By Clara MARCO, Charles Berthier, Charline Bihr, Marion Lagrange, University of Montpellier, Centre du Droit de l'Entreprise, Program of Master 2 "Droit du Commerce International"
What is the applicable law when legal rules change after the conclusion of a contract? The general answer is based on the principle of non-retroactivity of the law. Consequently, the applicable law to a contract throughout its duration should be the one in force at the time of its signature.
Contrary to this contract rule, there are several situations in which a new law may apply to an ongoing contract.
In this tricky context, the parties may conventionally reduce legal uncertainty involved by a change of law through specific provisions.
After describing the legal rules that apply to a contract in case of a change of legislation, this QuickCounsel will examine provisions that clarify which law will apply to the contract over time.
1. General rule
The rule regarding the applicable law in contractual matters relies on the non-retroactivity principle. The latter had been recognized on various occasions by the European Court of Human Rights (LILLY FRANCE c. FRANCE, November 25, 2010, nÂ°20429/07)
The Spanish Civil Code, in a final chapter, specifically provides for the application of the law at the time of the conclusion of the contract to ongoing agreements.
However, under some circumstances, exceptions are made to the principle of sovereignty of the previous law.
The newly enacted law may provide for its immediate application through transitional legal provisions (a). Likewise, a new law of public order may apply to ongoing contractual relationships (b). A third situation occurs when a contractual claim relates to the legal effects of an ongoing legal situation (c).
a. Transitional legal provisions
The law may expressly provide for a derogation to the principle of non-retroactivity. A new legal text may establish rules defining a temporary regime to smooth the transition to the new legal requirements.
Some court decisions even suggest that transitional legal provisions are mandatory to favor legal certainty (SOCIETE KPMG, French Conseil d'Etat, March 24, 2006, n°2884/60).
b. Public order laws
Public order laws apply immediately to future effects of ongoing contracts if they relate to issues of public policy and respond to overriding public-interest considerations. In France, this exception must be taken carefully: the expression "public order law", either as stated in the new law or as qualified by a court, does not justify by itself the immediate application of the new law. The new law must reinforce the existing legal order and meet overriding reasons of general interest. If the new or amended law does not meet these requirements, its immediate application will not occur.
For example, the French Cour de cassation assured the existence of a "social public order" imposing the immediate application, to ongoing employment contracts, of new laws aiming at improving employees' protection.
Within the European Union, one might consider the notion of "public order" in light of the EU case law. In the Arblade case of the European Court of Justice, November 23, 1999, public order laws were defined as "national provisions compliance which has been deemed to be so crucial for the protection of the political, social or economic order in the Member State concerned as to require compliance therewith by all persons present on the national territory of that Member State and all legal relationships within that State" (§30).
c. Legal effects of a contract
The immediate application of a new or amended law may also be justified for another reason. If the future effect of an ongoing legal situation is envisaged by the legislator, the new or amended law applies to this future effect. If the future effect of the ongoing legal situation results from the will of the parties to the contract, the law applicable at the time of its conclusion continues to prevail. In order to fall into the concept of legal effect, the content of the contract must be so imperatively fixed by the law that it is assimilated to a legal situation.
This exception has been illustrated by the French Cour de cassation. On February 16, 2015, it issued an opinion about the application to ongoing lease contracts of the new payment period of three years granted to the tenant by the law deleted (Act n°2014-366 of March 24, 2014). It stated that this new payment period should apply to ongoing lease contracts concluded before this new law, as it is a legal effect resulting from the will of the legislator and not subject to contractual freedom.
The immediate application of the new law to the future legal effects of ongoing legal situations may be justified by a non-discrimination principle. Its non-application to ongoing legal situations would create an unequal treatment between legal entities in identical contractual situations; depending on the date they concluded the contract.
In order to avoid the application of a newly enacted law, the contracting parties may insert contractual provisions in order to either stabilize the governing law to the contract (1) or to harmonize the applicable legal texts (2).
1. Stabilization clauses
There are three different forms of stabilization clauses: freezing clauses (a), hybrid stabilization clauses (b), and economic equilibrium clauses (c).
a. Freezing clauses
A freezing clause aims at mitigating the risk of legislative and regulatory changes over investment contracts by "freezing" the application of the law in force at the date of the contract conclusion. This contractual provision is often incorporated into long-term investment contracts between States and international investors.
This implies that the State, in its quality of party to the contract, agrees that any legislative or regulatory change enacted after the date of conclusion of the contract will not apply to the contract. The designated law will therefore apply throughout the duration of the contract, ensuring the contract's legal stability.
The key concern about freezing clauses is their enforceability: the clause has to be legally enforceable under domestic law. Some jurisdictions have established legal principles invalidating this type of clause such as common law States - including the UK - as well as some Middle Eastern States. The freezing clause is not considered as valid in several fields relative to human rights and its scope of validity is shrinking.
The arbitral decision LIAMCO confirmed the principle of State sovereignty, stating that it is impossible to prevent a State to change the law despite contractual provisions such as freezing clauses. However, if the freezing clause is considered as valid in a contract, the State would be responsible for a breach of contract before a court and thus the private party may claim for compensation on the legal grounds of real damages and loss of profits.
The Ruggie/IFC report points out the fact that governments with sophisticated negotiating capacity are able to come to terms with investors while avoiding freezing clauses. These clauses are especially involved in investment contracts with developing countries, due to their greater political and regulatory uncertainty.
b. Hybrid stabilization clauses
A hybrid stabilization clause aims at freezing the application of some legal rules within the contract. However, as opposed to a freezing clause, it provides for either a renegotiation or compensation by the State to the private party, in case of the application of a newly enacted law.
The scope of freezing clauses has been traditionally reduced to international or domestic investment contracts between a private party and a State, the latter being the unique entity entitled to freeze the law. Thus, the transposition of freezing clauses and hybrid stabilization clauses to private parties appears to be difficult, as it requires national sovereignty. However, this limitation is less relevant with regard to economic equilibrium clauses.
c. Economic equilibrium clauses
Under an economic equilibrium clause, it is not the legal framework but the economic return of the investor which is stabilized; the rationale for this is the economic equilibrium of the contract. The economic balance of the contract may be protected by compensation or a renegotiation of the contract terms.
2. Harmonization clauses
When a contract is entered into for a long period of time between several parties who may transfer their contractual rights, there is a risk that the contracting parties may be subject to various legal regimes. This is particularly true with respect to by-laws or shareholders agreements.
In order to prevent the risks of diversity of legal regimes, a clause may provide for the harmonization of the law to all the shareholders, irrespective of the date of acquisition of shares in the company. Such a harmonization clause would appear particularly relevant with respect to valuation of shares.
In France, article 1843-4 of the French Civil Code used to subject their valuation to the sovereign power of a court-appointed expert. Since August 3, 2014, the article provides that the expert should comply with the evaluation rules fixed in the by-laws of the company. The question of whether this new article 1843-4 applies to ongoing by-laws is debated (D. GALLOIS-COCHET, "L'application dans le temps de l'article 1843-4 du Code civil", Bulletin Joly Sociétés, January 2015, p51). A harmonization clause would clarify the question.
Contract drafters should consider the possibility of a legislative or regulatory change during the contract duration and the potential consequences that this change may have on the contract outcome. These risks may be reduced through stabilization or harmonization clauses to a limited extent, and subject to a change of the law.
Prof. MANIRUZZAMAN, "The pursuit of stability in international energy investment contracts: A critical appraisal of the emerging trends", The Journal of World Energy Law & Business Advance Access, June 24, 2008, Vol. 1, No. 2
D. WU, "Timing the choice of law by contracts », Northern journal of technology and Intellectual property", Spring 2011, Vol. 9, Issue 7