INTRODUCTION
At present, legal standards formed within the legal system of the United States are increasingly finding their place in contractual practice on the European continent. The causes of this phenomenon should be sought not only in the economic dominance of American companies but also in the functionality of the home country. Companies headquartered in the U.S. with a global presence implement their contractual practices within their system. Later, they extend these practices to include agreements with third parties. Since these are the most economically powerful companies in the world, they have the de facto ability, in their contractual relationships with third parties, to impose their contract models without any resistance, which are mainly based on the law of their home country. In doing so, contract models rarely go through the process of harmonization with the law applicable to such contracts. The reason for this approach is not only the inertia and uniformity of the internal system of the multinational company but also a reflection of caution regarding the extension of the public order of the U.S. No large company wants the provisions of a contract concluded by its foreign subsidiary with a third party to be at risk of being inconsistent with U.S. law, while compliance with local laws is less of a priority. The consequence of this is that contractual institutes originating in the U.S. are rapidly becoming established in third countries, primarily through contractual practice and later through the legitimization of that practice by the courts.
One of these institutes is the termination for convenience clause, which has also been recognized as legitimate in the practice of the courts of the Republic of Serbia on several occasions. This clause establishes the right of a contracting party to terminate the contract at its discretion, without giving reasons or any justification, and without bearing any harmful consequences. However, despite the fact that the clause has not been recognized as contrary to public order so far, the standards of its interpretation and its relationship to other contractual provisions undoubtedly represent an unexplored field that our judicial practice has not addressed, at least not with sufficient systematization. There are, in fact, situations where simply justifying the effect of this clause with the general notion of freedom of contract, without a more detailed analysis of its impact on the contract as a whole, leads to the negation of some other principles of contract law. Due to such effects, we believe it is necessary to conduct a more detailed analysis of both the clause itself and its effects in relation to the legal system of the Republic of Serbia.
DIFFERENCES IN THE CONSTITUTIONAL FRAMEWROKS OF THE REPUBLIC OF SERBIA AND THE UNITED STATES REGARDING FREEDOM OF CONTRACT
The Constitution of the Republic of Serbia does not recognize freedom of contract as a specific human right, but it can certainly be included under the freedom of entrepreneurship, which is guaranteed by Article 83 of the Constitution. As follows from the constitutional text itself, this freedom is not unlimited and is subject to legal restrictions. It is, therefore, the legislator’s responsibility to prescribe the specific restrictions on freedom of contract in the public interest, with the obligation to respect proportionality criteria when limiting this freedom. This is a direct consequence of the ratified international treaty with constitutional effect—the European Convention on Human Rights and Fundamental Freedoms, which places freedom of entrepreneurship and freedom of contract, in some of its aspects, under the protection of Article 8 of the Convention and Article 1 of Protocol 1 to the European Convention, in terms of guarantees for the right to respect for private and family life, as well as the right to property.
The situation is similar with the Constitution of the United States, except that freedom of contract is included under the guarantees of the 14th Amendment [1]. The U.S. Supreme Court explicitly addressed this in its opinion in the case of Allgeyer v. Louisiana.[2]
What makes a substantial difference between the concept of freedom of contract in the legal system of the Republic of Serbia compared to the concept in U.S. law is the traditional understanding of the importance of freedom of contract and, consequently, the scope of this freedom. While in our legal system it has never been disputed that freedom of contract is subject to significant restrictions imposed by various positive laws, the constitutionality of which from this aspect has never been seriously questioned [3], in U.S. courts, for the past two centuries, there has been a significant struggle among various interest groups precisely in the field of freedom of contract. Starting with the U.S. Supreme Court’s stance in the Holden v. Hardy decision[4], which introduced certain restrictions on this freedom, through the famous Lochner v. New York decision[5], which paved the way for unrestricted freedom of contract and ushered in the so-called Lochner era lasting two full decades, to the Ferguson v. Skrupa decision[6], which took the position that the 14th Amendment does not protect every freedom of contract, the U.S. Supreme Court has been intensively engaged in assessing the constitutionality of legal provisions imposing restrictions on freedom of contract.
In our legal tradition, there is no trace of such an approach from the highest judicial instances. The constitutionality of imperative provisions of systemic laws that limit freedom of contract, primarily the Law on Obligations from 1978, has not only never been questioned but legal theory has not criticized these rules either. Equally important, the courts have consistently applied these provisions in practice, albeit with varying levels of consistency, and have based their rulings on them. Therefore, it cannot be said that there was any distortion or de facto non-application of the restrictions. With a high degree of certainty, it can be argued that all restrictions on freedom of contract prescribed by systemic laws are indisputably constitutional and, at the same time, legitimate, even in cases where the state appears as a contractual party, and where a parallel can be drawn with the so-called Christian doctrine. Christian doctrine [7].
From the above, it can be concluded that freedom of contract significantly differs in the context of U.S. law compared to the interpretation of this concept in the legal system of the Republic of Serbia. United States law treats freedom of contract much more broadly, while the resistance to limitation that undoubtedly exists in its legal heritage is considered not only legitimate but also socially desirable. On the other hand, it can be said that the legal system of the Republic of Serbia exhausts freedom of contract in the legal principle of autonomy of will when entering into obligations, which is limited by mandatory regulations, public order, and good customs.[8].
DIFFERENCES IN LEGAL SYSTEMS REGARDING THE TREATMENT OF THE INSTIUTE OF CONTRACT TERMINATION
The regulation of the concept of contract termination significantly differs in legal systems based on common law compared to the legal system of the Republic of Serbia. Professor Jovanović holds the view that the legal system of the United States, which regulates contract termination in an essentially identical way as the English legal system, differs from the legal system of the Republic of Serbia in five key issues [9]related to:
- Reasons for termination
- Acquisition of the right to terminate
- Methods of termination
- Consequences of termination
- Disposability of termination (changes to the rules of objective law)
He observes that “English law understands the right to terminate more narrowly than Serbian law, although this is not immediately obvious. For a party to have the right to terminate, it is necessary that they have a justified interest.”Englesko pravo uže shvata pravo na raskid nego srpsko, iako to nije očigledno na prvi pogled. Da bi jedna stana imala pravo na raskid, nužno je da ima opravdan interes”.
What is more important for evaluating the specific clause are Jovanović’s remarks about changes to the rules of objective law regarding termination: “English law allows the contract to regulate termination differently, which is often the case in commercial contracts (for example, this can expand or limit the reasons for termination and regulate a different method of termination). This means that the regime of unilateral termination in English law is dispositive… Serbian law regulates termination with imperative rules (e.g., reasons for termination, acquisition of the right, method of termination, and consequences), so contractual modification is not possible. Exceptionally, modification is allowed in the case of a fixed-term contract, when the contract expires by law after the deadline for fulfilling the obligation, unless the creditor notifies the late debtor after the deadline that the contract remains in force…”[10]
It seems that for the purposes of our analysis, this is the key difference. Namely, if the legal system under which the TFC clause is established is based on disposition in the contract termination regime, then each institute is essentially based on disposition, without any correction that imperative rules would require.
On the other hand, if our legal system imposes numerous limitations on the freedom to regulate contract termination through imperative norms contracting an institute that is the result of pure and unrestricted disposition, without assessing its compliance with these limitations, it can lead to significant challenges. This introduces both the institute and the entire contract into a zone where compliance becomes extremely difficult or even impossible, a space where, according to Fuller, the internal and external morality of the law intersects. [11]Therefore, the clause itself, theoretically speaking, would represent a law for the parties that in the vast majority of cases demands the impossible [12]and, thus, in the vast majority of cases, would be subject to the sanction of nullity.
PRACTICAL APPLICATION OF THE CLAUSE AND THE SUPERFICIALITY OF JUDICIAL PRACTICE
In domestic practice, it appears that when evaluating the legal validity of specific TFC clauses, their violation or imperative legal norms is often downplayed, sometimes even in relation to fundamental legal principles. The permissibility of these clauses is typically assessed based on the principle of autonomy of will. Since the parties have agreed to the possibility of unilateral termination of the contract, regardless of the specific circumstances of the contractual relationship, their will must be respected. Whether the agreement and application of this clause lead to the violation of the equality of performance, whether the result is an abuse of rights by the stronger contracting party, and whether the party benefiting from the clause acted in accordance with the principle of good faith and fairness, are legal issues that our courts typically do not address, and the relationship to the cause is rarely discussed.[13].
However, these issues can hardly be disregarded when discussing the compatibility of the TFC clause. In fact, even in American practice, [14]it is not possible to defend the activation of this clause solely by invoking the principle of freedom of contract at the time of entering into the contract. For example, if the activation of this clause is based on bad faith, with the aim of avoiding contractual obligations[15], or if the clause is not supported by so-called consideration, or creates an illusory contract[16], as the subject of this analysis, the courts will sanction such conduct.
Of course, besides the general requirement, different countries also have different judicial practices regarding the range of actions that will be classified as bad faith. For instance, courts in Arizona seem to be much more restrictive than those in New Jersey, as they consider the cancellation of a contract to avoid administrative or judicial control over the state’s decision to award a contract as bad faith. [17]Similarly, terminating a contract with the intention of securing a better price in dealings with a third party is considered an act of bad faith. [18]For example, in the case of Greer Properties, Inc. v. LaSalle National Bank, the court ruled that a contract cannot be terminated under the TFC clause simply to negotiate a better price.[19]
On the other hand, even when considering the criteria set at the EU legislative level for assessing unfair contractual clauses that are subject to nullity sanctions, both in relationships between business and private parties,[20] and in relationships between business entities, three criteria clearly emerge that courts must consider when evaluating a contractual provision:
- Was the contractual provision individually negotiated, i.e., does it represent the imposed will of one of the contracting parties?
- Are the agreement and the consequences of applying such a provision in accordance with the principle of good faith, which corresponds to the principle of honesty and fairness?
- Does the provision cause a significant imbalance in the rights and obligations of the contracting parties?
In most cases, TFC is a contractual provision imposed on the weaker party and rarely reflects their true intentions. It is often misused to bypass mandatory rules on contract termination and disrupts the balance of obligation, making it easy to classify as unfair under European regulations. While there may be situations where these conditions are not met, such an assumption should not be made in advance, nor should it be treated as a legal fiction based solely on the contract signature. Instead, it must be the result of a specific analysis of each individual case.
Unfortunately, the domestic judicial practice does not address these issues. The argument for this is mostly quite superficial and boils down to the cliché that it is permissible to agree on a TFC clause, excluding the right to compensation, because unilateral contract termination is not prohibited per se. In a case where the court was asked to determine the invalidity of a TFC clause in a contract concluded for a fixed term, where its application disrupts the contractual balance and equality of performance, the Court of Appeals in Belgrade [21]held that since the contract in question (not involving a material error) “is not in obvious contradiction with certain social norms and principles of contract law,” [22]and was signed by the contracting parties, it represents a mutual statement of will, and the fact that such a provision was imposed has no effect.
What makes this decision particularly interesting is that it was made in a case where one of the contracting parties had nearly fully met its contractual obligations, yet payment for those performances was not yet due, as it was based on a percentage of the other party’s future income. To illustrate, if this judicial stance were applied to, for example, a concession contract, it would mean that in Serbia, unilateral termination could be agreed upon at will with immediate effect, without the right to compensation. This would allow termination precisely when the concessionaire has made all the investments and built the highway, thus preventing them from recovering costs and profits through a share of the tolls. Such practices are not found in decisions by U.S. or European courts.
Without speculating whether this stance is the result of excessive court caseloads, basic irresponsibility toward public order, or other factors, the fact remains that it opens the door to serious abuses of rights in the negotiation process. It also leads to the complete marginalization of the principles of equal exchange, good faith, and fairness, along with all other imperative legal norms that uphold these principles.
At the same time, it should not be forgotten that the same Court of Appeals in Belgrade ruled that the possibility of terminating a contract due to delay, which cannot be considered a significant breach of the contract, is subject to the sanction of nullity.[23].
Based on this, it seems that the practice of the Court of Appeals in Belgrade is consistent at least in one respect—who can do more, cannot do less, particularly when it comes to agreeing on the terms for unilateral termination of a contract.
STANDARDS OF NON-OBVIOUS DEVIATIONS
As can be concluded from the previous discussion, the basic postulate of our courts is that what is not obvious does not warrant detailed analysis. While the concept of “obviousness” is inherently subjective, depending on the observer’s perspective, for the purpose of this analysis, we will assume a common understanding of what “obvious” means. In this regard, in our further discussions, we will focus on deviations that, when considered in relation to the nature of the contractual relationship, the behavior of the contracting parties, and imperative legal norms, may not be obvious to every lawyer.
Let us assume that the agreed TFC clause authorizes a large company to terminate a fixed-term contract with a weaker market partner at any time, without the business partner being able to claim compensation for damages. For now, let us set aside the legal validity of waiving the right to compensation for damages, which possibility is excluded by the imperative legal provision of Article 163 of the Obligations Act (ZOO), [24]regardless of whether this is considered “non-obvious” by our courts. Instead, we will focus on possible situations where activating or agreeing to the TFC clause would be prohibited by law. In the absence of criteria defined by case law, we will take the liberty of establishing the criteria that must be applied in such cases.
First and foremost, the court, when evaluating the TFC clause, must first examine the impact of this clause on the cause of the contract itself. The essence of the cause was explained by Professor Antić[25], who stated that in civil law, the cause will always depend on the autonomy of will and the principles of good faith and fairness. The autonomy of will, and therefore the intention of the contracting parties, must always be taken into account when considering the cause of the contract. In accordance with the principle of good faith and fairness and the principle of equivalence of performances, it is always of an objective nature, reflecting the interdependence of obligations and consisting of the counter-performance of the other party, that is, in the legal symmetry of the performances of the contracting parties. A disturbance of that symmetry beyond a reasonable measure nullifies the cause, and thus the contract itself.
In this regard, the TFC clause must always be considered unlawful in contracts based on a long-term business relationship. If one party has made key performances at the beginning of the contract’s term, while the other party has not, any termination before the agreed-upon term disturbs the symmetry of the performances and leads to unjust enrichment of the party benefiting from those performances. For example, in the previously mentioned concession agreement, the TFC clause would be null because it contradicts the cause of the contract. The same would apply in a long-term lease agreement where the tenant has made significant investments in the property, or in an agency contract where the agent earns compensation based on the success of the business. On the other hand, the TFC clause would not necessarily be null in contracts where the performances are sequential and equivalent, and where no element of aleatory risk exists, provided that it is not imposed, does not violate the principle of good faith and fairness, and does not disturb the equivalence of performances.
Regarding conditional contracts, a particularly interesting issue is the relationship between this clause and the imperative norm of Article 74 of the ZOO, which stipulates that the condition will be considered fulfilled if its occurrence is prevented by the party on whose behalf it was agreed. Let us imagine a situation where a lawyer represents a client for a percentage of the compensation they are entitled to upon the finality of a judgment in favor of the client. In this case, the TFC clause is not necessary as a separate agreement, since it pertains to a specific legal relationship that can be relatively easily terminated. However, for the sake of discussion, let us assume it was agreed. The question then arises: what happens if the client terminates the representation agreement a month before the judgment becomes final, where the lawyer has performed all their duties, and only time separates them from fulfilling the condition? By applying Article 74 of the ZOO, the condition should be considered fulfilled, and the lawyer would be entitled to the full percentage of compensation. But would this mean that the TFC clause is valid and has not affected the cause? We believe that, even in the absence of harmful consequences, the TFC clause in this contract disrupts the cause of the contract due to the nature of the agreement and is, therefore, absolutely null.
The imperative norms regulating contract termination, as the second criterion, leave little room for the application of the TFC clause. If we assume that the legislator [26]has modified the principle of pacta sunt servanda [27] with the legal remedy of contract termination, primary to prevent deviant behavior of the parties, such as the non-performance of obligations – particularly non-performance of a certain severity[28] – and along with numerous other restrictions on termination,[29]it becomes clear that, as a rule, the stronger party cannot undermine this principle by agreeing to the possibility of unilaterally terminating the contract at any time, even when the other party is fulfilling its obligations properly. If this were allowed, the stronger party would be able, by simply agreeing to this clause, to completely avoid the application of the imperative rules of the Obligations Act, potentially causing chaos in legal transactions.
On the other hand, especially in cases where the TFC clause is agreed solely in favor of one contracting party, meaning there is no complete symmetry, this certainly affects the determinability of the subject matter of the obligation under Articles 47 and 50 of the ZOO and, under certain conditions, may lead to the nullity of the entire contract.
Finally, the third criterion that courts must apply is prescribed in Article 135 of the ZOO, where the legislator has instructed courts to take into account the rules of fair trade, considering the purpose of the contract, the normal risk involved in contracts of this type, and the interests of both parties. Although this condition we have set as a separate one partially overlaps with the previous two, we have ventured to isolate it as a distinct element, especially because it is a binding guideline for the courts set by the legislator.
Therefore, we can conclude that courts are always obliged, in every case, when evaluating the TFC clause, to consider its specific effect on the cause, the imperative legal norms regulating contract termination, and, finally, the rules of fair trade, the interests of the parties, and the risks of the transaction. These represent the so-called essential facts that, in accordance with the right to a reasoned judicial decision[30], must be assessed in the reasoning of any judgment involving with the TFC clause. Only once case law has crystallized on these issues can we draw clear parallels between the position of this clause in our legal system and that of the United States, where its position is already well-established.
CONCLUSION
Although the legal systems of Serbia and the United States have many differences, simply adopting an institution from one legal system into another is not possible without first examining the place of these institutions and making certain adjustments to align them with the public order. If the contracting parties are so determined to adopt an institution from foreign law, with the assumed element of foreignness, then the application of that institution can only be ensured through the proper choice of the governing law, and not by merely copying contract templates. On the other hand, courts in Serbia must treat (and at the very least, recognize) this phenomenon much more seriously, as the superficiality of judicial practice causes tremendous damage not only to individual interests but also to the consistency of the legal system of the state, with equally serious consequences for the rule of law. The extent and even the bizarre nature of the consequences of such an erroneous approach are most clearly seen in the case of the TFC clause, where courts, by invoking the autonomy of will regarding a contractual provision that is not an essential element of the contract, completely undermine the autonomy of will in relation to the essential elements of the contract, making the principle of pacta sunt servanda illusory. Perhaps it is time for the Constitutional Court of the Republic of Serbia to rule on this matter, given the place of the rule of law principle in the country’s constitutional order.
Autor Vojin Biljić
[1] This amendment, adopted by Congress on June 13, 1866 and ratified on July 9, 1868, contains a clause that guarantees the right to life, liberty, and property. Its author, Congressman John Bingham, intended to make the Bill of Rights applicable to all states, but this consequence, according to later interpretations by the Supreme Court, did not occur. More on this at https://www.archives.gov/milestone-documents/14th-amendment
[2]165 U.S. 578 (1897). Available at: https://supreme.justia.com/cases/federal/us/165/578/
[3] Partly due to historical circumstances, the later development of commodity-money relations, and the fact that self-management socialism significantly marginalized the importance of both contractual institutes and subjective rights related to entrepreneurship. On the other hand, it should not be forgotten that the legal quality of the Law on Obligations, and before that, the drafts by Professor Konstantinović, is beyond any doubt, and the question remains whether there was any real need for a struggle against the limitations imposed by these legal acts.
[4] 169. U.S. 366(1898) Available at: https://supreme.justia.com/cases/federal/us/169/366/
[5] 198 U.S. 45(1905) Available at: https://supreme.justia.com/cases/federal/us/198/45/
[6] 372 U.S. 726(1963) Available at: https://supreme.justia.com/cases/federal/us/372/726/
[7] This refers to the doctrine of contract law in the United States, where the state is one of the parties, established by the U.S. Court of Claims ruling in G.L. Cristinan & Associates v. United States, 312 F. 2d 418 (Ct. Cl. 1963), available at https://law.justia.com/cases/federal/appellate-courts/F2/312/418/53812/which states that the government can exercise the right to unilateral termination even in situations where such a right has not been explicitly agreed upon, but represents a well-established practice of the government.
[8] This is explicitly provided by Article 10 of the Law of Obligations (SL. List SFRJ, no.29/78 – SL. Glasnik RS 18/20)
[9] N. Jovanovic, Introduction to common law contract law, Belgrade, 2015, pp.105
[10] Ibid, pp.108-109
[11] L. Fuler, Morality of the Law, Belgrade, 2001, pp.87-97
[12] Ibid, pp.87
[13] The concept of cause (kauza) for courts in the Republic of Serbia represents a vague and unclear construction.
[14] Therefore, courts are more likely to seek ways to expand the scope of application of other imperative norms or even resort to open voluntarism, rather than daring to take clear positions on the foundation of the contract under the concept of cause.
[15] Torncello v. U.S. 231 Ct.CL.20,681 F.2d, 765,764(1982) available at: https://casetext.com/case/torncello-v-united-states
[16] Handi-Van. Inc v. Broward Cnty, No. 4D 12-1549(2013) available at: https://casetext.com/case/handi-van
[17] Arizona’s Towing Professionals, Inc. v State, Arizona Court of Appeals
[18] Krygoski Constr. Co v United States, 94 F.3d 1537, 1541 (Fed. Cl. 1996)
[19] “When the [defendant] entered a contract with [the plaintiff and] agreed to pay them a specific price for the property, [the defendant] gave up their opportunity to shop around for a better price. By using the termination clause to recapture that opportunity, [the defendant] would have acted in bad faith”
[20] In this sense, Article 3 of EU Directive 93/13 states: “A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance between the parties rights and obligation”. The European Principles of Contract Law are in the same line
[21] Gž. 950/22 from 09.03.2022. year
[22] has agreed to have damage inflicted upon them by an action that is prohibited by law is void.
[23] Gž. 1923/18 from 04.04.2018. year
[24] The statement of the victim, who has agreed to have harm done to them by an action that is prohibited by law, is null and void, according to Article 163, Paragraph 2 of the Civil Code.
[25] O.Antic, “Morality (Ethics) in Civil Law”, in the Proceedings “Harmonization of Civil Law in the Region”, 2013, pp.3-5
[26] Such a situation also exists in comparative legislation
[27] Which represents an obligation of the Republic of Serbia under Article 26 of the Vienna Convention on the Law of treaties (SL. Of the SFRY, International Treaties and Other Agreements, 30/72)
[28] In accordance with Article 131 of the Civil Code, a contract cannot be terminated due to insignificant non-fulfillment of an obligation.
[29] The duty of notification under Article 130 of the Civil Code, the debtor’s ability to fulfill the obligation even after a delay and maintain the contract in force under Article 126 of the Civil Code, the prescribing of special duties of the court when deciding on termination due to changed circumstances under Article 135 of the Civil Code, and so on.
[30] This right falls under the right to a fair trial as defined in Article 32 of the Constitution of the Republic of Serbia and Article 6, paragraph 1 of the European Convention