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Reproduced with permission from American Journal of Comparative Law (1979) 279-289

[This commentary centers around the definition of "fundamental breach" recited in Article 23 of the 1978 Draft: the history of this definition and its meaning. With modifications, that article became CISG Article 25. For a comparison of these provisions, see the match-up of CISG Article 25 with Article 23 of the 1978 Draft.]

Cancellation of Contract

Shinichiro Michida

The work for unification of the laws on international sale of goods by UNCITRAL has had to face one of the most difficult and delicate issues in commercial law does: every deviation from the contract by one party empower the other party to reject or return the goods -- a power that may be called rejection, rescission or cancellation. The current solution, embodied in the 1978 Draft Convention on Contracts for the International Sale of Goods,[1] deserves further attention in advance of the impending diplomatic conference of plenipotentiaries.

The Setting

Between the making of the contract and the time for performance there may be wide swings in commodity prices. For example, from September to November 1969, the price of beans rose from $180 to $260 per long ton, an increase within two months of 44.4%.[2] Comparable dislocations result from swings in the value of currency. In five days following 24 July 1978, the value of the U.S. dollar in Tokyo dropped from 200.10 to 192.10 Yen; a $1,000,000 contract entered into on July 24, to be paid five days later, would have involved a loss of 8 million Yen.[3]

In such settings, the losing party views the contract with regret and tends to look with a sharp eye to every aspect of the other's performance. Thus whether he may cancel the contract is crucial. The basic question is whether a party has the right to cancel the contract only for a serious breach by the other party, or for any breach, including those that may be trivial.

On this question, the Draft Convention provides that a party has a right immediately to cancellation of contract if a breach by the other party is fundamental; if a breach is not fundamental, a party may fix an additional period of time of reasonable length for performance by the other party and may cancel only if the latter then fails to perform or declares his intention not to perform.[4] In other words, the Draft Convention takes the single test of substantiality of breach for immediate cancellation in all cases, whether it is effected by buyer or seller, or before acceptance of goods or thereafter.

The Substantiality Test and the UCC

In the United States, under Art. 2 of the Uniform Commercial Code (UCC), substantiality of breach is also the test after the goods have been accepted by the buyer. § 2-608(1) provides as follows:

The buyer may revoke his acceptance of a lot or commercial unit whose non-conformity substantially impairs its value to him if. . . . [Emphasis added]

Thus once the goods are accepted, the UCC and the Draft Convention are similar in barring rejection of the goods based on a slight or non-substantial breach.

Prior to acceptance however, the UCC allows the buyer to reject the goods for any non-conformity without regard to whether the breach is substantial or insubstantial. Under § 2-601: [5]

. . . if the goods or the tender of delivery fail in any respect to conform to the contract, the buyer may (a) reject the whole. . . . [Emphasis added]

However commercial practice in America does not always follow the legal rule of the right to cancellation. Thirty years ago, a thorough study of commercial practices and mercantile rules led to the conclusion that there was "a marked tendency, particularly in the basic raw commodity markets, expressly to limit the remedy of rejection, and to substitute price adjustment." [6] Where parties enter into a contract for the sale of goods subject to such rules, cancellation or rejection of goods is limited and the goods move on in commerce without the economic waste that results from cancellation or rejection.

In light of this background, we can consider whether the Draft Convention should retain the test that only a substantial breach permits immediate cancellation of contract and, if so, how such an approach should be expressed.

It must be emphasized that the Draft Convention is designed for world-wide use. It is intended to be adhered to by capitalist and socialist states and by developing and developed states. In world-wide transactions, efficient communication and storage facilities for the preservation of goods are not always guaranteed. At seaports where adequate storage facilities do not exist one may see piles of industrial products on the ground, exposed to the weather. These conditions intensify the harshness that results from immediate cancellation by buyer or seller.

On the other hand, in countries like the United States, where merchants enjoy efficient systems of communication, preservation, storage and transportation, a rule permitting immediate cancellation for any sort of breach may be less harsh. And within such a country the harshness can be overcome by established trade rules or standard contract forms prepared by domestic industries. In international trade however, we shall need to consider whether it would be equally feasible for the parties to adopt contractual agreements to vary rules provided in the Convention.

There is another reason why domestic law, such as the UCC, is not a suitable model for international sales. The UCC was designed to apply not only to commercial transactions between professional merchants, but also to the full range of domestic transactions, including consumer sales. On the other hand, under the Draft Convention consumer sales of goods are excluded by the provisions of art. 2(a). [7] International sale of goods under the Convention typically involves commercial trade in large quantity or volume by professionals. In a law which is generally applicable to consumer sales, such as the UCC, it may be necessary to permit immediate cancellation in order to provide a remedy for consumers, unencumbered by questions concerning substantiality of breach.[*] Where rejection is not allowed, the buyer has the burden of disposing of the defective goods. Consumers are not equipped to handle such problems, while a commercial buyer usually has facilities for disposing of goods, and any burden can be compensated by damages. On the other hand, in an international transaction reshipment of the goods is particularly expensive and wasteful; where the defect or deficiency is not serious it is more efficient for the buyer to handle the goods subject, of course, to appropriate compensation for any cost or loss.

"Fundamental Breach": The Original Definition

Under the Draft Convention, as noted above, the right immediately to cancel the contract depends on whether the breach is "fundamental." [8] Consequently, the meaning of "fundamental breach" becomes crucial.

Some English-speaking people may think a definition of "fundamental breach" is not necessary; however, even among them, what this concept means may vary from country to country and from person to person. Besides, in world-wide trade there are many people whose languages are not English or any other official language used in the text of the Draft Convention. The UNCITRAL deliberations therefore revealed that "fundamental breach" was an unfamiliar concept. [9] A definition became necessary.

The Working Group, in completing its draft in 1976, included the following definition of "fundamental breach":[10]

A breach committed by one of the parties to the contract is fundamental if it results in substantial detriment to the other party and the party in breach foresaw or had reason to foresee such a result. [Emphasis added]

The Working Group's draft was sent to governments and international organizations for their comments, and in 1977 was placed before the Commission for discussion.

To clarify the intended effect of this definition I shall consider its application to two different cases.

a) The Christmas turkey case

Let us assume that a contract was made for the international sale of turkey meat for the Christmas season; the seller was one week late in making delivery with the result the buyer could not resell the turkeys for the Christmas market and thereby suffered substantial detriment to his business. The buyer thought that any reasonable person in the same situation as the buyer would not have entered into the contract if he had foreseen the seller's delay past the crucial season, and that the seller himself ought to have known that the delay would cause the detriment to the buyer's business. The buyer immediately notified the seller that he cancelled the contract. On the other hand, the seller insisted that he did not foresee such a result and the buyer therefore should take delivery without cancelling the contract. Here it will be noted that the seller insisted on his own subjective view, while the buyer set up an objective standard.

The original definition proposed by the Working Group was designed, in such a case, to allow the buyer to effect immediate cancellation under the wording "if . . . the party in breach . . . had reason to foresee such a result." Whether the party in breach had reason to foresee is not a subjective test; regardless of the seller's own view of the case, the buyer should prevail on the basis of objective "reason to foresee" in the circumstances. [11]

b) The ordinary chicken case

Let us now consider an international sale of chicken meat without any strict date on shipment under the term "shipment: during summer -- July and August." The seller made the shipment in the first week of September; there was no change in the price of chicken meat during July, August and September. The buyer immediately notified the seller of cancellation of the contract. The seller however insisted that if the buyer suffered detriment to his business by the delay of one week, the seller would gladly make a price adjustment or pay a reasonable amount of damages, and that the buyer must take the delivery of chicken meat and pay the price subject to any adjustments. The seller further insisted that any reasonable person in the same situation as the seller would not have "reason to foresee" substantial detriment to the buyer from such a short delay in such a transaction, and therefore the buyer could not justify his cancellation. The seller stressed that in any event the buyer has a right to damages under the Draft Convention [l2] and that the cancellation was unjustified and would result in economic waste.

In such a dispute, the original definition of fundamental breach proposed by the Working Group would tend to curb the cancellation. In order to justify the cancellation and escape from his own obligation, the buyer would need to show that the breach made by the other party was "fundamental." The buyer must persuade the seller (or, in litigation, the court) that "the party in breach [the seller] had reason to foresee such a result" -- substantial detriment under the circumstances of the case. There was no swing in price during the relevant period. Hence, it would be very difficult for the buyer to prevail. It is the present writer's view that the buyer in this case should not cancel the contract, but if he suffered detriment should be compensated by damages or price adjustment. This not only avoids excessive harshness to the other party and preserves contractual relations but also avoids economic waste in trade.

The original definition proposed by the Working Group [13] had the advantage of curbing the technical or unnecessary cancellation of contracts in world-wide trade on the objective test of foreseeability.

Proposal by the Philippines and the U.S.

Before the opening of the session in Vienna in 1977, the Hungarian representative expressed the view that the draft proposed by the Working Group created "a proper balance between the two contractual positions" and "special mention should be made of . . . the definition of the fundamental breach." [14] The International Chamber of Commerce commented that "the present definition represents a considerable improvement." [15]

Against these two favorable comments, the Government of the Philippines, which was also a member of the Working Group but not represented in its seventh session in 1976, sent in advance to the Vienna session a proposal for deletion of the foreseeability test:

We suggest the deletion of the last portion of the article:

"and the party in breach foresaw or had reason to foresee such a result." Unless so deleted, the party in breach will always allege to exempt himself from liability that he did not foresee and had no reason to foresee "substantial detriment" to the other party. It is sufficient that a "substantial detriment," as a fact, resulted from the breach; it is quite difficult to prove further that the party in breach "foresaw or had reason to foresee such a result." This will practically allow exemption of the party in breach from liability for breach of the contract as it would be easy for him to allege his ignorance of such substantial detriment but difficult for the injured party to prove otherwise. [l6] [Emphasis added]

However the problem was not really one of "liability." As repeatedly stated, under the Draft Convention "the injured party" may recover damages; the cancelling party can not get "exemption . . . from liability for breach of the contract."

At the Vienna session, deletion of the foreseeability test was formally proposed. The Summary Record of the proceedings is a short summary rather than a full verbatim record, but it reveals the trend of the proceedings.

Mr. GUEVARA (Philippines) proposed that the words "and the party in breach foresaw or had reason to foresee such a result" should be deleted, since they might give rise to unnecessary litigation. The term "fundamental breach" was not very familiar to him but he took it that it meant a serious breach. Under the provisions of the article as it stood, it would be necessary for the party in breach to foresee the result before a breach committed became a "fundamental breach." That was something that would be extremely difficult to prove in court and it seemed most unfair that the guilty party should be able to throw the burden of proof on to the aggrieved party. [l7] [Emphasis added]

Later in the same morning, the proposal was rephrased:

Mr. GUEVARA (Philippines) . . . [objected to] the last phrase whereby the burden of proof was laid on the injured party. That situation would be quite unfair. It was for the party in breach to prove his lack of liability. With a view to improving the text from that standpoint, he would propose that the final phrase should be reworded to read "unless the party in breach did not foresee or had no reason to foresee such a result." [18] [Emphasis added]

This proposal was immediately supported, with a minor change, by the United States, also a member of the Working Group that had proposed the original text:

Mr. FARNSWORTH (USA) said he would be happy to accept that amendment, with a minor drafting change, i.e., the word "or" to be replaced by "and." [19]

The proposed text by the Philippines and the United States read as follows:

A breach committed by one of the parties is fundamental if it results in substantial detriment to the other party unless the party in breach did not foresee and had no reason to foresee such a result. [Emphasis added]

These changes proposed by the two countries might appear to be minor. However, in their application to concrete cases, the proposed changes were drastic. Take again the above-mentioned sale of chicken meat. Under the new proposal the buyer would insist that the delay was fundamental simply because "it results in substantial detriment." Foreseeability of substantial detriment, subjectively or objectively, was no longer of concern to the cancelling party but a matter to be shown by the "party in breach" if he wished to deny the fundamentality of his breach. Against this, the seller would insist that if the matter is simply one of detriment or loss, it should be claimed as damages and there was no necessity for cancelling the existing contract.

However once the buyer cancels the contract and refuses to take delivery, the seller would have to dispose otherwise of the goods which he had already shipped to the buyer, regardless whether he chose to litigate the cancellation simply on the issue of "substantial detriment" during the period of years to come Whether he would litigate or not, in fact the contract was already dissolved. The proposed amendment thus posed a very delicate issue.

The Solution

The proposed amendment was debated for less than three hours in the Committee of the Whole. Some of those who supported the amendment seemed to have the impression that the original text would free the party in breach from liability for the breach -- a misapprehension. The present writer, speaking for his government, sought to clarify this matter and illustrated the problems that would arise in the application of the new language to specific cases in commercial practice. At the end of the discussion, [20] an informal vote showed 14 in favor of the amendment and 5 opposed. [21]

It had been assumed that the issues considered in the Committee of the Whole could be given further consideration in the Commission's plenary discussions of the Committee's recommendations. However, time ran out and on the last day of the four-week session; this and other provisions were approved without further discussion. [22] The crucial definition of "fundamental breach," as embodied in the Draft Convention, is therefore as follows:

Article [23]. A breach committed by one of the parties is fundamental if it results in substantial detriment to the other party unless the party in breach did not foresee and had no reason to foresee such a result. [23]

Offer to Cure

The hardship and economic waste involved in cancellation of the contract may be mitigated by appropriate rules permitting a party to "cure" a defect in his performance. ULIS included a provision permitting a seller, under limited circumstances, to cure defects with respect to his performance; [24] the UNCITRAL Draft Convention similarly permits the seller to "remedy at his own expense any failure to perform his obligations, if he can do so without such delay as will amount to a fundamental breach of contract. . . ." [25] There are additional restrictions on such "remedy" or "cure"; under one of these the seller may not cure a defect if "the buyer has declared the contract avoided in accordance with article 45"[26] -- a remedy that again invokes the test of "fundamental breach." [27]

Thus there is an intimate relationship between the cure provisions and fundamental breach. Unfortunately, in some respects the draft provisions were ambiguous. For example, may the buyer, by a quick declaration of avoidance under art. 45, block any subsequent cure by the seller, even if no serious delay would result? Furthermore, the cure provisions were incomplete: no provision was made for cure by the buyer of a defect in his performance -- such as an omission or error in a letter of credit.

To alleviate these problems, the U.S. proposed an amendment to the definition of "fundamental breach," under which the definition would have read as follows:

A breach committed by one of the parties to the contract is fundamental if, under all the circumstances, including a reasonable offer to cure, it results in substantial detriment to the other party and the party in breach foresaw or had reason to foresee such a result. [amendment italicized] [28]

The reasons for this proposal were explained as follows:

Mr. HONNOLD (USA) confirmed that his country's proposal resulted from the discussion which had taken place at the 14th meeting on the relationship between cure and avoidance of the contract. The purpose of the proposal was to make it quite plain that the buyer and seller were both protected against any technical avoidance of the contract declared by the other party when there had been an offer to cure. He had in mind not only the case in which a machine did not function on delivery and could easily be replaced, but also that in which the buyer made a hasty mistake in the letter of credit handed over to the seller and needed protection against a hasty declaration of avoidance of the contract by the latter, or again cases in which wide fluctuations in raw material prices made it necessary to revise the conditions of performance of the contract. [29]

This proposal was welcomed by Japan:

Mr. MICHIDA (Japan), comparing the existing text of the draft convention with Japanese legislation, expressed regret that the draft convention contained no reference to the basic principles of mutual trust and the good faith of the parties. He would not go so far as to propose the inclusion of those principles, which would be desirable but would give rise to great difficulties. He nevertheless noted with satisfaction that the United States proposal went in that direction by mentioning "under all the circumstances, including a reasonable offer to cure," which limited the number of cases in which there was a fundamental breach. His delegation therefore supported the proposal. [30]

After an hour's discussion it appeared that a majority did not support this proposal. [31] Opposition was partly based upon misunderstanding: one argument, for example, emphasized that the problem was fully covered by the specific provision dealing with the right to cure. [32] This was plainly an error; as was clearly explained during the discussion, the specific provision on cure (now art. 44 of the Draft Convention) is limited to cure by the seller while the new language was designed to extend similar protection to the buyer. [33] But, as we have seen, there was no opportunity to consider the draft in the plenary session of UNCITRAL.

Conclusion

One might say that there is no need to worry about the provisions of the Convention on "fundamental breach" or on any other matter, since the Draft Convention provides that the parties may "exclude the application" of the Convention or may "derogate from or vary the effect of any of its provisions." [34] Thus it might be argued that those who are concerned about the danger of cancellation can avoid the problem by specific provisions in their sales contracts.

As we have seen, in many trades there are standard contract provisions limiting rejection or cancellation. But such provisions are not yet generally available in worldwide transactions. The norms of the new Convention on Sales should be consistent with the most enlightened current commercial practice. It may be hoped that further improvement in the uniform rules can be achieved at the diplomatic conference.


FOOTNOTES

1. See the General Introduction to this Part of the Symposium, supra at II-A.

2. White Paper on International Trade of Japan (in Japanese) (1970) Volume on particular trades, at 213.

3. Asahi Newspaper (in Japanese), Evening Edition, 24 July 1978 at 1 and Morning Edition, 29 July 1978 at 1.

4. Draft Convention, art. 43 (notice by buyer fixing an additional period -- the Nachfrist); art. 59 (comparable notice by seller); art. 45 (grounds on which seller may declare the contract avoided); art. 60 (same for buyer).

5. The "perfect tender" rule is also relaxed if the contract "requires or authorizes the delivery of goods in separate lots to be separately accepted." See UCC 2-612(1) and (2).

6. Honnold, "Buyer’s Right of Rejection," 97 U. Pa. L. Rev. 464 (1949).

7. See Draft Convention text infra at II-H.

* Significantly, early versions of the UCC limited the right of unqualified rejection to consumers, in line with Llewellyn’s functional policy of applying special standards for merchants. See Winship, "Jurisprudence and the UCC," 31 Southw. L.J. 843, 850 ff. (1977). [J.F.]

8. See supra n. 4.

9. This was emphasized by the Philippine delegate at the 1977 session in Vienna. See the Summary Record, cited infra at n. 17.

10. Working Group, Report on Seventh Session (1976) A/CN.9/116, Annex I, p. 4, VII Yearbook 87, 90.

11. Under the definition, immediate cancellation would be justified if the seller should happen to admit subjectively that he "foresaw . . . such a result." Of course, in practical affairs such an admission is unlikely.

12. Under the 1978 Draft Convention the right to claim damages is provided in art. 41(1)(b) (buyer) and 57(1)(b) (seller). In the 1977 draft the comparable provisions were in art. 27 and 43.

13. See supra n. 10.

14. Comments by Governments and International Organizations on the Draft Convention on International Sale of Goods, A/CN.9/125, p. 20, paras. 5,6; VIII Yearbook 109, 118.

15. Id. at 66, para. 12; VIII Yearbook 137.

16. Id. at 42, para. 7, VIII Yearbook 127.

17. Summary Record, A/CN.9 (X)/C.1/SR.4, at 2, para. 4.

18. Id. at 6, para. 29.

19. Id. at 6, para. 30.

20. Id. at 6, paras. 33, 34, 41-44, 46-47; Summary Record, A/CN.9 (X)/C.1/SR.5, at 2, para. 1.

21. Id. at 3, para. 11. For explanations of the votes of the representatives of Singapore and Japan, see id. at 3, paras. 12, 13.

22. UNCITRAL, Report on Tenth Session (1977) para. 18.

23. Id., para. 35 at 12.

24. ULIS art. 44.

25. Art. 44 (1).

26. Id.

27. See art. 45(1)(a).

28. UNCITRAL, Report on Tenth Session (1977) para. 93, at 58. Cf. UCC 2-508 (cure).

29. Summary Record, A/CN.9(X)/C.1/SR.16, at 4, para. 24.

30. Id. at 5, para. 31.

31. Id. at 4-8, paras. 26-45. The chairman’s conclusion appears at para. 47.

32. Id. at 5, para. 27.

33. Id. at 5, para. 32.

34. Draft Convention, art. 5 1977 draft, art. 4.


Pace Law School Institute of International Commercial Law - Last updated August 13, 1999
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