Organisational contracts: rethinking the European paradigm

Contract law is out of touch, scholars argue – but why? A post by guest blogger Joeri De Smet

1.

Arguably, contracts are quintessential in the operation of the modern economy. Scholarly attention across many disciplines accordingly is abundant. In law as well, contracts are amply studied. Most of the work on contracts, however, remains doctrinal, discovering developments and trends within the current system of current law. In Belgium, this system has not fundamentally changed for the last two hundred years, but even on the European level, contract law seldom undergoes radical changes. Over the course of time, parties in a contract build up a common interest, a “going concern value”. In European contract law, there are insufficient safeguards to protect this value. Concerning the performance of obligations, parties are only required to do just that, not to cooperate, and there is no general system to adapt existing provisions to previously unknown circumstances. Concerning termination, there is no way for a party to leave the contractual framework without destroying it (through resolution or unilateral notice), along with its going concern value Some scholars are trying to move beyond this frame of reference and argue that current contract law is not adapted to real-life economic needs. They propose a new outlook on contract law, under the umbrella of organisational contracts. In this contribution, I briefly define and set out the key elements of what is understood as an organisational contract.

2.

A definition of an organisational contract, inspired by the work of leading scholar Stefan Grundmann, is: “‘a contract aiming to govern “complex economic activities without creating a new legal entity”’. Let us have a closer look at these defining elements. First of all, it is a contract. It is subject to the general rules of contract law, insofar as there are no more specific rules. Oftentimes, the organisational contract is what is called “unnamed”: it undisputedly is a contract, but is not governed by a specific body of rules. Second, an organisational contracts aims to govern cooperation. This aspect is thrice significant: cooperation necessarily occupies a period of time, (further) shapes a relation between them and implies that parties have to work together. Third, an organisational contract does not aim to create a legal entity. This means that parties do not wish to fall under any company law regime, as this creates automatic obligations for directors and shareholders. Moreover, there is no joint property, nor limited liability, nor sharing of profits.

3.

The first element is the long-term aspect of an organisational contract. In current contract law, contracts enter into force from the moment of consent. However, it is highly probable that parties are bound to each other for a significant period of time. This is overlooked in current contract law, which gives rise to three issues. First, there is often uncertainty about what the future will bring at the moment of consent. Legal practitioners try to remedy this by including clauses of all sorts (e.g. hardship, material adverse change), but this remains a conceptual lacuna. This issue is further addressed in the literature on relational contracts, cf. infra. Second, a long-term contract entails investment specifity. This means that parties make a particular investment that is unusable outside of their contractual relation. Parties thus become vulnerable: if their relation deteriorates, the investment is a sunk cost; the asset no longer generates income. Third, the incentive structure in a contract is severely influenced by its duration. This becomes relevant for termination: if one party has invested less into the cooperation, it can blackmail the other by threatening termination – especially when contractual terms are incomplete. Conversely, the possibility of termination is necessary to pressure the other party into performing its obligations.

It should also be noted that a long-term agreement has consequences before the moment of consent and after its completion. The former is illustrated by the fact that they are often preceded by long and intense negotiations, pre-contracts, or even full-fledged part-contracts which will later on become part of the main long-term contract; the latter by the fact that the termination of an organisational contract rarely happens from one day to the next. Rather, obligations are extended after the shared objective of parties has been achieved.

4.

The second element which characterizes an organisational contract is the relational aspect. It focuses on the first time-related issue, i.e. the uncertainty of future circumstances. A contract is relational to the extent that parties are incapable of reducing important terms of the arrangement to well-defined obligations. This can stem from the fact that the future conditions themselves are unclear, or from the fact that the future conditions are known but present-day adaptions prove to be too complex. The literature on this topic oftentimes links the relational aspect with the long term-aspect. Other authors argue that long duration is not essential for a contract to be relational. This discussion remains largely theoretical. However, the literature on the relational aspect loses relevance because of its strong common law heritage. Civil lawyers are more familiar with preliminary negotiations and filling gaps in the contract by falling back on supplementary legislation and general principles. Also, the relational contract becomes especially important in business relations between repeat players, who have a greater tendency to conclude very detailed arrangements. Between non-commercial parties, implicit understandings are often left that way, which is especially non-problematic in civil law for the reason stated above.

5.

The third and final key element of an organisational contract is the duty of cooperation. This stems from the duty of good faith. In “vanilla” contract law, the latter is perceived as a code of conduct, trying to steer parties away from grossly egoistic behaviour. However, it does not create a duty for parties to actively cooperate. Such a duty can be found in contract law, where the notion of common interest forces parties to work together in order to safeguard the going concern value of the enterprise. As set out in the introduction, current contract law is lacking in this respect. Research shows that courts across Europe are more likely to apply a doctrine of good faith (or, in England and Wales, specific measures to keep parties from abusing contractual terms), but it remains unclear to what extent parties are compelled to cooperate. This confusion partly stems from uncertainty surrounding the principle of good faith in European contract law and is partly attributable to the fact that scholarly work on the organisational contract is still emerging. This is problematic, as calling for a paradigm shift without providing a clear alternative is unconvincing.

6.

In conclusion, organisational contracts have been getting scholarly attention, but this literature is not yet well-recognized in the present doctrine on European contract law. Much remains to be said and done. To say the least, it is a fascinating topic which gives rise to many questions, especially concerning the duty of cooperation (e.g. to what extent are parties bound to cooperate? To what extent should they be bound?). To be continued.

Joeri De Smet
Research Master in Law (KU Leuven, expected 2018)

4 thoughts on “Organisational contracts: rethinking the European paradigm”

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s