The Operation of the Modern Lex Mercatoria: The Hierarchy of Norms

[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.

It was submitted that the essence of the transnationalization of private law is the consideration of different sources of law. They may conflict. This would suggest a need for a hierarchy, a problem that also surfaces in foreign investment law. In the lex mercatoria we may further find (as in foreign investment law), however, that the law, in as far as we have it, is still insufficiently complete or underdeveloped at the transnational level.  When no clear transnational legal regime emerges, we are therefore still relegated to a domestic law as the default rule, in private law found on the basis of the ordinary conflict rules.

To me that is fully acceptable and makes for a complete system for those who still think in those terms, but there are two observations to make. First, the room for the transnational sources will progressively expand and in international transactions the bias must be in their favour. Second, even where domestic law applies in international cases as the subsidiary or default rule, it becomes part of the transnational law or modern lex mercatoria and must fulfil its place therein.  In other words, if it does not make any sense or does not serve justified needs it will be adapted. It leads to the important conclusion that the application of English law in international cases is not the same as the application of English law in domestic cases. That then goes for all domestic laws.

In truth and upon a more proper analysis (and perhaps unknown to themselves), this is the way international arbitrators now increasingly operate in finding the applicable law and it is at the heart of the modern notion of the lex mercatoria.  Arbitrators will apply fundamental principles first, then mandatory custom and practices, then mandatory treaty law to the extent existing, then mandatory general principles, then party autonomy, subsequently directory rules of custom, treaty law and general principles, and finally, if all fails, domestic private law.  A choice of a domestic law by the parties moves it up from the residual level or default level to the level of party autonomy but no higher and fundamental transnational principles, mandatory custom, treaty law and general principle still prevail over it.  Again this chosen local law would function in the transnational legal order and be adapted accordingly in its lex mercatoria.  A choice of a domestic law by the parties in international transactions covers therefore much less ground than people often think and operates differently as I explained in my contribution for the Liber Amicorum for Lord Bingham.

The dominant fundamental principles in international commerce and finance are few but pacta sunt servanda or the binding force of the promise itself, the need to give back what does not belong to us, to undo the harm we have inflicted, to respect property, and to look after others in situations of dependency are here most immediate and important and the basis for the whole system of private law. This is also Grotius. The other sources will elaborate on these fundamental concepts. Party autonomy may be the most important, that is to say that we can do a lot in our contracts, but in property law there are limitations and the third party effect suggests here a regime that goes beyond the mere parties to a transaction.  Parties cannot determine their rank in a distribution which also affects others. The structures are here mandatory although in equity there may still be substantial flexibility, as I explained earlier, in favour therefore of trust structures, conditional and temporary ownership forms and the like, always subject to the protection of the ordinary commercial flows. Only insiders are here affected, like banks and suppliers. They should be aware of each other, but the public need not worry. These principles themselves are also of a higher order and could be considered to derive from public order in the transnational sphere itself.

An extremely important aspect is finally the question of respect for or deference to local public or regulatory law.  Local public policy or regulatory law is not part of the hierarchy of the modern lex mercatoria. Private law has to respect the public order as it finds it in each country where an international transaction has some effect or where there is conduct under it.  It is obvious that private parties using party autonomy under the lex mercatoria cannot affect the local tax laws (even if they can redistribute the burden amongst themselves).  The same goes for regulatory laws.  They are of a higher order.  Parties cannot opt in and out of them.  They are not at their free disposition and must be respected.  But if in an international transaction there are conflicting claims to prescriptive regulatory jurisdiction in this sense, arbitrators may have to look for the preponderant governmental interest, much in the way as Secs 402/403 of the Restatement (3d) Foreign Relations suggest in the US. But the key is that whatever the applicable regulatory law may be, it is not affected by the lex mercatoria and it is not true that this law operates mainly to avoid domestic regulatory laws as is sometimes argued. Quite the opposite. It respects domestic regulatory policy as a matter of principle.