An American company enters into a contract with a Chinese contractor to deliver and install certain modules necessary for the upgrade of a power plant, and the date for completed installation is set in the contract. The parties agree that the contract will be governed by New York law. No other mention of governing law is made in the contract.
As the delivery date approaches, the Chinese contractor realizes that, due to some labor issues, it will not be possible for it to comply with the exact date for delivery. The representative of the Chinese company telephones the American company and explains the situation to them, hoping that the American company may be willing to extend the delivery date.
The Chinese representative communicates that they will need seven more days in order to comply with the contract. The American representative replies simply with, “alright, we need those modules as soon as you can deliver them.” The parties never memorialize this in writing, nor do they clarify anything further, but the American representative reports to his boss that it looks like the contractor will be late and that he should start looking into how to enforce liquidated damages against the Chinese contractor if it cannot perform on time.
The Chinese company works hard to meet the original delivery date and actually delivers the modules only four days after the original delivery date, instead of their projected seven days. They Chinese contractor works hard to complete installation faster and make up two more days, resulting in completion only two days later than the original date in the contract. Soon after that, the American company sends a letter to the Chinese company expecting payment of liquidated damages for the two days of delay to the installation.
The Chinese company replies that, under the United Nations Convention for the International Sale of Goods, the delivery date was modified by the conversation between the parties’ representatives.
To the American company’s surprise, their own lawyers inform them that the Chinese company may have a good case against them and that the cost of litigation would not be warranted in their attempt to collect the liquidated damages.
How did this happen? New York law doesn’t allow for oral modification of contracts, and even if it did, there clearly wasn’t a meeting of the minds on modification. Also, this wasn’t a contract for goods; this was really just a contract for installation. So how did this odd convention on sales of goods that the American company never heard of end up being the governing law of their contract?
A Brief History Of The CISG
In the late 1980’s globalization was transforming the world, and there was a push to create a uniform commercial law for international sales of goods to alleviate some of the confusion and litigation caused by overlapping foreign legal systems. Out of this push came the United Nations Convention on the International Sale of Goods (“The CISG”). The United States was among the first countries to sign onto the Convention, adopting it as law on January 1, 1988.
The push to create a uniform international commercial law hit a snag, however, due to language in the CISG that allowed parties to abrogate any part of CISG, with certain limitations, or to disregard it altogether, with no limitations.
How To Exclude The CISG
The CISG is the default law for contract formation if no other mention is made in contracts for sales of goods between two parties who each have their primary place of business in different contracting countries. In its infancy, one accepted way to exclude the CISG was simply to choose the national law of a particular country to govern one’s contract, even if that country was a signatory to the CISG. The other way was to state explicitly that the CISG was excluded from the contract.
Over the past two and a half decades, increased familiarity with the CISG has resulted in the majority view that simply choosing the law of a signatory country is insufficient to exclude the CISG, because the CISG is part of that law. The accepted way to exclude the convention is to do so explicitly or to do so implicitly by choosing the law of a non-signatory state.
In 1988, the choice of law clause in the above hypothetical may have been sufficient to apply domestic New York law to the contract to the exclusion of the CISG. In 2014, however, that language would likely include the CISG as part of the law of New York, unless the parties specified a particular body of laws to govern the contract.
What Does The CISG Govern?
The fact that the CISG is not excluded from a contract, however, does not automatically result in its application. The CISG only applies to sales of goods. Article 3 of the CISG states, however, that the convention does not apply if the preponderant part of the contractor’s obligations is to provide labor or services under the contract. This clause clearly contemplates certain types of mixed contracts, and many courts and arbitral tribunals have used an economic value test to determine preponderance.
Thus, contractors that deal solely in construction and turn-key contracts probably don’t have to worry about the CISG as it does not apply to contracts in which the preponderant part of the contractor’s obligations consists of services or labor. Contractors may face uncertainty when that “preponderant” line is not so cut and dry. For example, the CISG may apply to contracts for the sale and delivery of modules or contracts to provide construction supplies and equipment coupled with obligations for the provision of labor and services. Simply put, if the value of the services under the contract does not comprise a majority of the total value of the contract, then those services are not likely to comprise a preponderant part of the contract and the CISG will therefore apply.
Even if the economic value of those services provided, for example, installation, were to exceed the value of the goods, some courts and tribunals have looked at the essential purpose of the contract and found that those services may simply be incidental to the sale of goods, and therefore still within the scope of the CISG.
In the case above, it is quite possible that the sale and delivery of the modules would be sufficient to trigger the application of the non-excluded CISG, unless the fact-finder were to determine that the installation was truly the focus of the contract and/or constituted the majority of the value of the contract.
Effects Of The Application Of The CISG
One key difference that might surprise an American company familiar with American contract law, is the CISG’s rules, or lack thereof, regarding the statute of frauds. The CISG also differs from American contract law on key issues of parol evidence, perfect tender, and battle of the forms, to name a few.
Under the CISG, the default rule is that no writing is required either for the formation or modification of a contract. Some countries have adopted the CISG with a reservation that would in fact require a writing for formation and modification, but the United States has not.
In the example above, the conversation between the two companies’ representatives might rise to the level of contract modification, even though the domestic law of New York would not recognize such a modification. The main issue would be for the fact-finder to determine if the Chinese company’s statement was a valid offer and the American response was an acceptance.
The CISG also offers guidance in Article 8 as to how to interpret statements made by one party to another, but this can lead to uncertainty and expensive litigation regarding that modification. Such litigation can be avoided if the parties are more precise in their communications – and being conscious of the CISG’s rules and application may lead to that level of precision in all communications between international contracting parties so that nothing gets lost in translation.
What Can You Do?
The ultimate lesson here is that the best practice is to be fully aware of the effect of choice-of-law clauses. If you are a seller who deals in the international sale of goods, it is especially important to determine whether the CISG is beneficial to you. The CISG can provide a common ground for business between companies based in foreign countries. There are pros and cons to choosing any particular law to govern your contract, so ensure you do so deliberately.
If your business operates in that gray area between manufacturing and construction, you can still elect to have the CISG govern your contract. Whatever you choose, it is important to explicitly include or exclude the CISG in your contract to avoid potential litigation regarding whether goods or services constitutes the preponderant subject matter of the contract. Such uncertainty can unnecessarily delay ultimate relief un