Sales agreements explained

Sales agreements are the cornerstone of almost every business. A sales contract requires tailoring for the particular product or goods, the locations of the seller and purchaser, how delivery must take pace, (if applicable) any after-sales servicing, and probably some requirements under the applicable law. This paragraph discusses the general framework of sales agreements by reference to ITC’s Model Contract for international sales of goods. For own use, the parties should adapt the sales contract developed by the ITC.

In this chapter, contracts for one-off sales transactions are discussed (one single sales transaction); for recurring sales transactions the chapter on long-term supply agreements (or manufacturing or distributorships) is more appropriate.

Scope of sales agreements #

While there is largely freedom of contract, a well-structured sales agreement contain the substantive rules for an international sales or purchase transaction, i.e. the main rights and obligations of the parties, the remedies for breach of contract by the buyer; the remedies for breach of contract by the seller; and general rules that apply equally to both parties. Both sales agreements also contain the boilerplate clauses common in international commercial contracts.

Four parts of sales contracts
Therefore, the ITC Model sales agreements can be divided into four parts:

  1. Key obligations related to the goods: delivery term, price, payment conditions, and documents to be provided;
  2. Remedies of the seller in case of non-payment at the agreed time, the remedies of the buyer in case of non-delivery of goods at the agreed time, lack of conformity of goods, transfer of property and defects;
  3. Avoidance or termination of contract and damages: termination grounds, avoidance procedure, effects of avoidance, restitution, damages and mitigation of harm; and
  4. Standard (boilerplate) provisions – for more about these clauses, see the various subchapters here on Hardship (change of circumstances), Force majeure, the ‘miscellaneous’ or boilerplate clauses, choosing the applicable law, and on the various aspects of dispute resolution.

CISG-based
The ITC Model sales agreements are greatly influenced by the United Nations Convention on Contracts for the International Sale of Goods (CISG, the “Vienna Convention” of 1980), widely accepted by lawyers of different traditions and backgrounds (we also explain why you should probably not exclude application of the CISG). The Model Contract articulates practical requirements arising from commercial practice within the general rules of the Vienna Convention – for the Vienna Convention see elsewhere in this book.

Sale of perishable goods
The sales agreement may not be suitable for the sale of perishable goods. Apart from the fact that perishable goods are often sold by reference to branch-established trading terms and conditions, such goods require a different (and more concise) conformity criterion, short periods of time for notifying non-compliance, and a specialised quality-inspection procedure.

Short vs. standard version
The ITC Model Contract for the international commercial sale of goods is presented in two versions – the ‘standard’ version and a ‘short’ version. The standard version contains definitions of relevant notions (e.g. lack of conformity), special comments (e.g. on the notice of non-conformity), explanations and warnings to the parties (e.g. on the limitation of the seller’s liability or on the validity of the agreed interest clause). The short version is more practice-oriented, covering the main rights and obligations of the parties with no special explanations. In addition, the short version contains only selected boilerplate clauses, whereas the standard version provides all the relevant boilerplate clauses included in the other ITC Model Contracts.

Key clauses in sales agreements #

Delivery term (INCOTERMS)
Many cross-border sales transactions require transportation. Questions then arise as to which party should do what, who should bear the risk of the various means of transportation, who should arrange for insurance and for customs clearance. This introduces a wide range of possible combinations of responsibilities, but in practice the parties will seek a combination in which those risks and responsibilities match. Commonly used combinations are reflected in the ‘Incoterms’.

Payment conditions
In cross-border sales where the parties do not hand over the goods, payment also entails an allocation of risk. Banks play an important trade-facilitating role in such cases. The parties may opt for various payment mechanisms, each of which presents a different allocation of risks for non-compliance. The allocation of risk may also engage the bank or banks involved, which affects the cost of the payment mechanism. Common payment mechanisms, provided for in the ITC Model Contract, are:

  • Payment in advance: the buyer pays (part of) the purchase price into the seller’s bank account;
  • Documentary collection, involving documents against payment (D/P) or documents against acceptance (D/A): a simple mechanism, suitable if the buyer considers the seller to be a trustworthy party, and if the seller would probably be able to sell the delivered goods to third parties in case of fundamental breach;
  • Irrevocable documentary credit, pursuant to a letter of credit (L/C), under the UCP600: this mechanism provides optimum security for both parties;
  • Payment supported by a bank guarantee; or
  • Another specified payment mechanism (or combination of mechanisms).

More about this in our dedicated subchapter on payment mechanisms.

Documents required by international sales agreements
When a party arranges for transportation, insurance or customs clearance, it receives documentary evidence: those documents should be identified, and the desired contents may also be specified, in the sales contract. Article 5 of the ITC model sales agreement serves as a stepping stone for such specifications.

Even when a seller draws up a document alone they must not omit information required to be reflected in that document. The information may be relevant for subsequent parties in the transportation and delivery chain.  For example, the invoice may need to reflect the VAT amount (otherwise the buyer may not be able to reclaim VAT or apply for exemption), and levies charged in connection with exportation may be recoverable under international treaties.

Furthermore, a bank engaged in an L/C payment will not verify if the goods are indeed the ones agreed in the contract, but it will investigate whether the certificate of origin, a certificate of inspection or a date of shipment are reflected the way the parties agreed in the contract. Types of commonly agreed documents are:

  • commercial documents (e.g. invoice, packing list)
  • shipping or transport documents (e.g. bill of lading (ocean or multi-modal or charter party), airway bill, lorry or truck receipt, railway receipt, forwarder cargo receipt);
  • official documents (e.g. customs documents, import permits, export permits, license, embassy legalization, certificate of origin, certificate of inspection, phytosanitary certificate);
  • financial documents (e.g. bill of exchange, co-accepted draft);
  • insurance documents (e.g. insurance policy or certificate).

Under a UCP600-governed L/C-payment transaction, the standard of examination to be applied by a bank is elaborated in UCP600 articles 18 to 28. These Articles provide, for example, that:

  • The start date of an insurance policy must be no later than the date of shipment, unless it is clear that the insurance coverage is retroactive (article 28(e)).
  • A bill of lading may be given any title (article 20(a)) but must indicate, inter alia, the name of the vessel (article 20(a)(ii)) and contain terms and conditions of carriage, even though the bank will not examine such terms and conditions (article 20(a)(v)).
  • An invoice must be expressed in the currency of the L/C (article 18(a)(iii)).

Breach of a sales contract (and remedies) #

Late payment (interest)
Obviously, a seller would like to ensure that the buyer will pay its invoice in due time. Although the applicable law may provide for an entitlement to interest, it is psychologically stronger to be able to refer to precise contract terms stating that interest will accrue on late payments. Moreover, the statutory interest rate may be too low to justify collection proceedings in court.

In the ITC Model, Article 6.2 provides for the seller’s right to demand interest on late payments. However, it is important to note that an interest rate per day or per month will also be ‘compounded’ daily or monthly (quickly resulting in interest over interest and hence in a rapidly increasing percentage per year). Because this effect may be very excessive over a relatively short period of time, many courts are inclined to adjust (or even set aside) an exaggeratedly high interest rate. If the applicable law nullifies excessive interest rates, a court will likely also disregard a stipulation such as “unless the applicable law prohibits such interest rate, in which case the highest permitted rate will apply” (for its opportunistically attempting to take a benefit over the inadvertent buyer).

The specified interest rate should at least cover the interest that the seller would pay if it had to borrow the same amount from a bank.

Delayed delivery (penalty or liquidated damages clause)
The buyer may also wish to agree on a firm incentive for the seller to perform in a timely manner. Article 7.2 of the ITC Model Contract provides an option to include such an incentive in the form of a penalty or liquidated damages clause. To be valid and fully enforceable, the agreed amount of liquidated damages should roughly correspond to the damages likely to fall upon the buyer. As liquidated damages are a type of estimated damages, the actual (exposure to) damages must be sufficiently uncertain at the time of contracting to warrant this option.

In common law contracts, the term “penalty” should be avoided. The enforcement of this term would require an equitable order of specific performance. Courts deciding in equity, however, will seek to achieve a fair result and therefore not enforce a term that leads a priori to an unjust enrichment of the enforcing party. The proper term under common law is “liquidated damages” and justified by clarifying that it is an incentive to perform duly and timely (and that the amount of the liquidated damages are an “accurate estimate of the damages” in case of undue or late performance).

Because a penalty or liquidated damages clause contains only an estimate, the actual damages suffered by the buyer may be much higher. Both under common law and in other jurisdictions, however, including a specified penalty excludes the right to claim actual damages (and in some jurisdictions even the right to invoke other remedies). It is therefore important to add a phrase such as “without prejudice to the Buyer’s right to claim damages” or wording of similar import.

Lack of conformity
The ITC Model Contract adopts the CISG concept of lack of conformity or non-conformity. This concept is wider than the concept of material defects (traditionally adopted in civil law countries) and includes differences in quality, as well as differences in quantity, delivery of goods of different kinds, and defects in packing. Nevertheless, specific cases of non-conformity defined under the Vienna Convention largely correspond to how material defects are defined in civil law countries. Such cases include unsuitability of the goods for their ordinary purpose or for a particular purpose, as well as non-conformity with a sample or model.

The liability of the seller for non-conformity under the Vienna Convention is dealt with almost identically under most national rules dealing with liability of the seller for material defects. Furthermore, in the Vienna Convention, “non-delivery” and “lack of conformity” are strictly separate forms of breach of contract. The same system is adopted in the ITC Model Contract, specifying:

  1. special rules on the remedies of the buyer in case of non-delivery at the agreed time;
  2. special rules on the remedies of the buyer in case of non-conformity of goods; and
  3. general rules on avoidance due to non-performance of contractual obligations.

Expertise procedure
To mitigate the risk of lasting controversies about an alleged non-conformity in the quality of delivered goods, the parties could provide for an expertise procedure. This procedure prevents such controversies from becoming ‘endless’, and ensures that one party will not engage a third-party expert whose expertise or independence may be questionable. Article 9 of the ITC model sales agreement provides for this kind of expert procedure.

Warranty disclaimer
Instead of the Model sales agreement’s Article 8 (lack of conformity), a seller may propose a limited warranty and complete disclaimer of any implied or express properties of the goods sold under the contract. An example of such a disclaimer is:

The Goods are provided “AS IS” and the Seller makes no other warranties regarding the Goods. The Seller expressly disclaims all representations and warranties, express and implied, including any warranties of merchantability, fitness for a particular purpose and non-infringement of any third-party rights.

If this choice is made, the provision should in particular replace Sections 8.1 to 8.3. Obviously, including this kind of disclaimer reduces to a minimum the scope and relevance of (negotiations on) Sections 8.4 to 8.5.

Transfer of property
The ownership of goods transfers in accordance with the law applicable to the transfer of movable goods. In most jurisdictions, in the absence of express stipulations otherwise (e.g. a retention of title clause), ownership transfers when the seller ‘delivers’ the goods to the buyer because the risk transfer to the buyer. In cross-border sales transactions, this would be at the moment (and the place) determined by the agreed Incoterm: under Ex Works, for example, ownership transfers at the door of the premises of the seller; but under FOB, the seller only delivers once the goods have actually been loaded on board the vessel selected by the buyer.

Retention of title clause
A seller with some negotiating power will ensure that ownership of the delivered goods does not transfer to the buyer before the purchase price has been paid (see optional Article 10.1 of the ITC model sales agreement). A transfer of ownership obviously reduces the seller’s right to reverse the sales transaction in case the buyer goes bankrupt or enters into suspension-of-payment proceedings.

Ownership might also transfer by mixing the goods delivered with similar, other goods (e.g. if the sale concerns generic products such as bricks, steel bars, pencils, raw materials, or components). Therefore, it is important to complement a retention-of-title clause with an obligation to keep the goods under contract separate from the buyer’s other goods.

Various clauses in the sales agreements explained #

Avoidance (termination) in the ITC Model sales agreements
The ITC model sales agreements use the term “avoidance” of contract, also taken from the Vienna Convention (CISG), to mean contract termination. It adopts the Vienna Convention concept of fundamental breach of contract, but with significant modifications. First, the ITC sales agreements define cases that constitute a breach of contract (where a party fails to perform any of its obligations under the contract, including defective, partial or late performance). Next, and on that basis, the ITC sales agreements establish rules for two different situations:

  • Fundamental breach. A breach of contract amounts to a ‘fundamental breach’ in cases where strict compliance of the obligation that has not been performed is of the essence under the contract, or where non-performance substantially deprives the aggrieved party of what it was reasonably entitled to expect. The ITC Model Contract allows the parties to specify cases that are to be considered as a fundamental breach (e.g. late payment, late delivery, non-conformity). In case of fundamental breach, the ITC Model Contract allows the aggrieved party to declare the contract void, without fixing an additional period of time to perform what is specified in the contract.
  • Other (material) breaches of contract. In all other situations, where a breach of contract does not amount to a fundamental breach, the aggrieved party is obliged to fix an additional period of time for performance. Only when the other party fails to perform the obligation within that period, may the aggrieved party declare the contract void. The ITC Model Contract adopts the following CISG rule: a declaration of avoidance is effective only if made by giving notice to the other party.

Material breach” of a sales contract as ground for termination
Many contracts provide for a termination right in case of a (persistent) material breach. In this context, courts will give the term “material” a meaning corresponding to “significant from the perspective of the aggrieved party”. This implies an assessment as to whether the breach in question has a serious adverse effect on the party that has been deprived of performance or compliance with the contract. The assessment does not require such a breach to be fundamental, but the effect may well be the same.

Given that providing for an assessment leaves uncertainty about what kind of breach will be deemed “material”, it is worth considering whether to expressly identify the specific breaches that will give rise to a right to terminate (as opposed to generic wording that each delay in payment or delivery, or every non-compliance with specifications, is material).

Restitution
Once a sales contract is avoided (terminated), the parties’ performances (if any) must be reversed. Obviously, given that the transaction crossed borders, there may be practical implications and additional costs to be incurred by either party. In the ITC model sales agreement, Article 13 provides for restitution that can be adjusted to meet the particularities of the case.

‘Minor’ details not to forget in a sales agreement #

Damages
Article 14 of the ITC model sales agreement contains an elaborate arrangement for claiming damages in case of non-performance (which includes non-conformity of delivered goods). First, paragraph 14.1 states the general principle that, except for cases of force majeure, any non-performance entitles the aggrieved party to damages.

Second, the damages eligible for compensation are limited to those reasonably foreseeable at the time of contracting (“which the breaching party ought to have foreseen”). In case of avoidance, such damages will be calculated by reference to the replacement costs of the contract goods, increased by any additional expenses incurred (paragraphs 14.2 to 14.5). This provision substantially reflects articles 74 to 76 of the Vienna Convention.

Limitation of liability
The ITC model sales agreement does limit the extent of liability by specifying the type of damages. The effect is that the buyer faces a discussion as to what “ought to have been foreseen” by the seller. This eliminates opportunistic claims, and the uncertainty introduces a certain “nuisance value” (as a probable complex discussion of foreseeability may discourage the buyer from submitting a claim).

In practice, the parties may seek more certainty: the seller will exclude its liability, and the parties will negotiate a limitation of liability that matches the circumstances. For a more detailed discussion of and the dynamics of such negotiations, see the subchapter addressing limitations-of-liability clauses.

Mitigation of harm
In the ITC model sales agreement, Article 15 expresses a general principle of law: even an aggrieved party must take such measures as may reasonably be expected in the circumstances to prevent that any damages or losses unnecessarily increase (also in CISG article 77, and the same principle is expressed in Unidroit Principles article 7.4.8.)

The scope and extent of such measures must be proportionate to the harm suffered if the measures are not taken. Potentially, this may even require the aggrieved party to incur considerable costs. Those expenses are recoverable, however, as part of the damages.

Applicable law
Article 23 of the ITC Model Contract is specific to the international commercial sale of goods. It stipulates that questions not regulated by the contract itself are governed by the Vienna Convention; and questions not covered by the Vienna Convention are governed by the Unidroit Principles; and to the extent that such questions are not covered by the Unidroit Principles, they are governed by reference to the national law chosen by the parties. The parties may agree on rules that modify, replace or supplement those of the Vienna Convention or the chosen applicable law.

Regulatory framework
The main sources of uniform contract law that were used in drafting the ITC Model Contract are the:

  • Vienna Convention (CISG);
  • Uniform Law on the International Sale of Goods (ULIS);
  • Unidroit Principles (you can read and download the Unidroit Principles for International Commercial Contracts here (available in numerous, some versions with black-letter text only (without the explanatory notes or illustrations));
  • Principles of European Contract Law (PECL); currently extended as the European Draft Common Frame of Reference (DCFR).
  • ITC model contract for the international commercial sale of perishable goods;
  • ICC Model International Sale Contract – Manufactured Goods Intended for Resale.

 

Note: this chapter is also included in the e-book Cross-border contracting – How to draft and negotiate international commercial contracts, written by Weagree-founder Willem Wiggers and published by the ITC (the joint agency of the U.N. and WTO) and downloadable free of charge.

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