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Review the attached Enforcing Contracts. Discuss some of the differences that may be encountered when executing procurements in the countries examined. Describe a scenario where you, as a citizen working in one country, could encounter problems executing a procurement in another country.

Doing Business 2015
Going Beyond Efficiency
Enforcing contracts
How judicial efficiency supports freedom of contract
ƒ In regulating freedom of contract,
authorities around the world have
had to strike a balance between
the desire to give contracting
parties the ability to enter into
mutually beneficial arrangements
and the need to provide adequate
safeguards against possible abuse.
ƒ Worldwide, the most common
limitations to freedom of contract
stem from local legislation, through
which the government attempts to
draw a boundary between the use
and misuse of bargaining power.
Other limitations stem from the
courts, which play a vital role in
shaping freedom of contract by
deciding whether or not to enforce
certain agreements.
ƒ In a sample of 34 economies, none
allow the parties to a contract to
exclude liability for gross negligence
or for damages resulting in personal
injury. Similarly, all of the economies
consider contracts void or voidable
if concluded in contravention of
public policy or under duress, fraud
or coercion. Only 4—the Democratic
Republic of Congo, Pakistan, the
Philippines and Sri Lanka—set no
statutory limit on interest rates.
Almost half (14) explicitly prohibit
covenants restricting the alienation
of real property.
ƒ Even where there is considerable
freedom of contract, slow resolution
of contract disputes can impose
implicit limitations. Without
reasonably expeditious dispute
resolution, the meaning of freedom
of contract can be greatly eroded.
F
reedom of contract is the ability of adults and groups—such
as corporations and other legal
entities—to freely decide whether to
enter into an enforceable agreement and
to determine the rights and obligations
of their bargain. This freedom is essential
to an efficient economy: without it, and
without enforcement of contracts, there
would be little stability in financial arrangements, and uncertainty and lack
of trust would discourage people from
participating in economic life.
This case study explores what freedom
of contract means and examines how
it is regulated in a sample of 34 economies belonging to different regions and
income groups, chosen mostly on the
basis of the quality of the data collected by the Doing Business team in
each economy.1 It also looks at judicial
efficiency in contract resolution in the
same 34 economies, using data for
the enforcing contracts indicators
as a proxy for judicial efficiency. Even
substantial freedom of contract could
become irrelevant without effective
mechanisms for resolving commercial
disputes, because firms would find
themselves operating in an environment where compliance with contractual obligations is not the norm.2 As in
previous years, the ranking on the ease
of enforcing contracts continues to
be based exclusively on the time, cost
and procedural complexity of resolving
commercial disputes before local firstinstance courts. This year’s research
on freedom of contract is a one-time
exercise that will not be replicated in
future editions of the report and has no
implications for the data or rankings
for enforcing contracts. Additionally,
in carrying out this exercise the team
does not intend to advocate in favor of
more or less freedom of contract but
instead aims to provide an overview of
local regulations.
In regulating freedom of contract,
economies worldwide have had to
draw the line between very extensive
and very limited freedom of contract
(figure 11.1). Most have drawn the line
somewhere in between. Where freedom
of contract is very narrowly regulated,
most transactions fall within the strict
schemes dictated by the law, leaving
the contracting parties with limited
negotiating power. But where it is not
narrowly regulated, the law contains
only the most common limitations
(such as for public policy reasons and
to prevent fraud and duress), allowing the parties to freely negotiate the
terms of their agreement.
Where there are few limitations to
freedom of contract, 2 capable and
consenting adults would be able to
conclude a 10-year loan contract with
an interest rate of 50% or even contract
to sell a house worth $1 million for a
penny. But they would not be able to
circumvent public policy limitations
and conclude a contract by which, for
example, one of the parties sells himself
as a slave or forces the other into an
unwanted agreement—limitations of
this sort have become widely accepted
in modern law. While most would agree
ENFORCING CONTRACTS
FIGURE 11.1 Spectrum of the possible limitations to freedom of contract
Very limited freedom
of contract
Midrange freedom
of contract
Very extensive freedom
of contract
Parties have little to no
freedom in negotiating
contract conditions
because of numerous
limitations imposed by law.
All economies in the sample
fall within this category.
Parties have considerable
freedom in negotiating
contract conditions because
the law limits freedom of
contract only for reasons
relating to public policy,
fraud and duress.
that contracts contravening public
policy should be illegitimate, some
would disagree on whether the first 2
contracts should be enforced.
HOW THE LITERATURE
DEFINES FREEDOM OF
CONTRACT
In the legal and economic literature
there is wide consensus on a definition
of freedom of contract, intended to
be the power of contracting parties
to freely determine the content of
their agreement without interference
from the government or from other
individuals.3 The concept is generally
given both a negative and a positive
meaning. Negative freedom of contract
is freedom from interference by the
government or by other individuals,
while positive freedom of contract is
the ability of parties to freely determine the content of an agreement.4
While there is broad agreement on
a general definition, every economy
limits freedom of contract in different
ways. In regulating these limitations,
the main debate has centered on the
role that should be played by the courts
and by the state in general. In the late
1800s and early 1900s legislators,
influenced by classical contract theory,
relied on the notion that only the parties
to a contract can evaluate whether it
is beneficial, leading to the idea that
whether agreements are prudent and
profitable should be determined not
by the courts but by the parties themselves.5 At the time, the private sphere
represented a realm in which individual
freedom and autonomy were protected
from state intervention. Any legislation that disturbed parties’ equality
was seen as an arbitrary interference
with liberty of contract, which no
government could legally justify. In this
context freedom of contract had few
limitations; legislators were more concerned with protecting the sanctity of
the bargain because they believed that
maximizing individual profits through
freedom of contract would promote
efficiency in commercial markets.6
During the mid-1900s, however,
governments and courts started to
acknowledge the tension between
the parties’ desire for certainty and
stability in private agreements and the
need to ensure fairness for weak and
vulnerable individuals; concepts such
as fraud, duress and undue influence
began to play a bigger role in court
decisions on limitations to freedom of
contract.7 In this context freedom of
contract was no longer seen as absolute but instead as a liberty to be enjoyed within the framework of the law,
designed to protect individuals from
threats to health, safety, morals and
welfare. The court decisions spurred
a debate over the government’s role
in imposing limitations on freedom of
contract, and a more paternalistic approach emerged. This entailed overruling individuals’ contractual preferences
for their own good, to protect them
from the damaging consequences of
their agreements.8 Several countries
started to regulate contractual relationships under the assumption that in
certain circumstances people are unable to identify their own preferences.9
Today most economies regulate limitations to freedom of contract by pairing
this paternalistic approach with a
program of social justice animated
by distributive motives, economic efficiency and overall fairness, which has
led to rules favoring some groups in the
struggle for welfare.10
U.S. labor law offers a great example
of this evolution. In the late 1800s
and early 1900s courts invalidated
laws that limited freedom of contract,
including laws with minimum wage
requirements, laws with restrictions on
maximum working hours or union participation and federal child labor laws.11
In these cases the court assumed a
near equality of bargaining power and
found it anomalous that the law would
favor one party over the other. This approach dominated in the early 1900s
and culminated in the 1905 decision
Lochner v. New York, in which the court
invalidated a New York law limiting the
daily number of hours a baker could
work. However, this Lochnerian freedom
of contract, the freedom that required
parties to live with their duly executed
contracts however overreaching or
disadvantageous to the weaker party,
succumbed to the state’s interests.12
During the late 1930s legislation and
case law relying on the notion that
countries should retain the right to
protect individuals from entering into
a contract against their health, safety
or welfare started to emerge. Laws
91
92
DOING BUSINESS 2015
regulating child labor, maximum hours,
health and safety, sexual and moral
harassment, and nondiscrimination in
recruitment and hiring were more and
more often enforced by the courts.
When distributive motives started to
play a bigger role in labor laws, so did
measures regulating minimum wage
and retirement security.
Today, despite the differences in approaches to setting the boundary
between the use and misuse of bargaining power, some limitations—such as
those relating to voluntariness, freedom
from coercion, and natural and legal
capacity—are universally accepted.
Worldwide, there are laws intended to
prevent people from using force, secrecy, duress or fraud to compel others to
enter into contracts that they would not
agree to under different circumstances.
Similarly, there are contract rules in effect to void agreements that appear to
have been freely entered into but were
not in actuality, because of the incapacity of one of the contracting parties.
These limitations have become an indispensable part of any comprehensive
definition of freedom of contract, now
intended to be both freedom of the
parties from interference by the state
and freedom from imposition by one
another.13 Among the 34 economies in
the sample, all have legislation deeming
contracts unenforceable for reasons of
public policy, duress, coercion, fraud,
incapacity or undue influence.
WHY FREEDOM OF
CONTRACT MATTERS
FOR FIRMS
Freedom of contract is a critical instrument for economic progress and
efficiency.14 Its unrestricted exercise by
parties with equal bargaining power,
comparable skills and good knowledge
of relevant market conditions maximizes individual welfare and promotes the
most efficient allocation of resources in
the marketplace.15 In addition, freedom
of contract contributes to the establishment of a functional economy in
which predictability is prized.16
Worldwide, the most common limitations to freedom of contract stem from
the government, through its attempt
to draw a boundary between the
use and misuse of bargaining power.
Others stem from the courts, which
play a vital role in shaping freedom
of contract when deciding whether to
enforce certain agreements. Indeed,
people have true freedom of contract
only if the courts enforce their agreements.17 Courts have a dual role in this
context—both to protect individuals
from unreasonable government regulations and to clarify and apply rightful
limitations. Additionally, the judiciary
must also make sure that freedom of
contract remains meaningful by ensuring timely enforcement of contracts.
WHAT METHODOLOGY WAS
USED
To investigate limitations to freedom of
contract in the 34 sampled economies,
the Doing Business team added several
new questions to this year’s questionnaire on enforcing contracts. These
questions focus on 10 possible limitations to freedom of contract, relating
to issues ranging from land transfers
to consideration, choice of law and
limited liability clauses (box 11.1). To observe meaningful differences between
economies, the team focused on issues
that have been extensively debated
throughout the relevant literature and
case law, although a consensus has
BOX 11.1 Possible limitations to freedom of contract explored through this
year’s research
O Statutory limits on interest rates
O Limitations on consideration and on determination of contract price in
future agreements
O Limitations on clauses restricting land transfers
O Limitations on “choice of law” clauses in commercial contracts (clauses
specifying that any dispute arising under the contract will be determined
in accordance with the law of a particular jurisdiction)
O Limitations relating to asymmetry of power and to unconscionability (a
doctrine in contract law referring to terms that are so one-sided in favor
of a party with superior bargaining power that they are contrary to good
conscience)
O Limitations on disclaimers on implied warranties (guarantees that the
item sold is merchantable and fit for the purpose intended)
O Limitations on clauses allowing termination at will (clauses usually included in employment agreements that permit an employee or employer
to terminate the employment relationship at any time for any or no reason
at all)
O Limitations on clauses limiting liability, such as for negligence (conduct
that departs from what would be expected of a reasonably prudent person
acting under similar circumstances)
O Restrictions on terms included in standard-form contracts (contracts between 2 parties in which the terms and conditions are set by one of the
parties and the other party has little or no ability to negotiate more favorable terms)
O Limitations for reasons relating to public policy, capacity, duress, coercion,
fraud and undue influence
ENFORCING CONTRACTS
been reached on most of them. The
34 economies were chosen from the
189 covered by Doing Business in a way
that ensures a representative sample
across regions and income groups.
One area explored through this research
deals with the limitations imposed
by national laws on consideration,
traditionally defined as anything of
value promised to the other party when
concluding a contract. Consideration
often takes the form of money, though
it does not have to. In the sale of a
house, for example, the selling party’s
consideration could be the purchase
price or a promise to pay this price,
while the buyer’s consideration could
be the house. The team investigated
whether local courts can exercise any
scrutiny on the adequacy of consideration and whether the determination
of consideration can be left to a future
agreement between the parties. If
freedom of contract is not restricted,
courts should exercise no scrutiny on
consideration as long as the parties
willingly and knowingly accepted the
terms of the contract. But if freedom of
contract is restricted, courts may rule
on the adequacy of consideration to
ensure the fairness of all transactions
carried out in the marketplace.
The inclusion of choice-of-law clauses
in international contracts was also examined. These clauses specify that any
dispute arising under the contract will
be determined under the law of a particular jurisdiction. Economies limiting
freedom of contract in this area usually
do not allow such clauses or allow them
only if the parties have a relationship
with the chosen jurisdiction. Those
without strict limitations on freedom of
contract do not forbid such provisions.
Other areas of research included in this
year’s questionnaire are somewhat
more controversial from a social, economic and philosophical perspective.
Two research questions in particular
provide an interesting example of this
controversy: whether an economy
has any regulations setting a cap on
interest rates and what rules govern
asymmetry of power. These questions
go to the heart of whether usury laws
and laws governing an imbalance in
bargaining power should legitimately
impose limits on freedom of contract.
Both sides of the debate have been
defended at length. Those arguing in
favor of these laws conclude that without them, free markets would produce
perverse incentives to take excessive
credit risks, which drive up the cost of
the welfare system as a whole.18 Those
arguing against them conclude that
courts should enforce all voluntary
contracts that do not produce negative consequences for others—while
redistribution of wealth should occur through the welfare system, not
through laws and regulations.19
On the question of asymmetry of
negotiating power, those who defend
freedom of contract argue that if
contracts signed between parties with
unequal bargaining power were treated
as invalid because of this asymmetry,
those with more power would refuse
to sign contracts with people with less
power, leading to the exclusion of these
people from the market.20 To capture
the differences in the legal treatment
of asymmetry of power in contracts,
the team collected data on whether local laws contain restrictions on terms
that can be used in standard-form
contracts or on provisions allowing
termination at will. In both cases, as
in all other cases covered in this study,
it is assumed that both parties have
full legal capacity and entered into the
contract freely.
After analyzing the laws addressing
these issues in the sampled economies, the team counted the number of
limitations to freedom of contract in
each economy. The higher the number
of limitations, the more limited the
freedom of contract. The maximum
number of limitations in the study is
10. Any limitation, even in the form of
an exception to a general principle, is
counted; no relevance is given to the intensity of the limitation. For limitations
on contract provisions restricting land
transfers, for example, 1 point is given
even if the limitations are not imposed
on all transactions but apply only to
those involving foreigners.
In carrying out this exercise the team
does not intend to advocate in favor of
more or less freedom of contract but
instead aims to provide an overview
of local regulations. Furthermore, in
counting the number of limitations
the team does not intend to suggest
that a lower number—connected with
greater freedom of contract in laws
and regulations—is more desirable. The
sole purpose in providing the number
of limitations is to understand how the
sampled economies regulate freedom
of contract, without giving any judgment on the quality of the regulations
or on their desirability.
WHAT THE RESULTS SHOW
Among the 34 economies covered,
Tunisia has the highest number of limitations to freedom of contract, with 8
of the 10 limitations measured. At the
opposite end of the spectrum is the
Democratic Republic of Congo, with
only 3 of the 10 limitations (figure 11.2).
The results not only show that all 34
economies have struck a balance between the extremes of very limited and
very extensive freedom of contract;
they also reflect some consensus on
the limitations that should be imposed.
For example, none of the economies
allow the parties to a contract to
exclude liability for gross negligence
or for damages resulting in personal
injury. Similarly, none of them allow
contracts concluded in contravention of public policy or under duress,
fraud or coercion. And only 4 of the
economies—the Democratic Republic
93
DOING BUSINESS 2015
FIGURE 11.2 The Democratic Republic of Congo has the fewest limitations to freedom of contract
Number of limitations to freedom of contract
10
9
8
7
6
5
4
3
2
Tunisia
Togo
Uruguay
Taiwan, China
Brazil
Greece
Turkey
Poland
Romania
Mozambique
Malta
India
Macedonia, FYR
France
Germany
Czech Republic
Croatia
Colombia
Bulgaria
Cambodia
South Africa
United Arab Emirates
Italy
Lebanon
China
El Salvador
Bhutan
Barbados
Sri Lanka
Singapore
Philippines
Nigeria
0

Pakistan
1
Congo, Dem. Rep.
94
Source: Doing Business database.
of Congo, Pakistan, the Philippines and
Sri Lanka—set no statutory limit on
interest rates.
But there is less agreement on other
limitations to freedom of contract. For
example, there is great variation among
the economies on whether the law prohibits covenants restricting alienation
of real property. A clause of this type
would, for example, forbid the buyer
from selling the property for a certain
number of years after purchasing it. Of
the 34 economies, 14 explicitly prohibit
this kind of covenant, though 9 of these
14 economies allow restrictions on alienation of real property when foreigners
are involved in the transaction. The rest
of the economies allow these contract
provisions.
Among the 7 regions covered, Europe
and Central Asia is the only one in which
no variation was found in the number
and type of limitations imposed on
freedom of contract. All sampled economies in the region have the following 6
limitations:
ƒ A cap is imposed by law on interest
rates.
ƒ Courts can exercise scrutiny on the
adequacy of consideration.
ƒ The determination of a contract
price cannot be left to a future
agreement, unless the contract
already establishes how the price will
be determined.
ƒ Limitations are imposed by law
on clauses that can be included in
standard-form contracts.
ƒ Liability for gross negligence cannot
be excluded through mutual agreement of the parties.
ƒ A contract cannot be agreed upon
if its terms are against public policy
or if one of the parties does not have
full legal capacity.
The other 6 regions show more variation
in the number and type of limitations.
Sub-Saharan Africa is a good example.
While the Democratic Republic of Congo
has the smallest number of limitations
in the overall sample, with 3, Togo has
one of the largest numbers, with 7. Togo
is the only Sub-Saharan African economy in the sample that allows the courts
to deny enforcement of a contract on
the basis of inadequate consideration.
In addition, only 2 of the 5 Sub-Saharan
African economies in the sample do not
limit the terms that can be included in
a standard-form contract, while all 5
allow termination at will, choice-of-law
clauses and disclaimers on implied
warranties as long as the seller was not
acting in bad faith.
Across all regions, only 3 economies
forbid choice-of-law clauses in international contracts. All 3—Brazil,
Colombia and Uruguay—are in Latin
America and the Caribbean.
Even where there is considerable
freedom of contract, slow resolution
of contract disputes can impose
implicit limitations. Without reasonably expeditious dispute resolution,
the meaning of freedom of contract
is eroded; parties might be able to
conclude most contracts on their own
terms, but long contract resolution
times would ultimately frustrate that
ability.
In Singapore parties not only have
broad negotiating power; they also
have the certainty that their contracts will be enforced promptly. The
country imposes few limitations on
freedom of contract, and resolving
ENFORCING CONTRACTS
FIGURE 11.3 Singapore is among the economies with both the fewest limitations to
freedom of contract and the fastest contract resolution
Time to enforce a contract
(days)
Greece
1,600
Sri Lanka
1,400
1,200
Pakistan
1,000
800
Congo, Dem. Rep.
Tunisia
600
400
Singapore
200
0
2
3
4
5
6
7
8
9
Number of limitations to freedom of contract
influencing the decisions of economic
actors. By promoting investment, good
judicial institutions can also contribute
to economic growth and development.
Indeed, an effective judiciary, by providing a structured, timely and orderly
framework for resolving disputes, fosters economic stability and growth.
Moreover, efficient contract enforcement is essential to allow true freedom
of contract. Even where the law allows
extensive freedom of contract, the benefits of this can be greatly undermined
if not matched by efficient contract enforcement. Without that, the predictability of the legal framework—which is
highly valued by firms operating in the
market—would be compromised.22
Source: Doing Business database.
NOTES
a standardized commercial dispute
through the courts—from the filing
of the case to the enforcement of the
contract—takes 150 days as measured
by Doing Business (figure 11.3), a global
best practice. In Sri Lanka there are
equally few limitations to freedom of
contract, but resolving the standardized dispute through the courts takes
1,318 days—almost 4 years. Parties
might be able to include a wide array
of covenants in their agreements, but
long enforcement times can nullify
the utility of those covenants. A slow
contract resolution process frustrates
freedom of contract.
The Democratic Republic of Congo is
another economy where long enforcement times frustrate freedom of
contract. It limits freedom of contract
only in the areas of future determination of contract price, exclusion of liability for gross negligence, and public
policy and legal capacity. But resolving the standardized dispute takes
610 days—almost 2 years. Pakistan
provides a similar example: there are
only 4 limitations to freedom of contract, but resolving the standardized
dispute takes 976 days in Karachi.
Freedom of contract and efficient
contract enforcement are often mutually dependent because one can lose
meaning without the other, as shown
in the examples above. Among the 34
economies in the sample, however,
there are cases where neither is prized.
Greece is a clear example. Not only does
Greece have one of the highest numbers
of limitations (7), it also has among the
longest resolution times in the sample.
Resolving the standardized dispute in
Athens takes 1,580 days—more than 4
years. Similarly, in Tunisia, the economy
with the highest number of limitations
in the sample (8), enforcing a contract
takes 565 days.
CONCLUSION
Freedom of contract and efficient contract enforcement matter to businesses. The exercise of freedom of contract
by parties with similar negotiating
power and good knowledge of market
conditions promotes efficiency in the
allocation of resources, maximizing individual welfare and spurring efficiency
in the marketplace.21 Efficient contract
enforcement promotes investment by
This case study was written by Erica Bosio and
Tanya Maria Santillan.
1.
The 34 economies in the sample are
Barbados; Bhutan; Brazil; Bulgaria;
Cambodia; China; Colombia; the Democratic
Republic of Congo; Croatia; the Czech
Republic; El Salvador; France; Germany;
Greece; India; Italy; Lebanon; the former
Yugoslav Republic of Macedonia; Malta;
Mozambique; Nigeria; Pakistan; the
Philippines; Poland; Romania; Singapore;
South Africa; Sri Lanka; Taiwan, China;
Togo; Tunisia; Turkey; the United Arab
Emirates; and Uruguay.
2. Ramello and Voigt 2012.
3. Braucher 1969.
4. Berlin 1969.
5. Eisenberg 1995; Edwards 2009; Marella
2006.
6. Scott 2002.
7. Edwards 2009; DiMatteo and Rich 2006.
8. Kronman 1983.
9 Shapiro 1988; Marella 2006.
10. Kennedy 1982, 2006; Kronman 1983.
11. Adkins v. Children’s Hospital; Adair v. United
States; Coppage v. Kansas; Hammer v.
Dagenhart; Carter v. Carter Coal Company;
Weber 2013.
12. West Coast Hotel Co. v. Parrish; Weber 2013.
13. Kennedy 1982.
14. Basu 2006; Edwards 2009.
15. Edwards 2009.
16. Weber 2013.
17. Kennedy 1982.
18. Posner 1995.
19. Pettit 1999; Posner 1995.
20. Basu 2006.
21. Edwards 2009.
22. Brunetti, Kisunko and Weder 1997, 1998.
95

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