General information on obligational relationships and the fundamental principles of contract law

All general principles of wider obligational relationship apply to contract law. Obligations otherwise represent a so-called wide variety of commitments. These commitments create a relationship between two parties, an obligor and an obligee; one party is the obligor and is committed to the performance of an obligation to the other party, the obligee. Performance is the obligor’s action – active or passive. The obligor is committed to giving or doing something, or allowing or abandoning something. In an obligational relationship, parties can be both entitled and liable at the same time. A party can choose the contents of its performance freely. There is no numerus clausus principle for obligations.

The general principle of contractual obligations is, in accordance with the Obligations Code, the dispositive nature of obligational relationship. Arrangement of relationship between parties in an obligational relationship is dispositive, unless an individual provision of this Code or its meaning states otherwise, or the arrangement is in violation with the Constitution, compulsory regulation or moral principles. Furthermore, the basic premise is the equality of parties in obligational relationship and the principle of good faith and fair dealing in exercising rights and performance of obligations. Bilateral contracts are based on the principle of equal value of mutual performance, which is enacted in law by the principle of equal value of performance. Another fundamental principle is the principle of diligence in legal transactions, considering the appropriateness or type of obligational relationship (diligence of a good businessman, good management, and the diligence of a competent professional). Rights are restricted by the rights of others; they can be exercised in accordance with the basic principles of this Code and its purpose. Parties in an obligational relationship are obligated to perform their obligation and are responsible for its performance (the principle of duty to perform obligations). Each party is obligated to refrain from action that could cause damage to others (prohibition on infliction of damage). Participants in an obligational relationship must endeavour to resolve disputes by coordination, mediation, or other amicable means. The business customs, usages and practices established between parties shall be taken into consideration in the assessment of the behaviour required and effects thereof in the obligational relationships of commercial entities.

Legal transactions are actions, or groups of coinciding actions by one or more legal persons, aimed at forming a civil-law (private-law) result, i.e. a change in legal relationship between individual legal persons. A legal transaction is a means of actualising the axiom of civil (private) law, i.e. autonomy of a party.

The essence of legal and business contract law are the general assumptions of validity of legal transactions, such as: free and genuine declaration of intention, assumptions on parties expressing their intention (legal capacity and capacity to contract, capacity to account for their actions), assumption on the subject of transaction (determinable, possible, and permissible), as well as rules on legal consequences if any assumption on the validity of legal transactions is not met.

Since the introduction of money as means of payment, a sales contract is the most important legal transaction, enabling exchanges of value of object or right to money. That is why the sales contract is today undoubtedly the most common legal transaction and probably the most systematically regulated. Individual rules that apply to a sales contract apply as appropriate to other contracts. This does not just include rules on liabilities for material and legal defects in performance of obligations, where the general rules directly refers to the appropriate application of provisions on sales contracts (Article 100 of the Obligations Code). The rules of the sales contract are very flexible, as they have to be adapted to different things. In case of a sale of a subject, the arrangement of relationship between a seller and a buyer often depends on the properties and value of the subject. Its legal nature is evident in the very definition of the sales contract (included in Article 435 of the Obligations Code); specifically, it is a bilateral compulsory reciprocal contract, which must be of a non-gratuitous nature.

Consensus of intention and defective intention of contracting parties

The essential element of every contract is the consensus of intentions of contracting parties. Article 15 of the Obligations Code states that a contract is concluded when contracting parties agree on its essential elements. The consensus of intentions as a requirement for the conclusion of contract is the fundamental principle of contract law.

Here, I premise my argument on a situation when such a consensus is not established (in the event of defective intentions as essential elements of agreement and the (potential) legal consequences). The Obligations Code defines the institute of defective intentions in Article 46 (Fundamental error) and Article 49 (Fraud).

Fundamental error
An error is a misconception of any circumstances. A conception does not meet the reality. A misconception becomes legally significant when a party declares its intention on the basis of such a misconception.

An error becomes relevant under the law if it is fundamental, if, among other alternatives, it relates to the essential characteristics of the subject, or to circumstances that according to the customs in the transaction or according to the intention of the parties are deemed to be decisive, as otherwise the mistaken party would not have concluded the contract with such content. In the case of error in objecto, it is a misconception on the concrete subject of the transaction. An error regarding the subject of performance: on identity, characteristic or value; an errpr can also be made regarding the quantity, which can be classified as error on characteristic, or not. Whether or not a characteristic of the subject is essential depends on the circumstances of the case; it is necessary to consider subjective and concrete criteria. Abstract, subjective or even objective criteria shall be used only if it is impossible to determine whether a characteristic is essential or not using this criterion. A subjective criterion is available to parties to determine whether or not a characteristic is essential. Parties can deem certain characteristics non-essential, even though they are considered essential characteristics using objective criteria, and vice versa: parties can deem certain characteristics essential, even though they are not by their nature. Cases of error regarding essential characteristics of the subject must be distinguished from errors of motive.

The mistaken party can request annulment of the contract due to a fundamental error, unless the party failed to act with the diligence required in legal transactions. Here, we have a dilemma on justifiable and unjustifiable error. The law can therefore be invoked only if the error is justifiable. From the theoretical perspective, the more correct position is that an unjustifiable error should be considered in the same way as a justifiable error, in terms of contract validity (the contract should not be valid). If the opposing party in the contractual relationship is willing to fulfil the contract as if error had not happened, i.e. in accordance with the true intention of the mistaken party, the reason for challenging the legal transaction no longer exists (reference to the error under Article 46 of the Obligations Code is no longer possible).

A fraud or misleading to force mistaken declaration under Article 49 of the Obligations Code includes the situation when one party causes the other party to be mistaken or keeps the other party mistaken for the purpose of leading the latter to conclude a contract. In this case, the other party can demand annulment of contract even if error is not fundamental. The party that was deceived in concluding a contract shall have the right to demand the reimbursement of any damage that occurs. A fraud enacted by a third person shall only affect a contract if the other contracting party knew or should have known thereof when the contract was concluded. Therefore, a fraud represents an error, which did not occur due to an indifferent reasons, but due to intentional action by the co-contracting party or third party. A fraud is an action by which a party causes another party to be mistaken, in order to conclude a legal transaction. However, it is not necessary that a party intended to harm the other party. A fraud did not occur when a party incurs a lower level of culpability than intent. Even though a co-contracting party did not commit a fraud, it must bear its consequences if it knew or should have known thereof, but failed to do so because of its own negligence. Otherwise, a co-contracting party is not liable for a third-party fraud; however, third parties do not include mediators, for which the party employing them as representatives is responsible as for its own actions.

Invalidity of contract

Below we examine the nullity and challengeability of contracts and related so-called theory of escalating invalidity of contracts. The theory distinguishes between absolute and relative invalidity of transactions. Absolute invalidity (nullity) can be invoked by any party recognised by law to have a legal interest, while relative invalidity can be invoked only by the party for which the invalidity (challengeability) is beneficial.

A contract that contravenes the Constitution, compulsory regulations or moral principles shall be null and void if the purpose of the contravened rule does not assign any other sanction or if an Act does not prescribe otherwise for the case in question.

The fundamental characteristics ascribed to nullity originate from the Roman law sentence: “Quod nullum est nullum producit effectum.” This is a negation of the legal existence of a transaction, as confirmed by case law. The following logical consequences are derived from the above: the right of anyone with interest to invoke nullity, the effectiveness of nullity by itself, without any act, non-extinction of request to establish nullity, inability to convalidate and restoration of previous condition. The needs of life and often unfair results have resulted in increasingly more frequent deviations from the strict principles of classical theory, dependence on the wishes and expectations of the parties, and the normal legal consequences. Today, damage liability is recognised due to nullity, conversion and partial (in) validity are allowed, and, in extreme cases, the legal transaction can be convalidated.

In terms of nullity, the Obligations Code emphasises the so-called nullity of public order, which originates in French law. According to the theory, transactions in violation of the Constitution, compulsory regulation or moral principles are deemed null (unconstitutional, unlawful and immoral contracts, whose effects we wish to prevent with the nullity sanction). The sanctions are not determined absolutely; as the final consequence, the decision is left to the court (second stage of consideration of interests). Using rules and methods of explanation, a judge should determine whether the purpose of rule violation assigns another sanction. It is therefore necessary to determine if the judgment of nullity sanction will achieve the intent of the legislator.

If a contract is null and void, each contracting party must return everything to the other party that was received on the basis of the contract. If this is impossible, or if return is prevented by the nature of that which was performed, appropriate monetary compensation must be provided according to the prices at the time the court ruling was issued. If a contract is null and void because in terms of its content or purpose it contravenes fundamental moral principles, the court may entirely or partly reject a claim by the dishonest party for the reimbursement of that provided to the other party; in ruling, the court shall consider the extent to which one or both of the parties acted in good faith and the significance of the interests under threat.

According to legal theory, a claim in restitution as the result of nullity is interpreted in accordance with the concept of unjust enrichment, as restitution most often occurs in cases of nullity and annulled challengeable contracts. In particular, the court has the option, in the event of immoral contracts (condictio ob turpem causam), to grant the claim or to reject it on account of the immorality of the claim itself. The decisions depends on the fairness of one or both parties and the significance of the interests under threat.

A contract is voidable if concluded by a party that has limited capacity to contract, if during its conclusion there were defects regarding the parties’ intention, or if so provided in the Obligations Code or by any other Act.

Voidability is a less severe form of invalidity, occurring as a sanction for less intensive mistakes, and is implemented primarily when the goal of the violated norm is in the interest of an individual – usually contracting party. Transactions are not ineffective by themselves, but require the entitled party to act for this sanction to become effective. The logical consequence is that convalidation and confirmation are always possible: the entitled party can explicitly confirm a voidable contract and thereby waive their right to void, or waive void tacitly by not exercising their right to void within a specified period. For this sanction, the law prescribes a preclusion period and limits the circle of entities entitled to claim voidability for the protection of individual interests.

One of the fundamental reasons for voidability are defective intentions of contracting parties (which includes error and fraud). A contracting party in whose interest voidability is defined may request that the contract be annulled, considering that the right to request the annulment of a viodable contract shall expire one year from the day the entitled person learnt of the grounds for voidability, or one year after the end of duress, and in any case this three years after the day the contract was concluded. According to the Obligations Code, legal theory and case law, the claim must be addressed to a specific party, i.e. judicial authority, which should decide on the request with a constitutive judgement (the need for constitutive and condemnatory claim) regarding the claim, and the court’s judgement is constitutive.

Consequently, anything that was performed on the basis of an annulled contract must be returned. If this is impossible or if return is prevented by the nature of that which was performed, appropriate monetary compensation must be provided. This is an identical consequence to that of nullity – claim in restitution. A successful annulment of a viodable contract is effective ex tunc, so an annulled contract has no legal effect and neither party has claim to specific performance.

General information on termination of contract due to non-performance

If in a bilateral contract a party fails to perform its own obligations and it is not stipulated otherwise, the other party may demand the performance of the obligations or withdraw from the contract under the conditions set out in the Obligations Code through an ordinary declaration if the contract is not rescinded by an Act per se, and is entitled to compensation in any case. If the performance of obligations by a specific deadline is an essential component of the contract and is not fulfilled, the contract is usually rescinded by an Act per se; however, if the performance of obligations by a specific deadline is not an essential component of the contract, the obligor retains the right to perform its obligation after the deadline, and the obligee to demand its performance (if in this case the obligee wants to withdraw from the contract, the obligee has to provide an additional period to the obligor for the performance; if the obligor fails to perform the obligations within the additional period, the contract is rescinded as if the deadline had been an essential component of the contract, i.e. by an Act per se).

The essential and wide-open question of legal theory regarding this institute is on the forms of non-performance. This is judged using the same criteria as non-performance of any other obligation. The issue is the status of obligor’s delay. If the obligor fails to do anything to perform its obligations, the situation is clear. There is no doubt regarding the status of non-performance, and entitlement to enforce sanctions is not contested. Contested situations can arise from partial (non)performance and incorrect performance. When explaining these situations, it is necessary to allow for the possibility that any form of deviation from the content of obligation, except non-performance of an insubstantial part, represents non-performance. If conditions for enforcement of other legal consequence arising from defective intention or warranty for defects also exist, the non-defaulting party has to be given the option to choose the consequences that are most suitable to its interests.

In this article, we presented a brief overview – particularly from the theoretical perspective – of individual general legal institutes of contract law. In the next article, we will examine this subject more closely and explain, based on our findings, their (non)applicability to the Volkswagen emissions affair – Dieselgate, the biggest affair in the history of the Volkswagen Group.

Source: Pravni vidiki afere Dieselgate [Legal Aspects of Dieselgate] (master’s thesis), 2016, Damjan Merhar