THE CONSTITUTIONALIZATION OF CONTRACT LAW Something New under the Sun? Olha Cherednychenko(1) Readers are reminded that this work is protected by copyright While they are free to use the expressed in it, they may not copy, distribute or publish the work or part of it, in any electronic or otherwise, except for reasonable quoting, clearly indicating the source. Readers are permitted to make copies, electronically or printed, for personal and classroom use Contents 1. Introduction 2. Different solutions to the same problem 3. Two parallel tendencies in modern private law 4. The constitutionalization of contract law what is this all about? 5. The Burgschaft case: A top-down approach by the German Constitutional Court 5. 1 From the theory of indirect effect of constitutional rights in private law indirectly to the theory of direct effect? 5.2 Balancing competing interests: The right to party autonomy v. the right to party autonomy in conjunction with the principle of the social state? 5.3 Party autonomy v. party autonomy in conjunction with the principle of the social state: Is there a possibility to strike an appropriate balance? 6. The O'Brien and Van Lanschot Bankiers v Bink cases: A bottom-up approach by the English House of Lords and the Dutch Supreme Court 7. Conclusion Constitutional rights and contract law -these notions, which were originally considered to be far apart from each other due to the sharp analytical and historical distinction common in European legal systems between public and private law, have recently started to move towards each other with increasing speed. The role of constitutional rights, which were conceived as an instrument for he protection of the individual against the power of the State, is no longer only limited to this kind of relationship. Purely private law relations, including contractual relations to which the State is not itself a party, have been rapidly losing their immunity from the effect of constitutional The constitutionalization of contract law is a part and an inevitable consequence of the general phenomenon of the constitutionalization of private law- the topic which has been most widely debated in Germany by both public and private lawyers. However, not only the minds of German
THE CONSTITUTIONALIZATION OF CONTRACT LAW: Something New under the Sun? Olha Cherednychenko(1) Readers are reminded that this work is protected by copyright. While they are free to use the ideas expressed in it, they may not copy, distribute or publish the work or part of it, in any form, printed, electronic or otherwise, except for reasonable quoting, clearly indicating the source. Readers are permitted to make copies, electronically or printed, for personal and classroom use. Contents 1. Introduction 2. Different solutions to the same problem 3. Two parallel tendencies in modern private law 4. The constitutionalization of contract law: What is this all about? 5. The Bürgschaft case: A top-down approach by the German Constitutional Court 5.1 From the theory of indirect effect of constitutional rights in private law indirectly to the theory of direct effect? 5.2 Balancing competing interests: The right to party autonomy v. the right to party autonomy in conjunction with the principle of the social state? 5.3 Party autonomy v. party autonomy in conjunction with the principle of the social state: Is there a possibility to strike an appropriate balance? 6. The O'Brien and Van Lanschot Bankiers v Bink cases: A bottom-up approach by the English House of Lords and the Dutch Supreme Court 7. Conclusion Notes 1. Introduction Constitutional rights and contract law - these notions, which were originally considered to be far apart from each other due to the sharp analytical and historical distinction common in European legal systems between public and private law, have recently started to move towards each other with increasing speed. The role of constitutional rights, which were conceived as an instrument for the protection of the individual against the power of the State, is no longer only limited to this kind of relationship. Purely private law relations, including contractual relations to which the State is not itself a party, have been rapidly losing their immunity from the effect of constitutional rights. The constitutionalization of contract law is a part and an inevitable consequence of the general phenomenon of the constitutionalization of private law - the topic which has been most widely debated in Germany by both public and private lawyers. However, not only the minds of German
lawyers have been preoccupied with this issue. Lawyers in other countries, following the developments in Germany, have also become concerned. One Dutch lawyer, M. B w. Biesheuvel expressed a rather pessimistic view on this problem. He describes its tragedy as follows: 'If one writes about the horizontal effect of constitutional rights from a public law perspective, the aspects are described so theoretically that civil law lawyers tend to give up on the exercise. And if the latter dare to embark upon this issue, then the principal aspect will remain underexposed. (2) What can be done in order to avoid the tragedy as signalled by Biesheuvel? In my view, it could make things at least much clearer for both public and private lawyers if one were to ask oneself whether, to use the words of the famous English saying, there is something new under the sun in the constitutionalization of contract law. However general it may seem at first sight, it is this very question which I would like to address in this paper. In order to provide an illustration of what is involved here, I will discuss three cases which have arisen in three different legal systems during nearly the same period of time and which are of particular importance to the present issue 2. Different solutions to the same problem On 19 October 1993, the German Constitutional Court(Bundesverfassungsgericht)delivered an interesting judgment in the Burgschaft case. 3)In that case, a bank had offered a businessman a loan of DM 100,000 on the condition that the businessman's daughter would sign the contract as a surety. Prior to the signing, the bank employee told the daughter: Would you just sign this here please? This won,'t make you enter into any important obligation; I need this for my files. The daughter, who was 21, uneducated, unemployed and without any property, accepted to act as a guarantor for the whole of her father's debt. Four years later, the father's business experienced financial difficulties and the bank claimed dm 100.000 with interest. amounting to a total of dm 60.000. from the daughter under the original contract By the tir case had reached the Bundesverfassungsgericht, the daughter was a single mother come. In the courts her defence met with alternating success. while the Landesgericht held that the contract was valid and ordered her to pay, the Oberlandesgericht maintained that the bank employee had violated his duty to inform the daughter. This decision was overturned by the Bundesgerichtshof, which did not accept such a duty, reasoning that any of age knows that signing a surety ship entails a risk. The father was solvent at the time of signing and therefore the information provided by the bank was correct However, this was not the end of the matter. The daughter appealed to the Bundesverfassungsgericht and claimed that the Bundesgerichtshof, through its decision, had olated her right to dignity(Article I(l)of the German Grundgesetz(GG) and party autonomy (Article 2(1)of the GG) in conjunction with the principle of the social state(Article 20(1)and Article 28(1) GG). Her constitutional claim was successfuL. According to the Bundesverfassungsgericht, in cases where a structural imbalance of bargaining power has led to a contract which is exceptionally onerous for the weaker party, the civil courts are obliged to
lawyers have been preoccupied with this issue. Lawyers in other countries, following the developments in Germany, have also become concerned. One Dutch lawyer, M.B.W. Biesheuvel, expressed a rather pessimistic view on this problem. He describes its tragedy as follows: 'If one writes about the horizontal effect of constitutional rights from a public law perspective, the aspects are described so theoretically that civil law lawyers tend to give up on the exercise. And if the latter dare to embark upon this issue, then the principal aspect will remain underexposed.'(2) What can be done in order to avoid the tragedy as signalled by Biesheuvel? In my view, it could make things at least much clearer for both public and private lawyers if one were to ask oneself whether, to use the words of the famous English saying, there is something new under the sun in the constitutionalization of contract law. However general it may seem at first sight, it is this very question which I would like to address in this paper. In order to provide an illustration of what is involved here, I will discuss three cases which have arisen in three different legal systems during nearly the same period of time and which are of particular importance to the present issue. 2. Different solutions to the same problem On 19 October 1993, the German Constitutional Court (Bundesverfassungsgericht) delivered an interesting judgment in the Bürgschaft case.(3) In that case, a bank had offered a businessman a loan of DM 100,000 on the condition that the businessman's daughter would sign the contract as a surety. Prior to the signing, the bank employee told the daughter: 'Would you just sign this here, please? This won't make you enter into any important obligation; I need this for my files.' The daughter, who was 21, uneducated, unemployed and without any property, accepted to act as a guarantor for the whole of her father's debt. Four years later, the father's business experienced financial difficulties and the bank claimed DM 100,000 with interest, amounting to a total of DM 160,000, from the daughter under the original contract. By the time the case had reached the Bundesverfassungsgericht, the daughter was a single mother without an income. In the courts her defence met with alternating success. While the Landesgericht held that the contract was valid and ordered her to pay, the Oberlandesgericht maintained that the bank employee had violated his duty to inform the daughter. This decision was overturned by the Bundesgerichtshof, which did not accept such a duty, reasoning that any person of age knows that signing a suretyship entails a risk. The father was solvent at the time of signing and therefore the information provided by the bank was correct. However, this was not the end of the matter. The daughter appealed to the Bundesverfassungsgericht and claimed that the Bundesgerichtshof, through its decision, had violated her right to dignity (Article 1(1) of the German Grundgesetz (GG)) and party autonomy (Article 2(1) of the GG) in conjunction with the principle of the social state (Article 20(1) and Article 28(1) GG). Her constitutional claim was successful. According to the Bundesverfassungsgericht, in cases where a structural imbalance of bargaining power has led to a contract which is exceptionally onerous for the weaker party, the civil courts are obliged to
intervene on the basis of the general clauses($ 138(1)and 242 of the Burgerliches Gesetzbuch (BGB) concerning, respectively, good morals and good faith). This obligation is based on their duty to protect the basic right to party autonomy in conjunction with the principle of the social state. In the case at hand. a contractual imbalance existed because the bank had failed to ufficiently inform the daughter about the risk relating to the surety, although the risk was relatively high compared to her income This case represents one of the most famous examples of the effect of constitutional rights on private law and is widely believed to have far-reaching consequences as far as the law of contracts is concerned. Far less famous, however, are similar 'surety' cases which have arisen in other jurisdictions and in which similar results ched, though in different ways Thus, in Barclays Bank plc v. O'Brien(the O'Brien case), (4) in which a wife had charged the matrimonial home to secure her husbands business debts, the House of Lords prevented the bank from enforcing the charge on the following ground The bank knew that the debtor and the surety were in the kind of relationship in which misrepresentation, undue influence or duress was likely and it also knew that the transaction was not to the wife,s advantage. Unless under thes circumstances it had satisfied itself that the practical implications of the proposed transaction had been brought home to the wife, the bank would be fixed with constructive notice of any wrong by the husband, 1. e the notice the bank has of the husbands impropriety, whether undue influence or misrepresentation, that creates the wife s right to set aside the transaction. Due to this oversight, the bank had not advised the wife to take independent advice and, as the husband had misrepresented the effect of the charge as being for a limited amount when in fact it was unlimited the charge was unenforceable In the Netherlands, the same type of case is exemplified by the Van Lanschot Bankiers v Bink case, (5)in which the Dutch Supreme Court(Hoge Raad) had to deal with the situation where a mother had provided surety in order to enable her son to obtain credit for his business. In this case ng under a duty to inform a non-professional party of the risks involved in providing a surety What can be seen in these two cases is that relief for the weaker party can be granted not only on the basis of constitutional rights, but also on the basis of duties to inform of a private law character which were also at stake in the subsequently overturned judgment of one of the lower German courts in the burgschaft case 3. Two parallel tendencies in modern private law The three cases described above illustrate two tendencies which can nowadays be traced in modern private law. On the one hand, the growing effect of constitutional rights on private law (6) in particular in the field of contract law, which is illustrated by the German case, makes it possibl to speak about the tendency towards a so-called ' constitutionalization of private law. The idea
intervene on the basis of the general clauses (§ 138(1) and 242 of the Bürgerliches Gesetzbuch (BGB) concerning, respectively, good morals and good faith). This obligation is based on their duty to protect the basic right to party autonomy in conjunction with the principle of the social state. In the case at hand, a contractual imbalance existed because the bank had failed to sufficiently inform the daughter about the risk relating to the surety, although the risk was relatively high compared to her income. This case represents one of the most famous examples of the effect of constitutional rights on private law and is widely believed to have far-reaching consequences as far as the law of contracts is concerned. Far less famous, however, are similar 'surety' cases which have arisen in other jurisdictions and in which similar results were reached, though in different ways. Thus, in Barclays' Bank plc v. O'Brien (the O'Brien case),(4) in which a wife had charged the matrimonial home to secure her husband's business debts, the House of Lords prevented the bank from enforcing the charge on the following ground. The bank knew that the debtor and the surety were in the kind of relationship in which misrepresentation, undue influence or duress was likely and it also knew that the transaction was not to the wife's advantage. Unless under these circumstances it had satisfied itself that the practical implications of the proposed transaction had been brought home to the wife, the bank would be fixed with constructive notice of any wrong by the husband, i.e. the notice the bank has of the husband's impropriety, whether undue influence or misrepresentation, that creates the wife's right to set aside the transaction. Due to this oversight, the bank had not advised the wife to take independent advice and, as the husband had misrepresented the effect of the charge as being for a limited amount when in fact it was unlimited, the charge was unenforceable. In the Netherlands, the same type of case is exemplified by the Van Lanschot Bankiers v Bink case,(5) in which the Dutch Supreme Court (Hoge Raad) had to deal with the situation where a mother had provided surety in order to enable her son to obtain credit for his business. In this case, the Hoge Raad laid down a rule according to which a bank, as a professional credit supplier, is under a duty to inform a non-professional party of the risks involved in providing a surety. What can be seen in these two cases is that relief for the weaker party can be granted not only on the basis of constitutional rights, but also on the basis of duties to inform of a private law character which were also at stake in the subsequently overturned judgment of one of the lower German courts in the Bürgschaft case. 3. Two parallel tendencies in modern private law The three cases described above illustrate two tendencies which can nowadays be traced in modern private law. On the one hand, the growing effect of constitutional rights on private law,(6) in particular in the field of contract law, which is illustrated by the German case, makes it possible to speak about the tendency towards a so-called 'constitutionalization of private law'. The idea
behind this development is that private law is not in itself a closed system for the regulation of private relationships, but that it is totally subordinate to the value system of constitutional rights As a result of this tendency the sharp analytical and historical distinction made in European legal systems between public and private law is put under pressure On the other hand, the dutch and English cases provide evidence that within private law itself one can speak of the tendency towards a more society-oriented private law which manifests itself in the growing protection of the weaker party, in particular in contract law. (7)The idea behind this development is that a party, in different phases of the contract's life, should no longer be guided only by his or her own interests, but also by the justified interests of the other party. In other words the party is no longer only responsible for him or herself, but also for the other party. In this context, some authors even speak of a so-called 'consumerization of private law in contrast to its commercialization. (8) Among the main indicators of this tendency is the development of various duties to inform not only in consumer law, but also in general contract law on the basis of the principle of good faith. (9)Such an attitude towards the other contracting party would have been unthinkable in the 19th century, when the prevailing doctrine of laissez-faire, presupposing the idea of unlimited self-reliance, made it possible, as is said in English, to buy a pig in a poke 4. The constitutionalization of contract law what is this all about? It appears to be clear from the foregoing that both tendencies aim to achieve an adequate level of protection for the weaker party. What is not clear, however, is how they relate to each other. Many authors have recognized the existence of these tendencies in general or with regard to a particular legal system (10) However, the striking feature of the existing literature is that, except in a few instances, (11) in most cases the two tendencies are dealt with separately. As a consequence,at present it is not very clear what the practical benefits are of the constitutionalization of contract law for the protection of the weaker party in comparison with the solutions provided by the concepts that are already well established in contract law. Accordingly, the question which one may ask in order to discover this is what the constitutionalization of contract law is all about is it a mere transformation of contract law issues into constitutional law issues or is it a more substantial transformation? In other words. the question which arises is whether, in the process of constitutionalization, contract law concepts are merely replaced by constitutional concepts with the same meaning and thus, here, there is really nothing new under the sun, or whether there are constitutional values which do not exist in contract law at present and should be introduced thereinto in order to ensure the protection of the weaker party In the light of this, it appears interesting to return to the three cases once again and to look more closely at the reasoning employed by the judges in the three different legal systems
behind this development is that private law is not in itself a closed system for the regulation of private relationships, but that it is totally subordinate to the value system of constitutional rights. As a result of this tendency, the sharp analytical and historical distinction made in European legal systems between public and private law is put under pressure. On the other hand, the Dutch and English cases provide evidence that within private law itself one can speak of the tendency towards a more soci ety-oriented private law which manifests itself in the growing protection of the weaker party, in particular in contract law.(7) The idea behind this development is that a party, in different phases of the contract's life, should no longer be guided only by his or her own interests, but also by the justified interests of the other party. In other words, the party is no longer only responsible for him or herself, but also for the other party. In this context, some authors even speak of a so-called 'consumerization' of private law in contrast to its commercialization.(8) Among the main indicators of this tendency is the development of various duties to inform not only in consumer law, but also in general contract law on the basis of the principle of good faith.(9) Such an attitude towards the other contracting party would have been unthinkable in the 19th century, when the prevailing doctrine of laissez-faire, presupposing the idea of unlimited self-reliance, made it possible, as is said in English, to 'buy a pig in a poke'. 4. The constitutionalization of contract law: What is this all about? It appears to be clear from the foregoing that both tendencies aim to achieve an adequate level of protection for the weaker party. What is not clear, however, is how they relate to each other. Many authors have recognized the existence of these tendencies in general or with regard to a particular legal system.(10) However, the striking feature of the existing literature is that, except in a few instances,(11) in most cases the two tendencies are dealt with separately. As a consequence, at present it is not very clear what the practical benefits are of the constitutionalization of contract law for the protection of the weaker party in comparison with the solutions provided by the concepts that are already well established in contract law. Accordingly, the question which one may ask in order to discover this is what the constitutionalization of contract law is all about: is it a mere transformation of contract law issues into constitutional law issues or is it a more substantial transformation? In other words, the question which arises is whether, in the process of constitutionalization, contract law concepts are merely replaced by constitutional concepts with the same meaning and thus, here, there is really nothing new under the sun, or whether there are constitutional values which do not exist in contract law at present and should be introduced thereinto in order to ensure the protection of the weaker party. In the light of this, it appears interesting to return to the three cases once again and to look more closely at the reasoning employed by the judges in the three different legal systems
5. The Burgschaft case: A top-down approach by the German Constitutional Court 5. 1 From the theory of indirect effect of constitutional rights in private law indirectly to the theory of direct effect? The official position of the Bundesverfassungsgericht regarding the way in which constitutional rights should affect private law was expressed in its decision in the Luth case ( 12)Considering the general question whether constitutional rights are applicable in private law, the Court remarked that it was confronted with two extreme positions 13) the first was the view that public and orivate law are two distinct systems and, therefore, that public law in general and constitutional law in particular have no bearing on private law(14) The second, 'extreme view was a diametrically opposed position. Before the Luth case, a number of scholars had advanced the view that the most important basic rights are not only directed against the state, but are also fully and directly applicable among individuals in private relationships. The implication of this theory was that certain constitutional rights should ordinarily be binding on individuals and private groups in approximately the same manner and to the same extent as they apply to the government (15) Having taken note of both of these 'extreme positions, the Court, however, did not adopt either of them, but rather opted for an intermediate theory, which permitted only a certain degree of constitutional control over the relations of private law. According to the Court basic rights are primarily to protect the citizen against the state, but as enacted in the gg they also incorporate an objective scale of values which apply, as a matter of constitutional law, throughout the entire legal system. A certain intellectual content flows from constitutional law into private law and affects the interpretation of existing civil norms, especially general clauses in the BGB such as$ 242(the duty of good faith),$ 138(1)(nullity of agreements infringing good morals) and$ 826(wilful damage contrary to public policy ), but it is nonetheless the civil law rules that are ultimately applied. Even in such cases, the Court emphasized, the dispute 'remains substantively and procedurally a civil law dispute! (16) In reaching this conclusion, the Court adopted what has to be alled the doctrine of the 'indirect effect of constitutional values on private legal relations( 17)-as opposed to the theory of direct effect mentioned above Thus, the main distinction officially drawn by the bundesverfassungsgericht is that between the direct and the indirect approach. The main difference between the two lies in the fact that while in the former case a private party has, in his action against another private party, a claim or a defence which is directly based on a constitutional right which overrides an otherwise applicable rule of private law, in the latter situation, the claim or defence is based on a provision in the Civil Code e.g. on a general good faith clause in contract law cases or on a provision for liability in tort law cases, which is interpreted in the light of the constitutional right in question. As a result, under the public values of constitutional law and, formally, the distinction between private law and public law is therefore preserved However, in practice it is highly questionable whether the Bundesverfassungsgericht still follows the theory of indirect effect of constitutional rights in private law. The rule which it established in
5. The Bürgschaft case: A top-down approach by the German Constitutional Court 5.1 From the theory of indirect effect of constitutional rights in private law indirectly to the theory of direct effect? The official position of the Bundesverfassungsgericht regarding the way in which constitutional rights should affect private law was expressed in its decision in the Lüth case.(12) Considering the general question whether constitutional rights are applicable in private law, the Court remarked that it was confronted with two 'extreme' positions;(13) the first was the view that public and private law are two distinct systems and, therefore, that public law in general and constitutional law in particular have no bearing on private law.(14) The second, 'extreme' view was a diametrically opposed position. Before the Lüth case, a number of scholars had advanced the view that the most important basic rights are not only directed against the state, but are also fully and 'directly' applicable among individuals in private relationships. The implication of this theory was that certain constitutional rights should ordinarily be binding on individuals and private groups in approximately the same manner and to the same extent as they apply to the government.(15) Having taken note of both of these 'extreme' positions', the Court, however, did not adopt either of them, but rather opted for an intermediate theory, which permitted only a certain degree of constitutional control over the relations of private law. According to the Court, basic rights are primarily to protect the citizen against the state, but as enacted in the GG they also incorporate an objective scale of values which apply, as a matter of constitutional law, throughout the entire legal system. A certain intellectual content flows from constitutional law into private law and affects the interpretation of existing civil norms, especially general clauses in the BGB such as § 242 (the duty of good faith), § 138(1) (nullity of agreements infringing good morals) and § 826 (wilful damage contrary to public policy), but it is nonetheless the civil law rules that are ultimately applied. Even in such cases, the Court emphasized, the dispute 'remains substantively and procedurally a civil law dispute'.(16) In reaching this conclusion, the Court adopted what has to be called the doctrine of the 'indirect' effect of constitutional values on private legal relations(17) - as opposed to the theory of 'direct' effect mentioned above. Thus, the main distinction officially drawn by the Bundesverfassungsgericht is that between the direct and the indirect approach. The main difference between the two lies in the fact that while in the former case a private party has, in his action against another private party, a claim or a defence which is directly based on a constitutional right which overrides an otherwise applicable rule of private law, in the latter situation, the claim or defence is based on a provision in the Civil Code, e.g. on a general good faith clause in contract law cases or on a provision for liability in tort law cases, which is interpreted in the light of the constitutional right in question. As a result, under the indirect approach private law values should retain considerable potency when confronted with public values of constitutional law and, formally, the distinction between private law and public law is therefore preserved. However, in practice it is highly questionable whether the Bundesverfassungsgericht still follows the theory of indirect effect of constitutional rights in private law. The rule which it established in