Special Issues in Cross-Border Contracts
By: STEVEN J. DICKINSON
March 2006
Thousands of businesses in the upper Midwest import and export billions of dollars of products each year. In many of these transactions, the parties use a standard purchase order, sales contract, or other agreement - the same document used when the other party is in the United States. However, there are some important differences between domestic and cross-border purchase or sale transactions that warrant a special look at international contracts. This article provides a brief overview of two such issues - international contract law and international shipping terms.
International Contract Law
Domestic contracts are generally drafted according to the basic principles of U.S. contract law - primarily those set out in Article 2 of the Uniform Commercial Code (UCC), which governs contracts for sales of goods. Article 2 establishes rules for how contracts are formed, the rights and obligations of the buyer and seller, what constitutes a breach of contract, and a party's remedies for breach of contract.
However, contracts with parties outside the U.S. may be governed by the United Nations Convention on International Sales of Goods (CISG), a treaty to which the U.S. and 66 other countries are a party. Many of our major trading partners (including Canada, Mexico, most European countries, China, Korea, Argentina, Chile, Australia, and Singapore, but excluding the United Kingdom and Japan) are parties to it. A contract for a sale of goods between a person in the U.S. and a person residing in another CISG country will be governed by the CISG. Consequently, the CISG may have a significant impact on Midwestern companies buying or selling goods outside the U.S.
The CISG performs much the same function as Article 2 - it governs the formation, performance, breach, and remedies relating to contracts for the sale of goods between parties in countries that have adopted the CISG. However, its principles of formation, performance, breach, and remedies differ from Article 2 in important respects. The outcome of a contract dispute under the CISG may be different from (even the opposite of) the result under Article 2. Take a common example: A Minnesota company wants to buy 1,000 widgets from a business in Canada. Buyer sends the proposed seller its standard purchase order, which contains no dispute resolution clause. Seller replies with a confirmation that accepts the terms of the purchase order, but adds that disputes will be subject to arbitration in Toronto. No further action is taken by either party. The next day, the price of widgets plummets, and the buyer wants out of the "contract" because they now are available elsewhere at a lower price.
Under Article 2, the parties reached a valid contract (unless the purchase order or confirmation had provisions dealing with the effect of additional or different terms). The arbitration clause is considered a material modification, so it is "knocked out," and the parties are found to have entered into a contract with no dispute resolution clause. Under the CISG, however, an acceptance must be the "mirror image" of the offer. Consequently, the new dispute resolution clause is considered a rejection of the buyer's offer and a counteroffer by the seller. Without further action on the part of the buyer, no valid contract is reached. So, if the transaction is governed by Article 2, the buyer must pay for the widgets at the contract price, but, if the transaction is governed by the CISG, the buyer would be free to buy them elsewhere. (Note that further action, such as the buyer paying for the goods, could have been considered an acceptance of the additional contract term - resulting in formation of a valid contract - even under the CISG. However, silence alone is not considered acceptance.)
Implied warranties are another area of difference. The UCC contains implied warranties of merchantability, fitness for a particular purpose, good title, and non-infringement of intellectual property rights. The CISG contains similar implied warranties, but also requires that the goods match up to those held out to the buyer as a sample or model and that the goods must be contained or packaged in the manner usual for such goods or, where there is no such manner, in a way adequate to preserve and protect them. Because of these differences, standard Article 2 warranty limitations are inadequate for a CISG contract.
Other important differences between the UCC and CISG include "perfect tender" vs. "fundamental breach" in determining whether a breach exists, the extent to which a party has a right to cure defective performance, and the nature of remedies for breach (the UCC emphasizes damages, while the CISG emphasizes performance, including the right to require specific performance by the breaching party).
The simple solution to UCC-CISG differences might appear to be a standard choice of law clause: "This contract shall be governed by the laws of the State of Minnesota, without regard to choice of law principles." However, this does not automatically mean that the UCC applies rather than the CISG. The CISG is a treaty and thus is part of Minnesota law. A court might decide that the choice of law clause shows the parties' intent to choose the UCC rather than the CISG, but why allow such uncertainty? To avoid doubt, the parties should affirmatively state in the contract whether the CISG does, or does not, apply. A party that routinely buys or sells goods outside the U.S. might find it preferable to opt into the CISG and adapt its contract forms accordingly rather than to explain to each foreign party why the CISG should not apply.
International Shipping Terms
Many U.S. businesses are familiar with the terms FOB, FAS, CIF and C&F under Article 2 of the UCC. However, in cross-border business, the lingua franca is "Incoterms" - the International Commercial Terms adopted by the International Chamber of Commerce. Incoterms contain detailed definitions, including a list of responsibilities of the buyer and seller on important business issues, for each of the following shipping terms:
- Ex Works (EXW)
- Free Carrier (FCA)
- Free Alongside Ship (FAS)
- Free on Board (FOB)
- Cost and Freight (CFR)
- Cost, Insurance and Freight (CIF)
- Carriage Paid To (CPT)
- Carriage and Insurance
- Paid To (CIP)
- Delivered at Frontier (DAF)
- Delivered Ex Ship (DES)
- Delivered Ex Quay (DEQ)
- Delivered Duty Unpaid (DDU)
- Delivered Duty Paid (DDP)
Incoterms definitions are far more precise than those in Article 2, and in some cases are different. For example, FOB under Incoterms only applies to goods that are loaded over a ship's rail. For containerized goods, FAS would be used instead of FOB. Importers and exporters should understand and use Incoterms in their contracts.
The CISG and Incoterms are specialized sources of legal rights and obligations for buyers and sellers in cross-border contracts. Used properly, they allow businesses to more effectively and efficiently document purchase and sale transactions and possibly avoid costly and time-consuming international disputes. As with most complex contract issues, businesses should consult with legal counsel when drafting international sales or procurement contracts.