STUDIES ON SPANISH-PHILIPPINE PRIVATE LAW
Papers of the Private Law of the Philippines and Spain International Scientific Congress

PRE-CONTRACTUAL LIABILITY

Teresa Rodríguez de las Heras Ballell
Associate Professor of Commercial Law
Universidad Carlos III de Madrid

Abstract

Pre-contractual stage has been long ignored by traditional Codes whose classical contract rules were mainly focused on defining and regulating offer and acceptance and their perfect matching as expression of the agreement. Commercial practice does contrarily offer an image that greatly differs from such simple, single-issue and adversarial offer-acceptance model. Pre-contractual statements, preliminary agreements, negotiations and other bargaining behaviours preceding the conclusion of the contract are not only frequent in commercial trade but do also play critical roles in relation to the contract that should not be disregarded: assisting in interpreting parties’ real intent, supplementing the contract and signalling eventual vices of consent caused by the breach of pre-contractual duties. In contrast to currently in force Code provisions that still remain silent, in some uniform texts, express rules on pre-contractual liability have been adopted. At the domestic level, two revealing, albeit partial, movements lead the long awaited legislative evolution. On the one hand, specific pre-contractual duties are being provided for in special laws (consumer law, rules on electronic commerce, insurance law, financial regulations). On the other hand, attempts to formulate general rules on pre-contractual liability have been made within the framework of two reform initiatives, still pending, aimed to modernize, respectively, Spanish Civil Code and Spanish Commercial Code.

Key Words

Contract formation, pre-contractual, liability, preliminary agreements, duty to inform, MoU (Memorandum of Understanding), freedom to deal.

I.- Contract Formation: Context and Process

In commercial trade, a contract is essentially the outcome of a process along which negotiating parties aim to reach an agreement within a specific transactional context. Therefore, gaining a full insight into a contract requires taking into consideration such two factors: the process leading to the agreement and the context within parties’ positions have approached. Far from a simplistic understanding of the contract as a perfect fitting of two converging parts – offer and acceptance -, contract formation is indeed a continuum along which negotiations and will formation stages pass. From a dynamic perspective, real negotiations visibly depart from the simple image envisioned by the classic rules of offer and acceptance that captures “single-issue, adversarial, zero-sum bargaining as opposed to multi-issue, problem-solving, gain-maximizing negotiation”1. 

Even if many cases in modern trade parties enter into an agreement instantaneously (daily transactions), in general terms, a contract is the result of a multi-phased and considerably complex process: the contract formation process. 

According to the mainstream thesis on contract life, three stages might well be worth being distinguished. Firstly, pre-contractual stage that comprises all acts and conducts intending to reach an agreement between the parties. Secondly, (“gradual or progressive”) conclusion of the contract that describes the moment or the phase where the agreement arises as a result of the offer and the acceptance. Thirdly, performance of the contract in order to satisfy parties’ interests – Supreme Court, judgments of 24 June 1991 (RJ 1991, 4578); of 28 February 1996 (RJ 1996, 1268); of 30 September 1988 (RJ 1988, 6939); of 3 October 1966 (RJ 1966, 4481); of 31 October 1951 (RL 1951, 2364); of 10 January 1922 (CL January 1922, num. 13); of 12 June 1900 (CL June 1900, num. 15).

Despite the more or less common perception of contracts in modern trade as instantaneous phenomena, process aiming to reach an agreement between the parties may be long, multi-phased and considerably complex, where negotiations, preliminary agreements and previous statement along the pre-contractual stage play a critical role. In sum, preliminary dealings are also building materials of the final agreement.  

Wrongly, expressions as “previous, preparatory or preliminary acts” might encourage the conception that such behaviours, dealings, covenants or genuine agreements are unnecessary and unimportant to the extent that they do simply precede the conclusion of the agreement and acclimatize negotiations. Certainly, negotiations prior to the agreement are neither indispensable nor necessary in the effective perfection of a valid and enforceable contract. Nonetheless, when preceding the formation of the contract, the pre-contractual stage performs essential functions in the interpretation, the gap filling and the enforceability of the final contract. Not surprisingly, sophisticated business parties and their legal counsels engage time and resources in preliminary contacts and dealings conducting a complex negotiation process, fully aware of their critical role for the success of the transaction.   

In long and complex transactions, the relevance of negotiations stands out naturally. But even in those transactions that appear to arise instantaneously and be concluded on a simultaneous basis, a decontextualized and static approach proves to be inadequate and partial. Mass trade’s needs have triggered the use of standard terms and contracts of adhesion, even to conclude commercial transactions. Not even in standard term contracts, pre-contractual stage becomes inexistent or irrelevant. Contrarily and despite that the apogee of the pre-contractual phase is revealed in long, complex and multifactor negotiations, information duties and other typically pre-contractual obligations are appreciably comparable and still decisive in the formation of the agreement in “dealings without dealings/negotiations”.  A number of Court decisions in banking, insurance or electronic commerce cases confirm the relevance of the compliance of pre-contractual obligations in assessing the validity and the enforceability of the final agreement.

In contrast to its crucial value in practice and its relative legal controversial nature, pre-contractual stage has been long ignored by legislator. Spanish Codes, both Civil Code and Commercial ones, have historically disregarded pre-contractual issues. Currently, international uniform instruments and some modernizing projects and proposals for legal reform are correcting such a traditional oversight and filling the historical gap. For reform initiatives are not enacted yet, a systematic, comprehensive and all-embracing legal treatment for pre-contractual stage is still missing in Spanish domestic rules.

Considering that, the aim of this Paper is to critically analyse most recent modernizing proposals to regulate pre-contractual obligations and liability in Spanish legal system compared to most significant uniform rules governing the preparatory phase in contract formation. To that end, the Paper is structured as follows. After these introductory remarks, Part II delimits the pre-contractual phase, proposes a definition and expounds its main functions. In Part III, uniform rules and, currently in force as well as proposed, domestic ones are traced. All rules pursue a stable balance between the exercise of freedom to deal and the due protection of reasonable expectations. Hence, on the one hand, cases where freedom to deal/not to deal and reasonable expectations conflict have to be identified and the resulting pre-contractual liability typified to the possible extent, and, on the other hand, available remedies, in such cases, have to be proposed. Under Part III, two main issues are discussed accordingly: duty to inform (non-disclosure obligations will not be dealt with) and pre-contractual liability. Part IV deals with preliminary agreements and how negotiating parties wish to “contractualize” their pre-contractual contacts and negotiations and to which extent they are entitled to depart from liability rules and to shape their pre-contractual obligations.

 II.- Pre-Contractual Stage: Concept, Scope and Functions

Any attempt to approach pre-contractual stage and define it in legal terms clashes with an inherent complexity, heterogeneity of acts and variety of behaviours likely to concur in the formless, imprecise and vague period preceding the conclusion of the contract. Certainly, the pre-contractual stage may comprise a wide range of actions, behaviours, agreements and activities of varied nature – mere contacts, information exchange, negotiations, advertisement, commercial dealings, preliminary agreements -. Such complexity, disparity and heterogeneity hinder all efforts to formulate a legal definition. By nature, pre-contractual stage encompasses a broad spectrum of acts, is open and indeterminate in length. Therefore, a working legal definition of pre-contractual stage has to manage and internalize such natural features, instead of attempting to conceal them or ignore them.

Considering that, it is my contention that two factors succeed in satisfactorily demarcating the legal outline of the pre-contractual stage: a time factor and a teleological or final factor.

a). Under a time perspective, the pre-contractual stage can comprise solely those acts, behaviours, activities or agreements, no matter their nature and scope that precede the conclusion of the agreement. Then, logically, once the contract is concluded, the pre-contractual stage has definitively finished and any action, statement or behaviour should be labelled “contractual” or “post-contractual” (performance stage). Although the rationale of the proposed time factor is extremely obvious and might even appear too simple, it may show some legal complexity when attempting to pinpoint the beginning and the end of the pre-contractual stage. Not surprisingly, it might be questioned, on the one hand, when informal conversations, a first approach, expressions of interest, mere contacts and requests of information qualify for being deemed genuine “pre-contractual” acts likely to exert any impact on the future contract, if finally reached. Interestingly, on the other hand, despite it is clear the assertion that the pre-contractual stage ends when the contract is concluded, it might be well worth discussing when the pure contract formation stage starts. Should it argue that the first firm offer opens the contract formation/perfection phase – offer, counteroffers, acceptance -, any subsequent declaration will not be then pre-contractual anymore. Therefore, to ascertain when a statement made by one party amount to an offer becomes the priority task. Departing from the definition of offer, previous acts and subsequent statements likely to affect the contract conclusion can be identified. 

Scholars’ opinions differ. A rigorous approach would understand that preliminary dealings would end when an offer is proposed. Under that perspective, although the contract is not perfected yet, the exchange of offers, counteroffers and acceptance would form the “successive contract formation stage”. Contrarily, from a broader and all-embracing approach, the pre-contractual stage would encompass all actions, dealings and negotiations until the perfection of the contract. Under such wide perspective, the pre-contractual stage may even start with an offer subsequently negotiated by parties until the reaching of the agreement.

Notwithstanding the different nature and the legal implications of simple negotiations compared to authentic offers or counteroffers, I tend to defend the broadest conception of pre-contractual stage.

B). The time perspective has to be necessarily completed with a final factor. Many imprecisions and uncertainties resulting from the sole application of the time factor are repaired by applying the final factor. The pre-contractual nature of an action is not only a question of time. Not all behaviours and statements preceding the conclusion of the contract are pre-contractual, unless they are aimed to reach an agreement. Hence, a final or teleological factor is needed to duly demarcate the scope of the pre-contractual stage. In sum, the pre-contractual stage comprises all acts, behaviours, negotiations, preliminary agreements or any other dealings that, preceding the conclusion of the contract, are addressed to reach an agreement between the negotiating parties.

The final factor enables to draw the distinction between preliminary agreements and the final agreement. Preliminary agreements - MoU (Memorandum of Understanding), Term Sheet, NDA (Non-Disclosure Agreements) - are not sought by the parties on an isolated basis; their value is instrumental, their conclusion is contributory to and oriented towards the reaching of the final contract.

To conclude, the pre-contractual stage demarcates a formless, broad and of imprecise limits set of acts, negotiations, dealings, expressions of interests, preliminary agreements and other commercial contacts that enable parties to approach their positions, evaluate their interests and reach an agreement. A time factor and a final one, as discussed above, amalgamate such a disparity of behaviours and statements under the pre-contractual label.

Broadly speaking, preliminary deals embrace a wide-ranging, elastic and multiform stage of the formation process comprising acts and statements whose common factor is precisely temporal: acts, conducts and statements made by on party aimed at reaching an agreement but prior to the arising of an offer (or under an extended understanding of formation stage, prior to the arising of a contract). Such deliberating period is not indispensable for the agreement to be concluded. That could probably explain the long disregard revealed by scholars and courts of the existence and the conditions of negotiating period rendering apparently unnecessary and inconvenient further legal analysis on preliminary deals from a contract law approach. Notwithstanding the foregoing limited perception of preliminary deals, if preceding the reaching of an agreement they are decisive to:

i). construe parties’ intent for interpretation 2 purposes. All preliminary dealings and previous statements are likely to operate as interpretative criteria to find out the real intent of contracting parties or to serve as reference points to assess the expected understanding of a reasonable person in similar circumstances. Even the inclusion in the contract of a merger clause (or entire agreement clause)3 does not automatically prevent the resort to previous statements or preliminary agreements for interpretation purposes, unless expressly stated so by parties in the said clause.  

ii). fill gaps or supplement the final agreement. According to Article 1258 Spanish Civil Code, parties are to abide by not only the expressly agreed terms but also the natural consequences of the agreement as far as they are in conformity with usages, law and good faith requirements. The foregoing wording is to be supplemented by Article 1287 that apart from stating interpretation rules establishes that usages normally observed in the country (or place of the conclusion of the contract) shall fill the gaps of contracts by including currently agreed clauses. Hence, usages generally observed in the specific trade concerned and in the place where the contract has been concluded shall play a supplementing role to fill the gaps of the agreement. In this regard, usages to be applied comprise practices regularly observed in the relevant place but they should not be mistaken for clauses, conducts or practices statistically frequent in trade when they do not amount to a country custom. In addition, the guiding principle of good faith, besides being a subjective model to interpret or qualify parties’ intent, represents a legal standard of conduct embodying specific duties for the parties according to socially accepted behaviours.

As far as consumer transactions are concerned, the courts have formulated a consumer-biased doctrine whereby statements made by the professional supplier in advertisement before or when the contract is concluded is to be treated as giving rise to a contractual obligation as regards the quality or use of the supplied services or goods or other property. In accordance to the described doctrine, the courts held that the developer was bound to build and deliver the housing development with the three tennis courts as published in the advertisement brochure thereof – Supreme Court, judgment of 23 May 2003 -. The same theory is inspiring Article 6.101 EPCL, although the rule is not only devoted to consumer contracts. Moreover, the rule is qualified by the requisite of ignorance of the inaccuracy of the statement as embodying indeed good party by the trusting party:
“(u)nless it is shown that the other party knew or could not have been unaware that the statement was incorrect”.

iii). signal vices of consent (i.e. mistaken consent due to lack of information provided by the counterpart during negotiations). Provided that one of the most paradigmatic pre-contractual duties is the duty to inform, misinformation, omissions or unreasonable reluctance to reveal relevant data likely to affect the proper decision-making process of the counterparty can be the cause of a subsequent mistake, error or vice in the manifested consent.

III.- Rules governing Pre-contractual stage: obligations and liability

In negotiating, parties are exercising their freedom to contract and, as a consequence, not to contract as well. Accordingly, the freedom to negotiate or to stop negotiations at a specific moment would be a natural expression of the general freedom to contract. Not surprisingly, parties are supposed to be free to leave or interrupt negotiations at any time or to renegotiate conditions at stake at their convenience. Freedom to deal and not to deal should be protected accordingly. Nonetheless, reasonable expectations of the counterparty and his/her confidence in the seriousness of the negotiation process should be also protected anyhow against harming acts in bad faith. A balance between protecting trust and honoring freedom to contract has to be carefully settled.

Three regulatory issues deserve special attention. Previously, a prior matter has to be briefly mentioned: whether current Philippines and Spain count on specific rules on pre-contractual stage. Against such a normative backdrop, three questions will be discussed. Firstly, whether in comparative law, and particularly, in Philippine and Spain, it is, either expressly or impliedly, provided for that good faith principle has to govern preliminary dealings. Secondly, which specific obligations negotiating parties are subject to and whether such pre-contractual duties are typified in statutes. Thirdly, which rules would govern pre-contractual liability: typical cases and remedies. 

III.A. Rules on pre-contractual stage

The theoretical construction of culpa in contrahendo doctrine was masterly formulated by the German scholar Rudolf von Ihering in the second half of XIX century. His ideas were widely adopted later by scholars and subsequently enshrined in some national codes (BGB, Swiss codes). But general rules on pre-contractual liability are not actually enacted until the promulgation of later codes such as the Greek code and the Italian one. Subsequently, other European Code, as the Portuguese one, follows the same policy. Along with such a slow legislative acknowledgement, the theoretical framework and the practical scope of pre-contractual liability have been always illuminated and fuelled by active German courts. Likewise, Faggella’s4 works leaded the evolution of such legal construction in European scientific literature and case law.

In Spain and Philippines, in particular, codes have been traditionally silent in respect to pre-contractual stage and, accordingly, a systematic set of rules governing, on a comprehensive basis, parties’ obligations and eventual liability in the negotiation period prior to the reaching of the agreement are lacking. On the one hand, basic duties were to infer from the general principle of good faith. Nonetheless, on the other hand, specific pre-contractual duties started to be typified in special legislation mainly tackling consumer transactions or transactional situations whose context or circumstantial conditions increase the need to protect one of the prospective contracting party – information obligations in electronic contracting (Article 27 Law 34/2002) – or information asymmetries need to be repaired – traditional duty to disclose risks in insurance contracts (Article 10 Law 50/1980 on Insurance) -. The regime is then fragmented in scattered legal rules of diverse scope and aims and fuelled by a powerful, albeit indeterminate, principle of good faith. Philippine legislation does also lack a general legal framework governing pre-contractual stage. Articles 19 and 20 of Philippine Civil Code acknowledges that the exercise of any right and the performance of any duty have to be in accordance with justice and in observance of honesty and good faith5 . Hence, the general principle of good faith would cast over the pre-contractual stage naturally.  
 
In contrast with the absence of a general regulation in domestic legislation, several supranational texts of different nature and scope, are expressly including rules on pre-contractual duties: Article 2.1.15 UNIDROIT Principles 6, Article 2:301 Principles of European Contract Law 7 or Article I.-1:103 Draft Common Frame of Reference.

Likewise, other European jurisdictions do also have express provisions on pre-contractual liability: Articles 197 and 198 Greek Civil Code, Articles 1337 and 1338 Italian Civil Code or Articles 8, 23 and 24 Swiss Civil Code.

Very recently, the draft new Commercial Code, albeit not in force yet, has nevertheless included two legal provisions dealing with pre-contractual issues (confidentiality obligation and pre-contractual liability): Articles 412-1 and 412-28 , respectively. Previously, in 2009, the Proposal for the Modernization of the Law of Contracts and Obligations expressly addressed pre-contractual liability as well in Article 1245 9 Civil Code 10. 

III.B. Good faith in negotiating

Preliminary deals are aimed at reaching an agreement but do not entail the existing of any contract between the negotiating parties. Therefore, in absence of contract, parties are not to abide by a set of rules agreed thereby. Good faith principle is the only guiding rule governing the negotiation period. Parties are expected to bargain in good faith.

Principle of good faith should permeate all acts and behaviors (Article 1:201 EPCL 11, Article 1.7 UNIDROIT Principles in similar terms), insofar as the exercise of rights and the compliance of duties should be in accordance to good faith requirements12 and fair dealing13 . The natural consequence of this prevailing principle is its extended application to all stages of contractual process: negotiations, contract formation and performance. Roman Law-rooted legal systems14 extensively accept such general assertion. Common Law systems are not totally unfamiliar with good faith principle and culpa in contrahendo, although approaches are majorly diverging. On the one hand, whereas a duty of fair dealing is generally imposed on the parties to a contract 15, the good faith principle is not formulated so as to extend to pre-contractual negotiations conceived more as an adversarial process 16 than a cooperative one. On the other hand, nevertheless, with different legal machinery - “duty to disclose”, “estoppel”, “implied subsidiary promise” or “instinct with an obligation” doctrine – same philosophy of culpa in contrahendo and similar rationale underlying the expansion of good faith are supported. Along the same lines, case law in common law jurisdictions, specially in US, is showing in last decades an increasing openness to accept pre-contractual cases and impose liability. Possible and most feasible grounds are in those cases grouped under three main categories: unjust enrichment, misrepresentation during the negotiations, breach of specific promise.

Interestingly, considering such a diverging Common Law-Civil Law approach17 on the observance of good faith in pre-contractual negotiations, it might be well worth discussing whether Filipino legal system reveals in that matter a more visible American perspective or, contrarily, perpetuates a civilian understanding. Far beyond codified rules, a proper characterization of a legal system need to take into consideration a range of historical, institutional, educational or social factors describing how law is made, applied, interpreted, taught and socially perceived - In re Shoop, Supreme Court of Philippines Islands decision, 1920 (41 Phil. 213) -.   

The above-mentioned divergences appear not be irreconcilable but it cannot be confirmed either that the application of good faith, in particular, to pre-contractual stage, is commonplace. Revealingly, in uniform instruments an express reference to the duty to act in good faith is avoided. UNIDROIT Principles and EPCL are illustrative in that regard when eluding an express recognition of good faith in pre-contractual dealings by resorting to a negative formulation: “negotiations in bad faith” (UNIDROIT Principles) and, less revealing but still opting for banning acts contrary to good faith instead of requiring a general observance of that principle, “negotiations contrary to good faith” (EPCL).   

Unlike Article 1245 Civil Code as proposed by the Modernisation Proposal that included an express declaration of good faith in negotiations 18, Draft new Commercial Code aligns with uniform texts and does only utilize the negative formula. So, Article 412-2 devises the pre-contractual liability scheme around the element of bad faith without a general declaration of the duty to act in good faith: “(l)a parte que hubiera negociado o interrumpido las negociaciones con mala fe será responsable por los daños causados a la otra parte”.

III.C. Pre-contractual duties

The general principle of good faith would distil in a varied set of specific pre-contractual duties considering transactional circumstances, condition of the parties and other concurring factors. An exhaustive list of pre-contractual obligations, drafted in general terms, is not provided for by existing laws. Some special laws have expressly formulated specific duties for the pre-contractual stage: consumer law, laws governing electronic commerce and Internet service provision, or financial markets law. Although these provisions serve to signal the main angles of outline of pre-contractual duties and help to better understand the principle of good faith in practice, their assistance in interpretation is limited. On the one hand, for their compliance and enforcement are confined to the scope and conditions set out by each legislation, and, aimed to meet specific goals. On the other hand, because a mere formalistic compliance does not necessarily exhaust all manifestations of good faith and, in reverse, the non-fulfillment of such provisions does not automatically entail consequences in the validity and the enforceability of the final agreement.

Recent practices in bank sector provide illustrative examples in that regard. Interestingly, a numerous case law in Spain has tackled the validity of controversial swaps contracts linked to mortgage loans as risk-coverage mechanisms. In most cases, bank clients have challenged the validity of the swap contract on the grounds of vitiated consent. Claims for nullity has been based on commonplace allegations: banks did not fulfill their statutory duties, basically, to clearly inform the client of the risks, implications and operation of such sophisticated financial transactions. As a consequence, clients could not gain a full insight into the nature and extent of the contractual obligations they were taking on. Court decisions19 differ but most of them do deeply rely on pre-contractual stage to assess whether clients were sufficiently informed in reasonable terms. In other words, whether the mistake the client incurred in was essential and excusable. In assessing the occurrence of an error invalidating consent, courts mainly consider the due fulfillment by the bank of information duties and other pre-contractual obligations as provided for by applicable regulations. Three recent Spanish Supreme Court judgments refine such a line of reasoning and clarify the consequences of the non-compliance - Spanish Supreme Court judgments 840/2013, of 20th of January of 2014, 385/2014, of 7th of July of 2014, 384/2014, of 7th of July of 2014 and 387/2014, of 8th of July of 2014 -. The Supreme Court held that the non-compliance of pre-contractual obligations does not automatically imply the nullity of the contract on grounds of error in consent. As a matter of fact, non-fulfilment or a defective compliance of obligations provided for by regulations influence the appreciation of a mistaken consent, whether the client could effectively understand the risks and the consequences of signing the contract, considering the circumstances, contract was not vitiated.  
 
III.D. Pre-contractual liability

Conceptualising pre-contractual liability (culpa in contrahendo) has encountered wide-ranging controversies. Trapped in the rigid binomial contractual liability and non-contractual liability, liability arising from damages caused in bargaining is hard to qualify. Spanish scholars uphold a major stance on non-contractual thesis, in particular, where pre-contractual liability arises as a result of the breaking-off of negotiations. Notwithstanding the major position, some scholars are inclined to defend a contractual qualification of pre-contractual liability insofar as it stems from a situation of nullity of the contract, along the lines of a part of case law. Case law is indeed incoherent and provides contradictory solutions. In my opinion, it should be noted that cases are different because they are addressing consequences of pre-contractual stage at different phases of the contract formation process. Although the source is the same (pre-contractual), the scenario where it effects determines a different starting point (pre-contractual or contractual, respectively).    

Under Philippines Civil Code, provisions on quasi-delict reveal an approach that appear roughly equivalent to torts in American law. Articles 2176 to 2195 of the Code encompass rules on quasi-delict. Article 2176 vertebrates the legal regime with the following wording: “Whoever by act or omission causes damage to another, there being fault or negligence, is obliged to pay for the damage done. Such fault or negligence, if there is no pre-existing contractual relation between the parties, is called a quasi-delict and is governed by the provisions of this Chapter.”

Against such a backdrop, a systematizing approach appears highly advisable in order to categorize cases, spot liability scenarios and consider available remedies.

In practice, pre-contractual liability may arise in three different scenarios:

A). Unjustified Breaking-Off Negotiations.

As a general rule, freedom to deal would entitle parties engaged in negotiations to decide not to continue, interrupt or renegotiate conditions. Freedom to deal would encompass freedom not to deal, to negotiate or not to negotiate. Nonetheless, the exercise of such freedom is not absolute but subject to certain limits, insofar as other rights or interests may deserve protection as well. Unexpected, unfair or unfounded interruption of negotiations before reaching an agreement is likely to frustrate other party’s reasonable expectations on the seriousness of the dealings and the continuation of the negotiations. Majority opinion20 affirms that in such cases reliance damages should be compensated, provided that several factors are met for pre-contractual liability to arise 21: reasonable reliance deserving of protection, unfair breaking-off of negotiations and losses caused thereby.

Delimiting the scope of reliance damages and determining which costs and expenses compensation should cover are critical tasks requiring attention. As a starting point, it has to be asserted that expected compensation should aim to place the injured party at the before-negotiation position. That means that any expense, cost or investment that were reasonable made during negotiations and to that end might be compensated. Contrarily, the expected compensation should not be addressed to replicate the financial scenario of a hypothetical contract. As a matter of fact, such an expansive position would exert a serious deterrence effect in the market, for commercial market players would be highly discouraged to initiate negotiations unless strongly relying on a success. Such a compensation option should be discarded then.      

In sum, all costs and expenses that were undertaken in the belief and for the purposes of the expected agreement would be compensable. Therefore, eligible costs have to meet two criteria: finality and reasonability. Only an objective and reasonable expectation in the reaching of the agreement justify compensation. Accordingly, unnecessary expenses, unjustified investments, or sumptuary payments would not be objectively compensable. Reasonability has to be determined in accordance to all circumstances surrounding the transaction (parties behaviour, exclusivity arrangements, complexity, stage of the negotiations).   

Article 412-2 of the Draft new Spanish Commercial Code states that when a party initiate or interrupt negotiations in bad faith, damages caused to the other party shall be compensated. Such succinct declaration still leaves unsolved two controversial issues.

Firstly, whether acting in “bad faith” comprises solely intentional or reckless behaviours.

It is discussed whether acting in bad faith also covers negligent or fault behaviours. Article 412-2.2 specifies in fine, in line with UNIDROIT Principles and EPCL,that “it will be deemed bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party”. An intentional factor, which should not be a prerequisite 22, is however clear remarked. Nevertheless, from the perspective of the protection of reasonable expectations of the relying party, it is argued23 that any behaviour, even without fault 24, able to generate that reliance might trigger liability. It has to be remembered first that only reasonable, legitimate and objective reliance deserves protection. Contrarily, the party who decides to leave negotiations is not liable for eventual damages suffered from the other party arising from a mistaken risk evaluation, an imprudent or unthinking investment or a hurried decision without any illegitimate pressure from the former. In particular, in commercial trade, it is frequently discussed whether the opportunity of a better deal is a sufficient reason to break off negotiations on a good faith basis. Apart from cases of negotiations on an exclusivity basis or where parties have included in preliminary agreements provisions banning parallel negotiations or providing other consequences for that, parties are free to engage in several negotiations and opt for the deal that it is perceived as the most convenient given the circumstances. In sum, more justifiable the reason for breaking off is, less likely is to appreciate bad faith.

Secondly, whether the loss of opportunities to negotiate with other parties can be compensated as well.

Along with costs, expenses and specific investments that due to the interruption of negotiations become compensable, the mere initiation of negotiations entail the dismissing of other competing business opportunities. When negotiations are then abruptly and unexpectedly broken off, it is asserted that the loss of those opportunities25 should be compensated as well. Two main concerns make the answer more complicated. On the one hand, it may be alleged that the loss of opportunities embodies an inherent risk of business activity. Market players evaluate available business opportunities, assess probabilities, analysis costs and benefits and make an informed decision to start negotiations. Therefore, losing opportunities would be a natural market risk for businesses. On the other hand, it is warned how difficult is to prove the likeliness of the lost opportunity, to estimate the damages caused by the alleged loss and to demonstrate the very existence of those competing opportunities. Notwithstanding such difficulties, loss of opportunities can be compensated when duly proved and reasonably estimated in probability terms.

Should negotiations be interrupted in bad faith, insofar as the party breaking off dealings entered into or continued negotiations without intending to reach an agreement (as typified by legal rules), it will be easier to prove that the obstructive behaviour of the counterparty blocked other competing options and provoked loss of opportunities with unsuccessful negotiations.

In all previous cases, it might be well worth reminding that compensation will cover only the estimated loss of an opportunity not the eventual advantages that the uncertain conclusion of a contract, in case that such lost opportunity were feasible and successful, would have entailed.

B). Conclusion of an agreement that happens to be null and void due to the violation of pre-contractual duties (duty to inform).

Recent cases on swap contracts linked to bank loan agreements for risk coverage purposes offer a revealing example. Spanish Courts and Arbitration tribunals have settled in last years an abundant number of disputes in bank transactions on grounds of contract nullity caused by the violation of pre-contractual obligations. As previously explained, financial services contracts (swaps) have been declared null and void on grounds of invalidating error caused by the infringement or defective compliance by the bank of pre-contractual obligations to inform and to assess client’s risk profile.

In all these cases, the contract is concluded but it is to any extent affected by the performance of the pre-contractual stage. At least two issues on remedies arise at a first sight.

Firstly, whether a claim to declare nullity of the contract on grounds of error 26 would be compatible to a claim of compensation for violation of pre-contractual obligations27 . Secondly, whether remedies for breach of contract would be actionable in those cases as well. The factual scenario might be as follows. One of the contracting parties provides during negotiations false or inaccurate information about the product, its quality, authenticity or characteristics. The other party agrees to conclude the contract relying on such information that becomes part of the contract. Accordingly, the performance will not be in conformity with contract terms. The injured party would be entitled to enforce contract terms and exercise remedies for breach of contract.      

At the uniform level, Article 40 UN Convention on International Sales of Goods, 1980 (CISG) provides for a very particular solution. Despite that it is commonplace that CISG did not intend to expressly regulate pre-contractual liability in international trade, a thorough analysis 28 of the uniform text reveals a few points to anchor the pre-contractual discourse. Article 4029 deprives the seller of relying on Articles 38 and 39 CISG when the “lack of conformity relates to facts of which he knew or could not have been unaware and which he did not disclose to the buyer”. Since the uniform provision does not subject to any time limit the awareness of the facts and the non-disclosure by the seller, it may be extended to cover the pre-contractual stage as well. Interestingly, Article 40 neither provides for nor acknowledges remedies in favour of the buyer against the infringement of the seller. Simply, it might be said that the seller is to any extent penalized for the defective information, the omission or the failure to disclose insofar as he/she is prevented from invoking Articles 38 and 39. These provisions set out those conditions under which the buyer can rely on the lack of conformity (duty to examine within a short period, give notice to the seller within a reasonable time). Under Article 40, the seller is not entitled to allege that the buyer did not comply with his/her duties in relation to the lack of conformity as laid down in Articles 38 and 39.    
 
C). Conclusion of an agreement that is valid despite of the fact that the injured party would have entered into the agreement under different conditions if the other party were disclosed all relevant information in negotiations.

The group of cases categorized under this category differ from the previous one in the fact that the violation of pre-contractual duties has not led to the invalidity of the contract. Notwithstanding, the contract, albeit validly concluded, has been agreed in different conditions, presumably unfavourable to the party who was not aware of all relevant information. For the contract is valid, the injured party is not entitled to claim for avoidance or termination. Nevertheless, it may be sustained that the injured party should be compensated for the damages caused by the unfavourable conditions. Two main options seem available.

On the one hand, the injured party might claim for compensation to cover the difference of between the value of the expected performance according to the pre-contractual representations and the value of the effective performance under the contract. On the other hand, following an in favor negotii approach, it may be contemplated the option of renegotiating contractual terms in order to adapt the agreed conditions to the expected value. Arguably, rebus sic stantibus or hardship seem to have been originally envisioned to manage extraordinary change of circumstances of absolute unpredictability with exorbitant effects on the equilibrium of the contract30 . Such requirements might be too stringent for cases where the violation of pre-contractual duties simply frustrates the expected value of the contract or destabilizes the balance of parties’ positions in the contract. It is indeed a highly controversial issue in modern contract law both at the international level and at a domestic one.          

IV.- Preliminary agreements in pre-contractual stage

As previously expounded, the pre-contractual stage comprises a variety of statements, representations, acts, negotiations or behaviours of varied nature including as well agreements31 (letters of intent, memorandum of understanding, term sheet, agreements to negotiate, non-disclosure agreements). Such preliminary agreements are aimed to regulate negotiations and its effects. As a consequence, parties determine their duties, set out principles and rules governing their dealings and agree (limiting or excluding) eventual compensation – disclaimers, limitation of liability, liquidated damages clauses, penalty clauses -. Overall, preliminary agreements have the ability to “transform” eventual pre-contractual liability from extracontractual to contractual. As a matter of fact, parties intend to “contractualize” the pre-contractual stage in order to rationalize costs, manage risks and enhance predictability.

Synthetically, preliminary agreements, in absence of express regulation, arouse an array of issues deserving further attention.

Firstly, it might be well worth raising the question whether good faith can be disclaimed by parties in a preliminary agreements and to which extent, and for the purposes of those legal systems reluctant to recognise the observance of that principle in negotiations, whether the agreement to observe good faith in pre-contractual stage is enforceable (and should be enforced by courts) and which are the available remedies.    

Secondly, it might be discussed whether parties are totally free to aggravate by agreement the consequences of any infringement of pre-contractual duties, for instance, including a generous liquidated damages clause or broadly extending compensable damages. The underlying concern is that parties could be de facto encroaching upon the freedom to deal. As a matter of fact, should breaking off negotiation trigger exorbitant and unusual consequences, parties would be in practice prisoner in negotiations and forced to contract to avoid unaffordable sanctions.

Thirdly, it is widely questioned whether preliminary agreements are binding. In practice, parties frequently include clauses aiming to diminish their binding character. But, on the other hand, the intrinsic value of such agreements is precisely their ability to establish a contractual framework for pre-contractual stage. Even more, should preliminary agreements be deemed binding, is specific performance an available (and feasible) remedy? 

V.- Final remarks

1). Commercial practices reveal that business dealings are far from the image of  simple, single-issue, instantaneous transactions. Parties’ statements, representations or behaviours preceding the conclusion of the contract, even in contract of adhesion and/or standard term contracts, play critical roles in relation to the contract: for the purposes of interpretation, supplementing contract terms and identifying vices of consent.

2). Notwithstanding its practical relevance and extended use, pre-contractual stage is still ignored or barely regulated in codes and legislation. Nonetheless, more and more attention is being paid recently by scholars, special legislation and supranational regulating authorities. Pre-contractual liability is still a topical issue, is still open to debate and reveals a significant relevant in the market.

3). Both Philippines and Spanish legal systems rely on the expansive force of the general principle of good faith to deal with pre-contractual issues. Uniform solutions (UNIDROIT Principles, EPCL, Draft) encourage a more elaborated and comprehensive regulation of the pre-contractual stage. Two recent modernisation projects, still pending, in Spain, have purported to address pre-contractual duties and liability under a general approach. The topic is not concluded yet.