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II. A Market Function Approach

A. Ethics or Economics – The Wrong Question

Th e majority of civil law scholars endorse the idea that the fault principle is ethically well founded, and some scholars clearly see it as ethically superior to strict liability.32 Th e core argument is the following: A system that grounds damages in fault gives the breaching party more freedom, since he does not have to answer for developments that he could not control. In a Kantian tradition, it is seen as an act of freedom to choose between breach or conformity with a contract. Others, however, argue that a regime of strict liability may also foster some level of freedom by furthering the principle of pacta sunt servanda, that agreements must be kept33 – a principle of equal importance with freedom of will. Therefore, balancing both principles seems necessary. In fact, this reasoning is used to explain why most systems include both fault and strict liability elements.34

While it is true that most systems follow a nuanced approach, the above explanation is misguided. First, freedom and pacta sunt servanda are not of equal importance, at least not in the context discussed here. There is actually a clear hierarchy between them, and pacta sunt servanda is clearly more important for the following reason. Those who advocate the ethical superiority of the fault principle because it gives the breaching party the freedom to answer only for those acts and events for which he is responsible forget one rather simple fact: There is an earlier type of freedom that allows each party to decide what offers he makes and to which standards he wants to bind himself, that is, the freedom of contract. In fact, fundamental concepts such as normative individualism or Böhm’s concept of a private law society35 are signifi cant because they clarify one thing: The most vital tenet

32 Karl Larenz, Lehrbuch des Schuldrechts: Erster Band, Allgemeiner Teil 286 (14th ed. 1987), at 276–9; Canaris, supra note 15, at 251; Erwin Deutsch, Die Fahrlässigkeit im neuen Schuldrecht, 202 Archiv für die civilistische Praxis 889, 892 (2002); Stephan Lorenz,

Schuldrechtsmodernisierung – Erfahrungen seit dem 1. Januar 2002, in Karlsruher Forum 20 05: Schuldrechtsmodernisierung – Erfahrungen seit dem 1. Januar 2002 59 (Egon Lorenz, ed., 2006).

33Riesenhuber, supra note 16, at 145.

34See id. at 148.

35Franz Böhm, Freiheit und Ordnung in der Marktwirtschaft 105–68 (1980); see also David J. Gerber, Constitutionalizing the Economy: German Neo-liberalism, Competition Law and the “New” Europe, 42 Am. J. Comp. L. 25 (1994) (describing and commenting on this concept in English); Stefan Grundmann, The Concept of the Private Law Society: After 50 Years of European and European Business Law, 16 Eur. Rev. Private L. 553 (2008); Manfred E. Streit & Werner Mussler, The Economic Constitution of the European Community: From “Rome” to “Maastricht”, 1 Eur. L. J. 5 (1995) (on the influence of Böhm’s ordo-liberalism).

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of freedom in modern times (and Böhm sees this time as starting with the French Revolution and the “private law society” it installed) is the right of each person to decide, to the greatest extent possible, which obligations to assume. This freedom – which comes first – is disregarded if the question of whether fault or strict liability should govern is decided, not on the basis of the parties’ expressed or implicit intentions, but rather on the basis of an “ethical credo” about the superiority of fault or of strict liability. If the freedom of the parties is taken seriously, the question is how to interpret their intentions, not to impose on them a regime judged by scholars, legislatures, or any other third party to foster their freedom and therefore be ethically superior. Replacing the choice made by the parties – even if justified as fostering freedom – is paternalistic. Normative individualism, on which the economic analysis of contract law rests, has mainly ethical foundations, too, including the assumption that each individual is given the freedom of choice as far and as early as possible.

Th e core question is therefore which regime best fosters the intentions the parties had in mind when entering the contract. Does strict liability better mirror their expectations or does fault liability? Is the answer the same for all contracts? Does a requirement of foreseeability mirror parties’ expectations? The next section uses party and market expectation as a guideline for answering these questions.

B. Party and Market Expectation as Guidelines

Liability in contract law is not really an issue when it comes to the recipient of goods or services. Payment is generally owed under a strict liability rule (some exceptions are discussed in the following section). Liability of the provider of goods or services, therefore, is the real issue. It is helpful to keep in mind that liability results in compensation. Damages account for what the recipient has bargained for but has not fully received. Thus, liability in all its forms helps to make the recipient whole if the performance he receives is not in conformity with the contract.

If liability requires more than mere nonconformity, however, the recipient’s expectation of receiving the benefit of the contract for which he bargained is not fulfilled in those cases where the additional requirement – for instance, fault – is not satisfied. Therefore, liability based exclusively on nonconformity with the contract – that is, strict liability – has the advantage of making different offers easier to compare. All costs resulting from a certain behavior, for instance, the production of the good sold in conformity with the contract – and the production of the good sold in nonconformity – are

The Fault Principle as the Chameleon • 45

calculated into the prices if liability is strict.36 Th is is so because the buyer either receives the benefit of the contract for which he bargained or he receives full compensation without any additional requirement. The benefit bargained for will be received irrespective of whether performance is in conformity with the contract (or at least something close to the benefit when potential litigation costs are factored in).

It would seem to be a cornerstone in a model of competitive markets that clients be put in a situation where comparability is best guaranteed. But any requirement of fault reduces comparability: A party that bargains for a specific benefit receives the full benefit only where the other party fulfills his contractual obligations, but a fault regime obligates him to fulfill an additional requirement before receiving the full benefit where the other party breaches. Under strict liability (if one ignores litigation costs), nonconformity does not matter. The buyer who receives performance in conformity with the contract is just as well off as the one who does not receive performance in conformity with the contract. Thus, strict liability reduces the influence of nonconformity on whether the full benefit of the bargain is received, and it increases comparability because developments in the future that the buyer cannot foresee (namely, breach) become irrelevant for the (value of the) benefit he derives from the contract.

An additional advantage of strict liability is related to governance. In strict liability, the person who can best influence and assess the quality of the performance, that is, the provider of goods or services, carries all costs of conformity. Therefore, no external person – for instance, a judge applying the Hand formula – has to make this assessment.37

C. Promise of Results or Promise of Best

Efforts – The Core Criteria

If strict liability better fosters freedom of contract, or freedom to bind oneself to a standard that the other party expects, and it also fosters comparability of offers, the core question is how to justify exceptions to strict liability. As a starting point, the distinction between contracts for results or best efforts, which is so fundamental in French law, would seem to be highly sensible. There are promises where no result has been promised or no such promise

36See Robert Cooter & Thomas Ulen, Law & Economics 208–12 (5th ed. 2008); Steven Shavell,

Strict Liability versus Negligence, 9 J. Legal Stud. 1, 4–8 (1980).

37See Shavell, supra note 36. The same line of reasoning can be applied to the question whether there should be a force majeure excuse or not. Compare Fabre-Magnan, supra note 23, at 573–4 (civil law) on the one hand, with Treitel, supra note 25 (common law), at 838 on the other.

46 • Stefan Grundmann

can be inferred from the parties’ typical interests because in some cases too many other factors can obstruct a certain result. In other words, where an obligation is such that the result can be promised because it is within the party’s control, strict liability is acceptable (and indeed fosters comparability and thus market and party expectations). But where this is not the case, strict liability is just not appropriate because parties would not expect a guarantee of result.

Th e first category, where strict liability is appropriate, includes virtually all sales of goods and some sales of services. For example, strict liability should typically apply to mass-production contracts. The German rule, which would hold that the seller is not accountable for the defects caused by the thirdparty producer, is clearly suboptimal in this context. This rule is not suboptimal (only) because of the shortcomings of the fault principle. In fact, it goes beyond fault and excludes liability if there clearly was fault on the side of the third-party producer. One way around this result would be to design vicarious liability differently, that is, to make the seller responsible at least for the fault of other members of the distribution chain (including the producer). But strict liability provides a much easier solution: The seller’s liability would be beyond doubt (vicarious liability would not matter) and, as a result, the producer’s recourse from the seller would also be known. The effect is that ultimately the person who caused the nonconformity is subject to liability and not exempt for reasons such as privity of contract. Uniform international law and its development confirm the correctness of applying strict liability to these contracts: Article 79 of the CISG, which covers sales, is the most prominent rule in which strict liability is carried through consistently.38

Th e second category – where strict liability is inappropriate – is composed of some, but by no means all, services. This is the really difficult category. The distinctive feature should not be the type of contract, but rather the question of whether reaching a certain result is within the party’s control or, more precisely, within a typical party’s control. In cases where the answer is negative, no promise of result can be inferred from the parties’ typical interests. In these cases, a guarantee is the exception, rather than the default, and must be proved by the nonbreaching party. The parties could agree to a guarantee, but the law should not infer it from the typical interests of the parties in such a case. If, however, the result is within a typical party’s control, a promise of result can be inferred from the parties’ typical interests, because such a promise is reasonable and it fosters comparability and thus market and party

38On the strict liability concept and the exact shape of the exceptions in this case, see, e.g., Hans Stoll & Georg Gruber, Exemptions, in Commentary on the CISG, supra note 5, art. 79, paras. 10–13, 30–2.

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expectations. In a contract for services, therefore, one has to ask whether the result intended is within the control of the seller (or within the control of the network he gathers around him). This explains why, for instance, in the case of credit transfers strict liability should indeed be applied. Credit transfers constitute one of the few classes of cases on liability – fault or strict – that the EC has decided, and indeed the legislature decided in favor of strict liability.39 The payment chain has control over whether the credit arrives at the beneficiary’s account – within a fixed period of time and without getting lost in the chain. Because of all this, a guarantee can easily be given; and the EC directive interprets the parties’ understanding as implying such a guarantee. It is worth noting that this is not even a very exceptional case in the area of services. Contracts that specifically provide for success or a particular result (so-called works’ contracts in European terminology)40 – and this is a large number of cases – fall into this category.

Deciding whether strict liability should apply based on whether the contract is within the party’s control would seem to be convincing on the side of the recipient as well. The recipient typically just owes payment. While this duty is a strict one and the recipient cannot simply claim he was not at fault for a lack of money, many legal systems nevertheless accept excuses for late payment, such as illness.41 Th is result is justified by the fact that comparability is not an issue. As recipients do not make offers on the market, there are few factors that suppliers of goods or services use to compare potential recipients. While solvency is certainly one, temporary illness is not. And while a suitable contingency for coping with such “unexpected” obstacles is a factor for which a “guarantee” is expected on the side of the supplier, it is probably not on the side of the purchaser (client). This is because illness is not seen as being within the purchaser’s control, while the capacity to cope with illness is seen to be within the control of a supplier enterprise; that is, the supplier enterprise can more easily organize his affairs to deal with illness.

Similar criteria can be applied to long-term contracts in which a party can control whether he applies certain procedures, and otherwise refrains from acting in a grossly negligent way, but cannot control the outcome.42

39 Parliament and Council Directive 2007/64/EC, 2007 O.J. (L 319) 1, 8. See, e.g., Despina Mavromati, The Law of Payment Services in the EU (2008); Johannes Priesemann, Proposal for a Directive on Payment Services in the Internal Market: Overview and initial comments, 1 Euredia 15 (2006).

40In the German context, see BGB § 631 and standard commentaries on this section. In the French context, see, e.g., Fabre-Magnan, supra note 23, at 418.

41For German Law, see Heinrichs, supra note 19, § 276, para. 28.

42At least if it is a long-term relational contract that takes up most or all of the breaching party’s working power for a considerable time.