The Modern Lex Mercatoria and its Dynamism

[Jan H. Dalhuisen is Professor at King’s College in London, the Miranda Chair of Transnational Financial Law at the Catholic University in Lisbon, and is Visiting Professor at UC Berkeley]

Professor Dalhuisen is guest-blogging with us this week on the transnationalization of private law. Links to his other posts can be found under “Related Posts” below.

In my last post, I said that the modern transnational lex mercatoria is dynamic, does not depend on statutory or treaty law, is not statist and allows for immanent or informal law formation through the market place, therefore by the participants themselves.  That is foremost through custom and practice, in fact the normativity of all routine on which any society depends for its proper functioning. Party autonomy follows. Such a law is also built on other sources, foremost fundamental principles and its set of values, but also on general principles developed in commerce and finance in different legal systems. This has considerable consequences for our view as to how the modern law works in international commerce and finance. It is very different from the civil law codification model and its method of interpretation. I already said that in contract, good faith may thus acquire quite a different profile in business and consumer transactions. In the first it may extend protection, in the latter it may minimize it when the contractual road map and risk distribution requires a much more literal interpretation. But another key insight is that with these different participatory sources of law, the modern lex mercatoria is also likely to be dynamic and moves away from a static notion of contract and movable property law.

Especially in duration contracts, it is clear e.g. that the moment of the conclusion of the contract, if it can at all be clearly determined, is not conclusive any longer of the rights and duties of the parties.  There are pre- and post-contractual rights and obligations which emerge all the time out of the behaviour and reasonable expectations of the parties. Thus conduct and reliance are here the key, not the formal mating dance of offer and acceptance. Will and intent acquire a much more objective meaning also. They are in fact often irrelevant and in any event in a corporate environment difficult to determine where the one who has the signing authority often knows little of the content, different departments are involved in the negotiation of different parts, and the text as whole may emanate from an outside law firm.  Object and purpose are then more relevant and perhaps easier to handle as more objective notions.  Cooperation and fiduciary duties, especially in situations of dependency, may further be implied.  This is the world of modern contract theory at the heart of which there is a dynamic concept of contract and of the rights and obligations thereunder and a firm distinction as to the nature of the parties, especially between professionals or consumers.

This dynamic contract model is quite different from what is mostly still taught under national law in national law schools, where we still pay tribute to offer and acceptance notions, a fixed moment as of which a contract is concluded and in contract interpretation to an exalted idea of the will, often in a psychological sense. This presents an atavistic model of contracting that is entirely out of date, even domestically. The newer model, at least in the professional sphere, is based on conduct and reliance, and on a substantial degree of risk acceptance beyond the contractual risk allocation unless the result becomes manifestly unreasonable which in business will not arise soon and would have to take into account the overall position of the complaining party and not merely the situation of advantage or disadvantage under the particular contract.

In a more modern approach to private law, we are also getting used to more dynamic thinking in movable property.  That may be more extraordinary. Here the key issue is also a more advanced insight into the role of party autonomy. In civil law, there is traditionally the notion of a closed system of proprietary rights. They are defined in the codes, there are no others, at least that is the idea. Parties are not free or able to create more. This dogma is recent – the notion itself was first articulated in the 18^th Century at the University of Helmsted in Germany – and became infallible only in the 20^th Century.  In common law countries, at law a similar situation exists. We have the estates in land and in personal property only two proprietary rights: title and possession or rather ownership and bailment. But in equity the system is open and new property structures can be developed by the parties. To this we owe the operation of floating charges, temporary and conditional ownership rights in movable property, trust structures and the like.

Pretty much everything is possible for parties to create here, but the limit is the protection of the commercial flows. The insiders or professionals, especially banks and suppliers, can do what they like between themselves, create priority and ranking as suits them. They have here a search duty and must enquire to protect themselves – that is their due diligence. However, the outsider or bona fide purchaser and all buyers in the ordinary course of business of commoditized products buy free and clear of these charges and have no search duty, not even where there is a register or filing under Article 9 UCC in the US. That kind of filing may make life easier for the insiders but that is all. For the others, it has no relevance. To sum it up: codification cuts off proprietary rights at the time of their creation, equity at the level of their operation.  That is also the direction in transnational law or the new lex mercatoria. It has proved a source of great flexibility and dynamism in common law countries; it works and is undoubtedly also the direction of transnational law, especially in international finance.

In finance, all asset backed funding using movable property including receivables, whether in leasing, repos, receivable financing, securitisations, floating charges or whatever, are in common law terms equitable. Equity in this sense is at the heart of all modern financial products. Civil law misses here out in a major way and it is no wonder that the major financial centres are London, New York, Hong Kong and Singapore, all common law jurisdictions, but even then there are still problems with the location of assets in other countries when used in financing schemes. Transnationalization, whether or not helped by treaty law, must overcome these problems. It is here only in its beginning. If it is to be of use, it must then also deal at the transnational level with trust structures, tracing, conditional and temporary forms of ownership like in leasing and repos, floating charges, set-off and netting, and the assignment, especially those in bulk and those that include future claims.

This is clear in respect of claims arising in different countries. It is one of the greatest headaches which comes up all the time in receivable financing, floating charges and securitisations.  It is regrettable that the 2001 UNCITRAL Convention in this area was conceptually so poor and confused that is could never get off the ground.  Nobody ratified. Only the US and Luxembourg signed: the elephant and the mouse. Party autonomy is here an answer, and indeed promotes a dynamic concept of movable property, again with the caveat that outsiders who collect in good faith or in the ordinary course of business are always protected. The draftsmen of the Convention could never get to this basic understanding.

Especially civil law has difficulty with the concept of dynamism, particularly in personal property law to which the DCFR as model for EU codification testifies in the EU, but it is also still alive in contract law where in modern times it is also more of a struggle in England. Here contractual wills theories have wafted over from the European Continent as well as offer and acceptance notions. More generally, equity is stultified in its development, waits now mostly for legislation, even though in the 20^th Century there were still important developments in the floating charge and injunctive relief.  Lord Denning and Lord Bingham remained activist equity judges and thought that equity was not “beyond the age of child bearing”, but the equity practice is now much more subdued in England and the general attitude is indeed to wait instead for legislation, one reason why it is sometimes said that English law is now closer to the European than the American tradition. This is supported in England by a high degree of legal formalism in law school teaching. In finance, New York is therefore more inventive than London.

At the transnational level in the modern lex mercatoria these confines do not or should not similarly exist.  There is no natural legislator and international arbitrators have much freedom in formulating and further developing the applicable law even if they are not free. They are not amiables compositeurs and must find on the basis of the law, but they have substantial power in this regard and act in fact much in the manner of equity judges, at least that is what I argued last year in the Liber Amicorum for Detlev Vagts.

The issue of a dynamic law in the above sense raises important issues, in commerce and finance especially in the area of certainty, finality and predictability. There may also be issues of democratic legitimization of that law to consider and I shall come back to this. But first we need to deal with how the lex mercatoria and its multiplicity of norms operate in practice.