party, who is supposed to assume this risk, has taken such risk. As stated by an I.C.C. arbitrator:

As 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 . . . . 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.

The decision on whether or not performance has become so onerous that relief should be granted depends on the risks assumed by each of the parties. In this context arbitrators sometimes distinguish between speculative and non-speculative contracts. When parties did not enter into a contract with speculative intentions, relief for changed circumstances should be more easily granted. The arbitrators in S.E.E.E. v. Yugoslavia, for instance, stated: “As regards an international contract concluded without speculative intention, it ought to be admitted, as it has been judged, that the devaluation guarantee was meant by the parties, save express convention.”

Similarly, I.C.C. arbitrators have based their relief for changed circumstances on the non-speculative nature of the contract: “C’est une règle de la Lex Mercatoria que les prestations restent équilibrées sur le plan financier et hier ce principe reviendrait à faire du contrat commercial un contrat aléatoire fondé sur la spéculation ou le hasard.“.

Arbitrators of the Japan Shipping Exchange similarly stated: “In contracts such as the present one, of a commercial base, where the cost may be set arbitrarily and which has a speculative nature to a degree, it is not possible to decide that there existed a situation to which so-called change in situation principle could be applied.”

The fundamental changes in the political conditions as a consequence of the Revolution in Iran, the different attitude of the new Government and the new foreign policy especially towards the United States which had considerable support in large sections of the people, the drastically changed significance of highly sensitive military contracts as the present one, especially those to which the United States companies were parties, are all factors that brought about such a change of circumstances as to give the Respondent (the Iranian government) a right to terminate the contract when the Ministry of Defense decided not to go on.

8. Conclusion:

It may be questioned whether the third person, who adapts the contract, is really an “arbitrator”, in the legal sense of this term. Indeed, an arbitrator is supposed to solve legal disputes, i.e., disputes over existing rights and duties. The person, who adapts contract terms, merely rearranges the contractual relationship and behalf of the parties. In the strict sense of the term, adaptation is not arbitration.

In many long term-contracts, time is of the essence and delays in performance are sanctioned heavily by substantial penalty clauses. When a change in circumstances affects contract performance, the contract will often not be suspended or terminated. The party continues performance but notifies the other side that compensation for additional performances or for unjust enrichment will be claimed after the work is finished. Compensation thus has been granted in arbitration to an Italian subcontractor who had continued to perform for a Lybian general contractor in spite of more difficult performance<href=”#Footnote-772facf6ca9b47245303981194fcfcea”>91 . It has been doubted whether the person who adjusts contract terms, still can be considered to be an arbitrator. However, delicate questions as to the nature of contract adjustment are avoided when arbitrators do not adapt the contract terms, but grant a posteriori compensation.

9. Bibliography:

1. R. Stimler, C.K.U.I., 6-13; 231-233.

2. I.C.C. award No. 3267 (1984), Yb. Comm. Arb., 1987, 87 at 109.

3. New Civil Code, article

4. R. KÖBLER, olec., 203-233.

5. Bremen (Free Hansa) v. Prussia (1925), Annual Digest, 1925-1926, No. 266.

6. Arbitral award March 15, 1963, I.L.R., 1967, 136 at 181.

7. B. GOLDMAN, “La Lex Mercatoria dans les contrats et l’arbitrage internationaux : réalité et perspectives”, J.D.I, 1979, 471, at 493-495; B. GOLDMAN, Lex Mercatoria, Forum Internationale, Kluwer, Deventer 1983, 19.

8. M. FONTAINE, Droit des contrats internationaux, Analyse et rédaction de clauses, FEC Paris, 1989, 649.

9. F. DASSER, o.c., 109-110; M. MUSTILL, “The new Lex Mercatoria : The First Twenty-Five years”, Arbitration International, 1988, 86 at 110-111.

[1] I.C.C. award No. 2321 (1974), Yb. Comm. Arb., 1976, 133; Ad hoc award January 19, 1977, Texaco v. Libya, Yb. Comm. Arb., 1979, 177 at 182; J.D.I., 1977, 350; Ad hoc award January 14, 1982, Yb. Comm. Arb., 1986, 97 at 101, Rev. Arb., 1984, 401; Ad hoc award April 1982, Yb. Comm. Arb., 1983, 94 at 114; I.C.C. award No. 3493 (1983), Yb. Comm. Arb., 1984, 111 at 117; ICSID award November 27, 1985 and April 14, 1988, Yb. Comm. Arb., 1991, 16.

[2] I.C.C. award No. 5485 (1987), Yb. Comm. Arb., 1989, 156 at 168.

[3] Cass. December 31, 1924, Gaz. Pal., 1925, I, 284; Cass. February 25, 1929, J.D.I., 1929, 1306 ; Cass. March 20, 1956, J.C.P., 1956, II, 9646.