Chronicles of a Failure: From a Renegotiation Clause to Arbitration of Transnational Contracts

Author:by Luigi Russi

I. INTRODUCTION The fundamental tenet of the institution of contract is the aptitude for enabling cooperative solutions amongst economic operators. In fact, when an exchange takes place through a contract, a resource is transferred from one party to the other, and consent of both parties to such transfer generally guarantees that each participant gains from the exchange.

For instance, in a sales contract, the transferor receives a price, which exceeds the value she places on the transferred asset; meaning that the next best use she could make of it could not yield as high a payoff as that obtained by transferring the asset against the given price. In turn, the transferee obtains a positive net payoff by paying a certain price in exchange for the transferred resource, since the latter enables her to produce a greater amount of wealth than is given away to purchase said asset. In other words, contracts allow to "move a resource . . . from someone . . . who values it less to someone . . . who values it more [and]. . . . [C]ooperative surplus is the name for the value created by moving the resource to a more valuable use."(1) The paradigm for this economic understanding of contract consists of on-the-spot transactions, in which the exchange is simultaneous. On the other hand, when the transfer of the relevant resource is delayed or protracted in time, the profitability of the transaction for either party may vary, depending on the possible alternative uses for the concerned asset (which may change over time). This problem is of paramount importance in the context of long-term supply contracts: when one party promises to provide the promisee with a given commodity over a specified period of time, the contract price may initially be deemed adequate by both parties. Subsequent changes in the economic context,(2) however, may affect the profitability of the transaction. This entails the risk that one of the parties be left with a losing contract, meaning a contract in which she no longer benefits from the terms of the exchange, since a resource is to be transferred at a price that is lower - for the supplier - or higher - for the transferee - than the value of the next best use she could make of it.

A solution to this problem, which is often resorted to in commercial contractual practice, is the drafting of a renegotiation clause in the supply contract, whereby in light of certain predetermined events - which account for possible changes in the relevant economic variables - parties are supposed to redefine certain aspects of their contractual relationship, in order to adapt it to the changed circumstances.

Just as often, parties also draft price indexation clauses as a means to allow for automatic adaptation of the contract price. These two types of clauses may also be combined, and the price indexation clause may itself be subject to renegotiation.

At any rate, human foresight is at best limited. In light of subsequent events which the price indexing formula could not have accounted for, the balance of the contract may be deeply undermined, leaving one party with a negative surplus.

In such cases, of course, the renegotiation clause could provide a "back door" to overcoming this alteration of the contractual balance. Often, however, a higher burden on one of the parties may result in unexpected profits to the other, which may in turn affect the willingness of the benefited party to negotiate.

Let us think, for instance, of a supply contract for resource β: if, following increased scarcity of such resource (unaccounted for in the price indexing formula), the supplier were to furnish a commodity which she could sell on the open market at a higher price, she would essentially obtain a smaller share of cooperative surplus. Symmetrically, however, the promisee would find herself benefiting from the contractual entitlement to a low-cost supply of resource β. This being the case, it can be sufficient to consider, in order to assess the difficulty of the renegotiation process, how the entitlement to a higher fraction of surplus as a result of the change in circumstances makes the promisee comparatively wealthier under the contract than she could have expected at the time of contracting. Such wealth differential with respect to this specific relationship may in turn affect her scale of preferred negotiation outcomes.(3) This could then possibly make it harder for parties to reach a new balance.

All in all, it is not improbable that both mechanisms established by a price indexation and a renegotiation clause may fail. In this situation, a practitioner might then have to come to terms with another provision that is even more common in transnational contractual practice: an arbitration clause.

In view of the foregoing, it can finally be clarified which issues have been addressed in this work. Our main aim has, in fact, been that of understanding what legal issues are at stake in the event of failure of the renegotiation process, in case parties were to resort to arbitration procedures.

To this end, it has been attempted to parallel the methodology of comparative statics, by considering separately the issues involved in the ante-litigation scenario, and those at stake upon the onset of litigation. To this end, Part I analyzes (a) the typical structure of renegotiation provisions as well as (b) the nature of the ensuing obligations of the parties, in order to define the general "equilibrium" of the parties' entitlements before any litigation arises.

On the other hand, Part II considers (a) the possible controversies that may arise in connection with a renegotiation provision, and, with special focus on their arbitral solution, the issues of (b) the power of the arbitral tribunal to adapt the contract upon failure of negotiations, as well as (c) the compatibility of the ensuing award with the New York Convention on the Recognition and Enforcement of Arbitral Awards.(4) Finally, a comparative overview has been sketched with respect to (d) the conditions which the applicable substantive law requires to be met, in order to allow judicial and arbitral adaptation of contracts.

CHRONICLES OF A FAILURE 5 II. ANTE-LITIGATION SCENARIO A. Typical Structure of Renegotiation Clauses The above-referred characteristics of long term contracts qualify them as "'obsolescing bargain[s]' in which the perceptions of the parties regarding the usefulness and profitability of the venture and their relative bargaining strengths undergo constant changes."(5) In this context, international contractual practice has given birth to a number of different provisions, including - but not limited to - renegotiation clauses, aimed at introducing more flexibility in the contractual relationship, so as to ensure enduring profitability for both parties.(6) As a consequence, it is important to draw a preliminary distinction. Renegotiation clauses are in principle susceptible of application to any part of a contract: there are no inherent limitations - aside from those agreed upon by the parties - that functionally restrict their scope. In this respect, they differ from automatic adjustment provisions - also called "correction clauses" (Korrekturklausel) - which rely on external measurable variables (e.g. the price of a certain commodity, minimum hourly wages or stock market indices) in order to instill in the contract an element of change: such reliance on quantitative data functionally limits their applicability to the determination of price or quantity. Secondly, whereas the latter directly affect the regulation of the contractual relationship, by automatically adjusting it to changed circumstances, renegotiation clauses merely outline "the procedure to be followed without any attendant obligation to achieve a specific result."(7) Furthermore, automatic adjustment clauses usually serve to account for "normal, regular events, typical fluctuations in market prices, costs [and] demand."(8) Instead, renegotiation clauses are usually rooted in "extraordinary - and as such also unforeseeable - as well as [in] unexpected situations and developments,"9 which is why they are sometimes attached to "correction clauses" in order to provide a "failsafe" mechanism in case of changes of such magnitude as to render the adaptation device unworkable.10 RENEGOTIATION OF CONTRACTS IN INTERNATIONAL TRADE AND FINANCE, 121 ff. (Norbert Horn ed. 1985) (providing a classification of adaptation clauses).

  1. The bases for the determination [of the contract price] are the general economic conditions on January 1, 1969. A measure of these conditions are...the starting price of coal (Ko) and ... the starting hourly wage (Lo), which equal the price of coal and the hourly wage as of January 1, 1969. Should the [actual] price of coal or the [actual] hourly wage change upwards or downwards with respect to the above starting prices, the new [contract price] should be determined through the multiplication of the [original contract price] by factor f, yielded by the following formula: (0.6 0.15 0.25 ) o o K L K L Where... K = [actual] price of coal..., L = [actual] hourly wage.... ...

    f = + + 1. Triggering Events The essential focus of renegotiation clauses is on the change in economic circumstances and, more specifically, in those that have a bearing "on the actual contract, on the agreed goods, their price, their supply and sale."(11) In particular, renegotiation clauses should encompass negative variations in costs and profits, provided that such variations are unforeseeable. In favour of such construction, it has been observed how " [a] ... complete enumeration of all changes, that could affect the general economic conditions, lays beyond what is practically possible"(12) and that, in light of this, it would hinder the conclusion of long-term contracts to leave unforeseeable losses where they fall. In this respect, the very inclusion of a renegotiation clause should serve as an...

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