How courts apply non-state rules

Applying non-state rules as a source of domestic law

Introduction

This chapter focuses on the application of non-statc rules as a source of domestic law: that is to say when non-statc rules are a source of the applicable law to the contract. As an example, this chapter examines how trade usages are applied to understand how non-statc rules function as part of domestic law and how courts interpret them.

Trade usages arc usually recognised as sources of domestic law. For example, the Spanish Civil Code lists general principles and customs as a source of law.^[1] In France the Civil Code states that contracts are not only binding in what is expressly included, but are also binding in all that follows from the contract: equity, trade usages, and law. English common law treats usages as implied terms of the contract. It should be noted that when non-state rules arc recognised as a source in domestic law, they are also applicable to domestic contracts (unless the law makes a distinction between the two.) The specific trade usages and general principles that are applicable can vary between domestic contracts and international contracts.

This chapter uses two examples of how trade usages arc applied as a source of law. The first is the UCC and the second the CISG. Both of these pieces of legislation give an important place to trade usages and as such contribute to the development of non-statc rules. This chapter demonstrates how domestic law gives legal authority to non-state rules by acknowledging their importance as a source of law. Codified non-statc rules are regularly applied as an expression of these trade usages and as such gain legal authority through their assimilation with a recognised source of law.

The application of non-state rules as a source of domestic law: trade usages & the UCC

UCC §1-103 (a) (2) states that ‘The Uniform Commercial Code must be liberally construed and applied to promote its underlying purposes and policies, which are. ...to permit the continued expansion of commercial practices through custom, usage, and agreement of the parties.* Paragraph b of the same article states that the principles of law and equity, including the law merchant, must be taken into account, unless other provisions of the UCC displace these.^[2] In article §1-201 an agreement is defined as ‘the bargain of the parties in fact, as found in their language or inferredfrom other circumstances, including course ofperformance and course of dealing, or usage of trade. ’ These articles indicate that trade usages are an important source of law under the UCC.

Article §1-205 on Course of Dealing and Usage ofTrade defines the concept of trade usages. It clarifies that a trade usage is any practice that occurs with such regularity in a place, vocation, or trade that the expectation that it will be adhered to is justified. The term regularity' implies that usages do not have to be followed perfectly, but only to such a degree that there is a clear observable pattern. It is only necessary for parties to know the usages of their own trade and not those that are common in other trades, even when they have cross-dealings with these other trades. §1-205 is also reflected in article §221 of the Restatement (Second) of the Law of Contracts:

(1) Ail agreement is supplemented or qualified by a reasonable usage with respeet to agreements of the same type if each party knows or has reason to know of the usage and neither party knows or has reason to know that the other party has an intention inconsistent with the usage.

Article §219 of the Restatement defines usage as ‘habitual or customary practice.⁹

The UCC does not clarify if a trade usage can only be used to interpret an agreement or whether it can add new terms to the contract.¹⁰ In the case of Barnard v. Kellogg, which predates the UCC, it was argued that usages can only be used to interpret any ambiguities in the contract and that they cannot be applied when they contradict an express term of the contract.¹¹ Nevertheless, in other cases trade usages were applied that contradicted express terms of the contract.¹² The UCC tried to reconcile these cases by stating that if a trade usage and an express term seem to contradict each other they should be constructed as to be consistent, and only if that is not possible the express term should trump the trade usage.¹³ From this it can be extrapolated that trade usages can add new terms to the contract. The importance of trade usages is such that they have been applied to vary express terms of a written contract, even if according to the UCC they should not.¹⁴ Courts

• 9 §219. Usage is habitual or customary practice.
• (1) A usage of trade is a usage having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to a particular agreement. It may include a system of rules regularly observed even though particular rules are changed from time to time.
• 10 Joseph H Levie, ‘Trade Usage and Custom under the Common Law and the Uniform Commercial Code’ (1965) 40 New York University Law Review 1101, 1109.
• 11 Barnard v. Kellogg 77 U.S. 10 Wall. 383 (1869);

‘The proper office of a custom or usage in trade is to ascertain and explain the meaning and intention of the parties to a contract, whether written or in parol, which could not be done without the aid of this extrinsic evidence. It does not go beyond this and is used as a mode of interpretation on the theory that the parties knew of its existence and contracted with reference to it. It is often employed to explain words or phrases in a contract of doubtful signification, or which may be understood in different senses, according to the subject matter to which they are applied. But if it be inconsistent with the contract, or expressly or by necessary implication contradicts it, it cannot be received in evidence to affect it. Usage, says Lord Lyndhurst, ‘may be admissible to explain what is doubtful; it is never admissible to contradict what is plain.’ And it is well settled that usage cannot be allowed to subvert the settled rules of law.’

• 12 Roger W Kirst, ‘Usage of Trade and Course of Dealing: Subversion of the UCC Theory’ [1977] University of Illinois Law Review 811, 819.
• 13 § 2-208. Course of Performance or Practical Construction (2).
• 14 Lisa Bernstein, ‘Merchant Law in a Merchant Court: Rethinking the Code’s Search for Immanent Business Norms’ (1996) 144 University of Pennsylvania Law Review 1765, 1784

An example of a case is Columbia Nitrogen Corp v Royster Co, 451 F2d 3, 8-11 (4th Cir 1971) where a usage of trade was admitted as evidence to show that the express terms with regard to quantity were actually not terms and conditions but instead represented options for the buyer.

justify this on the grounds that the usages clarify or supplement the contract terms.^[3] Trade usages are therefore considered implied terms of the contract. Usages can be contracted out of by expressly excluding them. Even if the parties include a general clause to exclude trade usages the court searches for the intent of the parties. For instance, if the clause is a boilerplate clause, the exclusion might not express the actual intent of the parties, as they might not have given conscious thought to whether they wished to exclude any trade usages. The exclusion clause should thus be drafted in a precise and explicit manner. This favourable approach to trade usages can present difficulties if parties are not aware of the trade usage or if they are not aware that they need to contract out of them. Seeking the intent of the parties is not always straightforward, especially when there arc conflicting opinions between the contracting parties on whether they have excluded the trade usage.

The UCC presumes that the parties are aware of the relevant trade usages. This could seem unfair on those who arc new to the trade as the importance of unwritten usages makes it more daunting for newcomers to enter the field. However, if pleading ignorance would be a reasonable defence for newcomers, this would hamper trade, as it would decrease legal certainty and discourage established traders from contracting with newcomers. In the long run this would not be practical, as it would prevent fledging competition from

Applying non-state rules 159 growing, and thus prevent the existence of a healthy, competitive market.^[4] Furthermore, it would prevent trade usages from having any legal authority if a statement of ignorance by one of the parties would be enough for courts not to apply them. Taking the above into consideration it is unmistakable that under the UCC trade usages are a primary source of law and will always be applied, unless the intent of the parties that they should be excluded is clearly made manifest.

The UCC favours the word usage over custom. Under the common law the party' seeking to establish custom should prove that this custom is legal, notorious, reasonable, certain, universal, obligatory, and ancient or immemorial. The UCC distinguishes between usage and custom by stating in the official commentary that usage is not bound by the common law test of custom. Usages do not have to be universal, but can exist only in a specific location. Usages do not have to be ancient or immemorial. There is no minimum amount of time that needs to elapse before a practice can be considered a trade usage.

The change from custom to usage under the UCC is significant. Under custom the perceived legal obligation of the participants is a vital component. This is not important for trade usages. This change represents a power shift from the business community to the court. Under the traditional understanding of what custom is, the business community' could choose which customs they considered binding whereas under the UCC it is the court that declares which usages arc binding. Courts declare a practice binding based on observation. Custom and usages are thus recognised in different ways: subjectively (opinio iuris) and objectively (observance). It takes away legal authority' from the merchant community' to declare whether they should be bound by a rule. Merchants can be required to follow a trade usage regardless of whether they consider this practice binding. Usages will continue to develop independently from the courts, but the courts have the power to declare these binding.

There are several reasons why trade usages have an extensive place in the UCC. Firstly, the drafters consider the lex mercatoria as predecessor to the UCC. They were therefore sympathetic to the argument that merchants should have the possibility' to self-organise. The UCC recognises that merchants operate in a community framework that can make collective decisions, which are imposed on individuals.^[5] The drafters considered that trade usages better express the intention of the parties than the contract itself does as these usages are internalised so their inclusion should be presumed. It makes the law more flexible and adaptable to the needs of trade. It can also reduce legal costs as not every single eventuality would need to be included in the contract and thus less time is needed for negotiations. Consequently, trade usages allow merchants to operate within a flexible and low-cost environment: ‘ without freedom, individuals could not develop rational business practices in the pursuit of profit. When one looks at business practices, one sees the reflection, the echo of individual choices made over time. Business practices, as the products of liberty, have an inherent moral legitimacy.^w

Bernstein questions whether when given the choice the parties would opt to be bound by' trade usages or whether they would prefer to be solely bound by the contract and statutory law. That merchants follow certain trade usages does not necessarily mean that they wish to be legally obliged to observe these as for reasons of trust, friendship, reputation, and/or long

Applying non-state rules 161 term gain, parties might make concessions on issues such as delivery, quantity, price, time, or other. They do not do so because they consider these concessions as trade usages, but because they value the longer-term contractual relationship and therefore want to be flexible with their trading partner. An example is warranties on software, which are limited in the contract, but are applied more generously in practice.^[6] This is to the satisfaction of both parties: the software provider who limits his liability & the buyer who gets a cheaper product (as the warranty provisions arc less extensive and thus less costly) but will enjoy a more generous practice. If this is considered a trade usage this could lead to the provider restricting this practice or raising his prices. This would ultimately be a loss for both the buyer and the seller.

When the parties wish to end the contractual relationship, they do not necessarily wish to be held to the practices they established when preserving the relationship was the goal. Therefore, they do not perceive these practices as binding. As the binding value of usages under the UCC does not come from a sense of obligation, but from observance of the pattern this perception would have no effect on the legal obligations of the parties. Courts do not always distinguish between practices done out of courtesy, and trade usages. The parties can follow trade usages because they allocate authoritative value to them or because they wish to give space to informal practices that solidify the contractual relationship. Within business relationships reputation is key, this is especially so in more closed trades where the number of participants is smaller and entry costs arc higher.

The official comments to §1-205 specify that the articles on unconscionable contracts and clauses should be used to deal with any unreasonable usage. This article suggests three ways an unconscionable clause should be dealt with:

• • Refuse to enforce the contract
• • Enforce the contract without the clause
• • Limit the application of the clause to avoid injustice

An unreasonable trade usage could thus be dealt with by not enforcing the contract, enforcing the contract without taking the trade usage into account, or limiting the application of the trade usage. It is difficult to see why a valid contract would not be enforced just because a trade usage is unreasonable, except if the whole contract rests upon this usage. Limiting the application of the trade usage or simply not enforcing this would in most cases be the proper way to deal with this issue.

What would the case be for codified non-state rules? Could these be applied as trade usages under the UCC? The Incoterms and the UCP are mainly considered contractual terms as discussed in chapter 4. This would also be the case for rules promulgated by trade branch associations. The UCC has its own trade terms which closely resemble the Incoterms, but which define them differently. Several Incoterms (such as DDP and CFR) do not appear in the UCC but others like FOB and CIF do. FOB is defined slightly differently under the UCC and can be used for any mode of transportation and not just transport by ship so this impacts when risk transfers between the buyer and the seller as this depends on the type of transportation.^[7] The Incoterms should be included by name if that is the intent of the parties. If FOB is included without any additional information the court could apply FOB as defined in the UCC. The court could also decide that the intention of the parties was to include the Incoterms if the contract is international. This would thus cause some uncertainty for the parties.

The UCC has its own article on letters of credits, which is constructed to be consistent with the UCP. The importance of the UCP in documentary credits is such that the drafters of the UCC wanted to ensure compatibility between the two. Nonetheless, the UCP would have no effect if they arc not included in the contract as they are considered contractual rules.

The status of international restatements of law as trade usages is not clear. The official commentary on the UCC gives room to ‘usage agreed upon by merchants in trade codes.’ Of course, merchants did not necessarily develop the international restatements, but the formulation is such that if merchants would use them then they could become trade usages. The Preamble of the UPICC states that they can be applied if parties have used a formula such as ‘usages and customs of international trade’ in their contract. It would thus be possible for the court to apply parts of the UPICC as trade usages. Whether they would do so in practice is a different question.

In a survey done in Florida on the application of the UPICC there was no indication that courts would apply these without the parties requesting this. The same survey indicated that most judges did not feel they were

Applying non-state rules 163 familiar with the UPICC.^[8] This supports the argument that they would not be applied as trade usages. Although this survey concerned the application of the UPICC as the law of the contract it is reasonable to conclude from this that the UPICC arc not established enough to be considered trade usages by American courts. A follow-up survey was conducted in 2007 among practitioners, academics, and judges from several different US states. 88% of judges declared they were unfamiliar with the UPICC. The results also indicate that the judiciary would only consider applying the UPICC if these are referenced in the contract. If the UPICC or a single Principle is considered a trade usage then there is no reason why they could not be applied under the UCC. The lack of familiarity with the UPICC and their infrequent application would suggest that this is currently not the case although this can of course change in the future.

• [1] Código Civil de España Artículo 3. 2 Art. 1194.- Les contrats obligent non seulement à ce qui y est exprimé, mais encore à toutes les suites que leur donnent l’équité, l’usage ou la loi. 3 See for instance: Cunliffe-Owen v Leather & Greenwood [1967] 1 WLR 1421. 4 Note that the UCC and the CISG are also non-state rules in origin. If parties were to choose either of these instruments directly as the governing law such a choice would likely not be honoured in states that do not accept a choice of law for non-state rules. Yet if parties choose the French law (which has ratified the CISG) as the applicable law or Californian Law (where both the UCC and the CISG are part of positive law) these would be applied. See for this also: Olugbenga Bamodu, ‘The Rome I Regulation and the Relevance of Non-State Law’ in Peter Stone and Youseph Farah (Editors), Research Handbook in EU Private International Law (2015 Edward Elgar Publishing) 221.
• [2] UCC §1-103 (a) (2) https://www.law.corncll.edU/ucc/l/l-103. 2 See also: Swift v. Tyson 41 U.S. 1 (1842): the law respecting negotiable instruments may be truly declared... to be in a great measure, not the law of a single country only, but of the commercial world. And contrast with: Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938) where the Supreme Court rejects the general law concept of Swift v Tyson. 3 §1-205 (2) A usage of trade is any practice or method of dealing having such regularity of observance in a place, vocation or trade as to justify an expectation that it will be observed with respect to the transaction in question. The existence and scope of such a usage are to be proved as facts. If it is established that such a usage is embodied in a written trade code or similar writing the interpretation of the writing is for the court. 4 JH Rayner and Company, LTD. v. Hambros Bank LTD, Court of Appeal, [1943] 1 K.B. 37; This case concerned a company in Denmark, which asked the defendant to open a line of credit. The bank refused to pay because the invoice did not match the letter of credit. The name of the product was different in each document (machine shelled groundnut kernels versus Cormandel groundnuts.) The plaintiff claimed that these are the same and that the letters C.R.S in the invoice were short for Coros or Cormandel and that how these terms are used interchangeably is a trade usage. The court held that the bank did not have to honour the invoice or the bill of lading because the terms used were different and the bank not being in this particular trade was not expected to know that trade usage. ‘A banker is not affected with knowledge of the customs... of every one of the thousands of trades for whose dealings he may issue letters of credit.’
• [3] Ibid; See also: Joseph H Levie, ‘Trade Usage and Custom under the Common Law and the Uniform Commercial Code’ (1965) 40 New York University Law Review 1101, 1112. 2 See for a pre UCC example: Dixons Irmaos & Cia v Chase National Rank 53 F. Supp. 933 (S.D.N.Y. 1943) which concerned a conflict between a usage and a written term that was sometimes ignored in favour of the usage. The defendant confirmed a letter of credit issued by a Belgian bank for a Brazilian shipper. A provision in this letter required a full set of bills of lading. The bills of lading that were presented to the bank only contained one set instead of two sets. In lieu of the second set a letter of indemnity was issued. The bank rejected this and refused to pay. The issue was whether the express term of requiring a full set of bills of lading could be contradicted by a usage of trade, which accepted an indemnity letter in lieu of the full set. The trial court ruled that the defendant was not required to accept the letter of indemnity even though the usage did exist. The court of appeal ruled that the defendant was required to follow the usage because there was not a single instance to be found when the usage was not followed, and this therefore indicated it was not a discretionary matter. For a thorough expose of this case see: Dana Backus and Henry Harfield, ‘Custom and Letters of Credit: The Dixon, Irmaos Case’ (1952) 52 Colombia Law Review 589 John Honnold, ‘Letters of Credit, Custom, Missing Documents and the Dixon Case: A Reply to Backus and Harfield’ (1953) 53 Columbia Law Review 504. 3 See for instance: Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772 (9th Cir. 1981) which stated that under the UCC trade usages can explain or supplement the express terms of a written contract. 4 Roger W Kirst, ‘Usage of Trade and Course of Dealing: Subversion of the UCC Theory’ [1977] University of Illinois Law Review 811, 866. 5 David V Snyder, ‘Private Law-making’ (2003) 64 Ohio State Journal 371,417.
• [4] Jim C Chen, ‘Code, Custom, and Contract: The Uniform Commercial Code as Law Merchant’ (1992) 27 Texas International Journal 91, 126. 2 Official commentary article §1-205 Course of Dealing and Usage ofTrade: A usage of trade under subsection (2) must have the “regularity of observance” specified. The ancient English tests for “custom” are abandoned in this connection. Therefore, it is not required that a usage of trade be “ancient or immemorial’, “universal’ or the like. Under the requirement of subsection (2) full recognition is thus available for new usages and for usages currently observed by the great majority of decent dealers, even though dissidents ready to cut corners do not agree. There is room also for proper recognition of usage agreed upon by merchants in trade codes This is also reflected in the Restatement (Second) of Contracts in the official comments of Article §222: A usage of trade need not be “ancient or immemorial,” “universal,” or the like. 3 See for instance the decision in Ebasco Services Inc. >>. Pennsylvania Power &L. Co., 402 F. Supp. 421 (E.D. Pa. 1975). 4 Jim C Chen, ‘Code, Custom, and Contract: The Uniform Commercial Code as Law Merchant’ (1992) 27 Texas International Journal 91, 118. 5 Joseph H Levie, ‘Trade Usage and Custom under the Common Law and the Uniform Commercial Code’ (1965) 40 New York University Law Review 1101, 1104. 6 Jim C Chen, ‘Code, Custom, and Contract: The Uniform Commercial Code as Law Merchant’ (1992) 27 Texas International Journal 91, 121.
• [5] Amy H Kastely, ‘Stock Equipment for the Bargain in Fact: Trade Usage, Express Terms, and Consistency under § 1-205 of the Uniform Commercial Code’ (1986) 64 North Carolina Law Review 777, 813. 2 Urbana Farmers Union Elevator Co. v Schock 351 N.W.2d 88 (1984) - established practices and usages within a particular trade can more reliably reveal the parties’ intent than the sometimes imperfect and often incomplete language of the contract. 3 Lisa Bernstein, ‘Merchant Law in a Merchant Court: Rethinking the Code’s Search for Immanent Business Norms’ (1996) 144 University of Pennsylvania Law Review 1765, 1769. 4 Kerry Lynn Mackintosh, ‘Liberty, Trade, and the Uniform Commercial Code, When Should Default Rules Be Based on Business Practices?’ (1996) 38 William & Mary Law Review 1465, 1478. 5 Lisa Bernstein, ‘Merchant Law in a Merchant Court: Rethinking the Code’s Search for Immanent Business Norms’ (1996) 144 University of Pennsylvania Law Review 1765, 1769 In this article the author is critical of this approach by the UCC and analyses how it actually countermands the flexibility of the UCC. She uses a case study of the National Grain and Feed Association (NGFA) tribunal which very rarely uses commercial practices and usages in their awards and instead relies upon their own trade rules. Bernstein notes that the arbitrators seem to be reluctant to use general trade practices and signal their dislike of these in the awards. Bernstein does note several uses of trade usages and practices: they are used as additional justification, to assess credibility of evidence, to signal whether the contract is out of sync with standard trade practices, and when they believe a standard trade practice should be incorporated in the Trade Rules. Despite this the arbitrators do not rely on trade usages as terms of the contract. Bernstein considers whether this stricter approach, which is initiated by the merchant community itself might not be more reflective of the wishes of the community than the approach of the UCC which prioritises trade usages as terms of the contract.
• [6] Ibid, 1790. 2 Ibid. 3 The policy of this Act controlling explicit unconscionable contracts and clauses ...applies to implicit clauses which rest on usage of trade and carries forward the policy underlying the ancient requirement that a custom or usage must be "reasonable". 4 § 2-302 Unconscionable Contract or Clause.
• [7] § 2-319. F O B. and F.A.S. Terms. 2 For a thorough expose on this see: Kerry Lynn Mackintosh, ‘Liberty, Trade, and the Uniform Commercial Code, When Should Default Rules Be Based on Business Practices?’ (1996) 38 William & Mary Law Review 1465 The drafters stated that: ‘to facilitate its [article 5] usefulness it is essential that US law be in harmony with international rules and practices.’ and ‘They [the rules] need to be substantively and procedurally consistent with international practices.’ (American Law Institute, UCC Revised Article 5, Final Draft). 3 Official commentary article §1-205 Course of Dealing and Usage of Trade: 4 Michael Wallace Gordon, ‘Part II Some Thoughts on the Receptiveness of Contract Rules in the CISG and the UNIDROIT Principles as Reflected in One State’s (Florida) Experience of (1) Law School Faculty, (2) Members of the Bar with an International Practice, and (3) Judges’ (1998) 46 American Journal of Comparative Law Supplement 361,369.
• [8] Ibid. 2 Peter L Fitzgerald, ‘The International Contracting Practices Survey Project: An Empirical Study of the Value and Utility of the CISG and the UNI DROIT Principles of International Commercial Contracts to Practitioners, Jurists, and Legal Academics in the United States’ (2008) 27 Journal of Law and Commerce 1. 3 Ibid, 43. 4 Ibid, 80. 5 This is confirmed by the UNILEX case law database on use of the UPICC where none of the cases from the US have applied these as trade usages.