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Legal rules for good faith and fair dealing in foreign trade

Legal rules
for good faith and fair dealing in foreign trade

Business terms and conditions ► Good faith and fair dealing in foreign trade

The legal notions of "good faith" and "fair dealing" are still not accepted by Russian commercial (civil) law due to complications of their formal definition. However, it should be noted that article 10 of the Civil Code provides a legal ground for refusal in defeding person's rights by court if such person abuses his/her rights and there are judicial precedents of judgements made on the basis of that article.

Russian tax and customs authorities apply the concepts of "(bad) good faith taxpayer" and "(bad) good faith foreign trade subject" in substantiating their claims against dishonest companies and entrepreneurs. Recently, the Supreme Arbitrazh Court of the Russian Federation (the court for commercial disputes) introduced a new concept of "the unfounded tax gain". In the bank sector, the same idea of "bad faith" operations transformed into "dubious operations" the criteria of which is given in several indications of the Central Bank of Russia. All this might have direct implications on the activities of foreign companies in Russia, especially offshore companies.

In contractual business relationships, in view of the absence of current legal regulations it is recommended to use in contracts respective provisions of the UNIDROIT Principles of International Commercial Contracts, 1994 which are given below. In many cases, pricesely such kind of contractual clauses and aspects of behaviour permits to detect from the very beginning fraud scams of possible partners and future non-performance or improper performance of obligations.

UNIDROIT Principles of International Commercial Contracts, 1994

Article 1.7 - Good faith and fair dealing

(1) Each party must act in accordance with good faith and fair dealing in international trade.

(2) The parties may not exclude or limit this duty.

COMMENT (It forms part of the Principles.)

1. Good faith and fair dealing as a fundamental idea underlying the Principles.

There are a number of provisions throughout the different chapters of the Principles which constitute a direct or indirect application of the principle of good faith and fair dealing. See, for instance, Articles 2.4(2)(b), 2.15, 2.16, 2.18, 2.20, 3.5, 3.8, 3.10, 4.1(2), 4.2(2), 4.6, 4.8, 5.2, 5.3, 6.1.3, 6.1.5, 6.1.16(2), 6.1.17(1), 6.2.3(3)(4), 7.1.2, 7.1.6, 7.1.7, 7.2.2(b)(c), 7.4.8 and 7.4.13. This means that good faith and fair dealing may be considered to be one of the fundamental ideas underlying the Principles. By stating in general terms that each party must act in accordance with good faith and fair dealing para. (1) of this article makes it clear that even in the absence of special provisions in the Principles the parties behaviour throughout the life of the contract, including the negotiation process, must conform to good faith and fair dealing.

Illustrations

1. A grants B forty-eight hours as the time within which B may accept its offer. When B, shortly before the expiry of the deadline, decides to accept, it is unable to do so: it is the weekend, the fax at As office is disconnected and there is no telephone answering machine which can take the message. When on the following Monday A refuses Bs acceptance A acts contrary to good faith since when it fixed the time-limit for acceptance it was for A to ensure that messages could be received at its office throughout the forty-eight hour period.

2. A contract for the supply and installation of a special production line contains a provision according to which A, the seller, is obliged to communicate to B, the purchaser, any improvements made by A to the technology of that line. After a year B learns of an important improvement of which it had not been informed. A is not excused by the fact that the production of that particular type of production line is no longer its responsibility but that of C, a wholly-owned affiliated company of A. It would be against good faith for A to invoke the separate entity of C, which was specifically set up to take over this production in order to avoid As contractual obligations vis-`a-vis B.

3. A, an agent, undertakes on behalf of B, the principal, to promote the sale of Bs goods in a given area. Under the contract As right to compensation arises only after Bs approval of the contracts procured by A. While B is free to decide whether or not to approve the contracts procured by A, a systematic and unjustified refusal to approve any contract procured by A would be against good faith.

4. Under a line of credit agreement between A, a bank, and 166 B, a customer, A suddenly and inexplicably refuses to make further advances to B whose business suffers heavy losses as a consequence. Notwithstanding the fact that the agreement contains a term permitting A to accelerate payment at will, As demand for payment in full without prior warning and with no justification would be against good faith.

2. Good faith and fair dealing in international trade

The reference to good faith and fair dealing in international trade first makes it clear that in the context of the Principles the two concepts are not to be applied according to the standards ordinarily adopted within the different national legal systems. In other words, such domestic standards may be taken into account only to the extent that they are shown to be generally accepted among the various legal systems. A further implication of the formula used is that good faith and fair dealing must be construed in the light of the special conditions of international trade. Standards of business practice may indeed vary considerably from one trade sector to another, and even within a given trade sector they may be more or less stringent depending on the socio-economic environment in which the enterprises operate, their size and technical skill, etc.

It should be noted that the provisions of the Principles and/or the comments thereto at times refer only to good faith or to good faith and fair dealing. Such references should always be understood as a reference to good faith and fair dealing in international trade as specified in this article.

Illustrations

5. Under a contract for the sale of high-technology equipment the purchaser loses the right to rely on any defect in the goods if it does not give notice to the seller specifying the nature of the defect without undue delay after it has discovered or ought to have discovered the defect. A, a buyer operating in a country where such equipment is commonly used, discovers a defect in the equipment after having put it into operation, but in its notice to B, the seller of the equipment, A gives misleading indications as to the nature of the defect. A loses its right to rely on the defect since a more careful examination of the defect would have permitted it to give B the necessary specifications.

6. The facts are the same as in Illustration 5, the difference being that A operates in a country where this type of equipment is so far almost unknown. A does not lose its right to rely on the defect because B, being aware of As lack of technical knowledge, could not reasonably have expected A properly to identify the nature of the defect.

3. The mandatory nature of the principle of good faith and fair dealing The parties duty to act in accordance with good faith and fair dealing is of such a fundamental nature that the parties may not contractually exclude or limit it (para. (2)). As to specific applications of the general prohibition to exclude or limit the principle of good faith and fair dealing between the parties, see Arts. 3.19, 7.1.6 and 7.4.13. On the other hand, nothing prevents parties from providing in their contract for a duty to observe more stringent standards of behaviour.

Article 2.15 - Negotiations in bad faith

(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.

COMMENT

1. Freedom of negotiation

As a rule, parties are not only free to decide when and with whom to enter into negotiations with a view to concluding a contract, but also if, how and for how long to proceed with their efforts to reach an agreement. This follows from the basic principle of freedom of contract enunciated in Art. 1.1, and is essential in order to guarantee healthy competition among business people engaged in international trade.

2. Liability for negotiating in bad faith

A partys right freely to enter into negotiations and to decide on the terms to be negotiated is, however, not unlimited, and must not conflict with the principle of good faith and fair dealing laid down in Art. 1.7. One particular instance of negotiating in bad faith which is expressly indicated in para. (3) of this article is that where a party enters into negotiations or continues to negotiate without any intention of concluding an agreement with the other party. Other instances are where one party has deliberately or by negligence misled the other party as to the nature or terms of the proposed contract, either by actually misrepresenting facts, or by not disclosing facts which, given the nature of the parties and/or the contract, should have been disclosed. As to the duty of confidentiality, see Art. 2.16.

A partys liability for negotiating in bad faith is limited to the losses caused to the other party (para. (2)). In other words, the aggrieved party may recover the expenses incurred in the negotiations and may also be compensated for the lost opportunity to conclude another contract with a third person (so-called reliance or negative interest), but may generally not recover the profit which would have resulted had the original contract been concluded (so-called expectation or positive interest).

Illustrations

1. A learns of Bs intention to sell its restaurant. A, who has no intention whatsoever of buying the restaurant, evertheless enters into lengthy negotiations with B for the sole purpose of preventing B from selling the restaurant to C, a competitor of As. A, who breaks off negotiations when C has bought another restaurant, is liable to B, who ultimately succeeds in selling the restaurant at a lower price than that offered by C, for the difference in price.

2. A, who is negotiating with B for the promotion of the purchase of military equipment by the armed forces of Bs country, learns that B will not receive the necessary export licence from its own governmental authorities, a pre-requisite for permission to pay Bs fees. A does not reveal this fact to B and finally concludes the contract, which, however, cannot be enforced by reason of the missing licences. A is liable to B for the costs incurred after A had learned of the impossibility of obtaining the required licences.

3. A enters into lengthy negotiations for a bank loan from Bs branch office. At the last minute the branch office discloses that it had no authority to sign and that its head office had decided not to approve the draft agreement. A, who could in the meantime have obtained the loan from another bank, is entitled to recover the expenses entailed by the negotiations and the profits it would have made during the delay before obtaining the loan from the other bank.

3. Liability for breaking off negotiations in bad faith

The right to break off negotiations also is subject to the principle of good faith and fair dealing. Once an offer has been made, it may be revoked only within the limits provided for in Art. 2.4. Yet even before this stage is reached, or in a negotiation process with no ascertainable sequence of offer and acceptance, a party may no longer be free to break off negotiations abruptly and without justification. When such a point of no return is reached depends of course on the circumstances of the case, in particular the extent to which the other party, as a result of the conduct of the first party, had reason to rely on the positive outcome of the negotiations, and on the number of issues relating to the future contract on which the parties have already reached agreement.

Illustration

4. A assures B of the grant of a franchise if B takes steps to gain experience and is prepared to invest US$ 150,000. During the next two years B makes extensive preparations with a view to concluding the contract, always with As assurance that B will be granted the franchise. When all is ready for the signing of the agreement, A informs B that the latter must invest a substantially higher sum. B, who refuses, is entitled to recover from A the expenses incurred with a view to the conclusion of the contract.

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