Authority & Execution: Contractual Gap-Filling in International Commercial Arbitration

I. Introduction

The power of arbitrators to fill gaps in international business contracts, and the execution of that power, are important and contentious topics. But they rarely get the attention they deserve. Almost a quarter century has passed since Klaus Peter Berger published his pathbreaking study of the power of arbitrators to fill gaps in international business contracts. Nearly a decade has passed since this author examined the United States Supreme Court’s jurisprudence on the power of arbitrators to fill gaps in arbitration agreements. Subsequent contributions on the power of arbitrators to fill gaps have been rare. Virtually no scholarship addresses the challenges that international arbitrators face when carrying that power into effect, either in general or as applied to particular types of transactions.

The reasons for the scarcity of commentary on gap-filling in international commercial arbitration are not clear. Perhaps it is due to a lack of underlying data. Awards in international commercial arbitration typically are not public. This makes it difficult to identify and analyze emerging trends in practice even on important topics.

A recent conference hosted by the Brazilian Arbitration Committee (CBAr) provided the opportunity to revisit arbitral gap-filling in the context of infrastructure concession contracts in Latin America. That exercise produced new insights on the power of arbitrators to fill gaps in international business contracts. It also provided a rare opportunity to consider the challenges arbitrators face when executing that power, particularly in the context of long-term concession agreements likely to include terms deliberately left open by the parties. This article presents the conclusions of that exercise.

Elaborating on the points just made, Part II defines the universe of genuine gaps in international business contracts, explains why they are not prevalent in many types of transactions, identifies the situations in which gaps arise, and predicts that certain kinds of gaps will tend to correlate with certain kinds of transactions. Part III discusses the power of arbitrators to fill gaps in international business contracts. In doing so, it reviews the largely historical debate on the topic, but also adds fresh insights on a gray area where the parties have deliberately left open material terms and reserved for themselves the right to fill those terms by subsequent agreement. Part IV addresses the challenges arbitrators face when carrying that power into execution. Among other things, it examines different approaches to gap-filling prescribed by various rules of contract law. It also describes the challenges arbitrators encounter in applying those strategies. Part V describes the nature and importance of infrastructure concessions in Latin America and explains how arbitrators might resolve gap-filling problems likely to arise in that context. Part VI concludes.

II. Gaps

Before discussing whether arbitrators have the power to fill gaps in international business contracts and the challenges associated with gap-filling, one must define the universe of genuine gaps in contracts. One must also understand why genuine gaps are rare in many types of transactions. However, there are situations where gaps tend to arise, and it is possible to suggest that certain types of gaps will correlate with certain types of transactions.

A. Defining Genuine Gaps

For purposes of this article, gaps involve situations where contracts completely fail to address an important or material term. On a broad view, gaps could include any issue not addressed by the express terms of oral or written contracts or by the latticework of implied-in-law terms. That latticework includes a wide range of terms implied in law in all contracts (such as the implied covenant of good faith), terms that are implied by law in certain classes of contracts (such as the implied undertaking of best efforts in exclusive-dealing contracts), or implied in law with respect to particular issues (such as the understanding that an open price term should mean a reasonable price or that an open delivery term should mean delivery within a reasonable time).

In other words, broadly, gaps might include all issues not already resolved by the express terms of agreements, legislation, or judicial decisions. But many of these so-called “gaps” can be filled by implied-in-fact terms derived from the intentions of the parties as inferred from the overall logic of the agreement, a constellation of express provisions, the prior or subsequent conduct of the parties, or the generalized conduct of similarly situated parties. For example, an agreement to sell complex machinery might necessarily imply an undertaking to provide basic documentation on the use of that equipment. Likewise, a constellation of express terms on exclusive dealing, percentage-based compensation, and the provision of monthly accountings might support the recognition of an implied-in-fact obligation to use reasonable efforts in generating sales. Similarly, a consistent pattern of behavior between the parties when performing the agreement or similar agreements might be useful not merely for interpreting the agreement, but also for supplementing the agreement. Finally, a consistent pattern of behavior among participants in the same industry could help to establish the likely intentions of the parties not only with respect to the interpretation of express terms, but also with respect to their supplementation.

Although reasonable people could disagree, the author does not view any of the situations just described as involving gaps in the parties’ agreement. To be sure, the words used by the parties may not expressly address every contingency. But the words, their context, or the actions of relevant stakeholders can still provide the information needed to infer reliably the actual or likely intent of the parties. Viewed holistically, the parties have not left gaps in any of the situations just described. They have simply recorded their agreement in a broader range of media and, thus, required consideration of additional evidence regarding the substance of the terms.

Viewed from this perspective, in order for a genuine gap to exist in a contract, it is not enough that the express terms of the contract, legislation, and judicial decisions do not address a material issue. Strictly speaking, genuine gaps in contracts occur only when the silence of express terms and legal doctrine cannot be filled though any of implied-in-fact terms described above. Given the foresight and sophistication of the parties that draft international business contracts, the development of modern legal systems with many implied-in-law terms, and the maturity of industries that have created internationally recognized customs, few contracts will be completely silent on material terms. In other words, genuine gaps are not prevalent for many transactions.

B. Categories of Gaps and the Situations Where They Arise

Yet, there are situations where gaps tend to arise. The following examples illustrate common scenarios, but they are not intended to be exhaustive. To begin with, the literature refers to supervening gaps that were not apparent at the time of contracting but which subsequently emerged due to the occurrence of contingencies not foreseen at the time of contracting. In the author’s view, the sophistication of repeat players in international business should allow them to identify and plan for most contingencies, with the result that supervening gaps should not present problems in many international business transactions. However, supervening gaps are more likely to occur in smaller transactions involving less sophisticated parties. Also, supervening gaps are more likely to emerge in long-term contracts where shifts in technology and political context may produce contingencies not foreseen by even the most sophisticated parties.

The literature also refers to gaps that the parties clearly perceived at the time of contracting but deliberately chose not to address. While often mentioned as a single category, the parties might have a range of motivations for declining to address known gaps. For example, parties may deliberately leave gaps when the cost of negotiating solutions is so high that the parties prefer to leave the topic open. This seems most likely to occur in the context of smaller transactions where the cost of achieving clarity on some issues may outweigh the expected benefit for the principals.

Alternatively, gaps might reflect a deliberate strategy by only one party. For example, one party may have material information it does not want to share with its counterparty because doing so could be costly for the better-informed party. While not drawn from the literature of international commerce, a frequently cited example involves a contract between a retirement community and one of its residents. The contract required a significant initial payment, but contemplated a refund in the event the resident moved out within the first two months. The contract did not specify what would happen if the resident died within the trial period, presumably because the operator of the retirement community knew this was a significant possibility and did not want to share information that might prompt the resident to demand extension of the refund to situations involving death within the first two months.

As a further alternative, parties may deliberately leave a term open with the understanding that they will fill the resulting gap by subsequent negotiations and agreement. This could occur in any situation where neither party wants to settle for a judicially imposed, compromise gap-filler and, therefore, each party prefers to retain a veto over any proposal that does not suit it. But it also can occur with particular frequency in long-term contracts where the parties do not have enough information at the time of contracting to make sensible choices about things that will become clear only with the passage of time. For example, the parties may choose to leave open the delivery date for a piece of equipment or machinery because timing may depend on the completion of a building or supporting structures before delivery. Likewise, in a volatile market, the parties might be able to agree on pricing for the first year but leave the price term open for negotiation and agreement in subsequent years.

In short, the sophistication of parties, the latticework of implied-in-law terms, and a broad range of implied-in-fact terms mean that material gaps in contracts have become exceptional. But as a class, long-term contracts have characteristics that can promote the formation of material gaps, sometimes due to bounded rationality and sometimes due to deliberate choice.

III. Authority

In the rare but important cases where international business contracts have material gaps, the question is whether a third party can fill them definitively if the parties do not. Because those contracts are likely to provide for arbitration, the focus of the question becomes whether arbitrators have the authority to fill material gaps in contracts. As explained below, the authority of arbitrators to fill gaps requires a surprisingly complex analysis that used to fuel contentious debates. Although the contours of the debate have moderated in recent years, this article offers fresh insights into a situation likely to raise legitimate questions about the authority of arbitrators to fill gaps.

A. Historical Debates

The authority of arbitrators to fill gaps in contracts involves a complex analysis because that authority depends on the ability to navigate two different keyholes: (1) the authority of arbitrators to fill gaps under the arbitration law of the place of arbitration (lex arbitri); and (2) the authority of arbitrators to fill gaps under the law applicable to the substance of the contract (lex causae).

On the broad view of gaps discussed in Part II, the authority of arbitrators to fill gaps would often be unremarkable. The search for the intent of the parties from among plausible alternatives using a range of evidence derived from the words and conduct of the parties undoubtedly involves a legal dispute for purposes of the lex arbitri. Identification and application of implied-in-fact terms have long been accepted as part of the lex causae in the legal systems most relevant to international commerce. Historically, judges have embraced recourse to implied-in-fact terms, even when they were unprepared to fill genuine gaps in contracts where the parties failed to address an issue and left no evidence of intent.

Recourse to implied terms is one thing. Supplying terms to fill genuine gaps in contracts left by the parties without any objective evidence of intent involves a different conceptual task. The person supplying those terms must literally make a contract for the parties, choosing among terms that may have significant economic consequences. Through the latter half of the twentieth century, observers seriously doubted whether arbitrators had the authority to fill genuine gaps under the lex arbitri. The principal reason for this conclusion was the view that supplying omitted terms involves a purely contractual function that can be delegated to trusted experts, whose decisions merely have the force of the contracts they complete. In other words, gap-filling involves the completion of contracts on behalf of the parties and not the adjudication of their legal disputes. Therefore, gap-filling did not fall within the accepted definition of arbitration or the scope of arbitration statutes.

Turning to the lex causae, the historical view was that parties make contracts. Courts do not make contracts for them. Viewed from this perspective, the process of choosing how to supply omitted terms from a potentially wide menu of options is like pulling numbers out of thin air. It was often not seen as a judicial act.

Because the authority of arbitrators to fill genuine gaps in contracts required the successful passage through two keyholes, both of which were inhospitable to navigation, logic weighed against recognition of that authority. But practical necessity cut the other way. In a world where arbitration had become the gold standard for the resolution of international business disputes, and where factors such as political instability and the growth of long-term commercial relationships increased the likelihood that contracts might turn out to have material gaps, the inability of arbitrators to fill them seemed most unfortunate.

By the beginning of the twenty-first century, practical necessity appeared to have won the day, at least in jurisdictions that had become popular venues for international arbitration. Thus, writing in the early 2000s, scholars declared that the authority of arbitrators to fill gaps had been recognized in the legal systems of England, France, Germany, the Netherlands, Sweden, and the United States.

B. A Gray Area

As a generalization, the optimistic conclusions of scholars regarding the authority of arbitrators to fill gaps in contracts make sense. However, there is an important class of situations where the power of arbitrators to fill gaps remains open to doubt. As mentioned above, some parties deliberately leave material terms open for a variety of reasons. When they do so to avoid the cost of negotiation, one can assume they prefer arbitrators to fill the gaps by supplying terms that reflect something of a compromise. When parties deliberately leave open material terms because they lack sufficient information at the time of contracting, they may or may not want arbitrators to fill them by supplying terms that reflect a compromise. But some parties reserve to themselves the exclusive right to fill open terms by subsequent agreement because each party wants to retain a veto over how the gaps are filled. According to one observer, this is a mechanism “regularly used to embody a mild form of commitment.”

In the situation just described, there are reasons to believe arbitrators might not have the power to fill the open terms. First, party autonomy is a central pillar of arbitration. If the parties have reserved to themselves the exclusive right to fill open terms through subsequent agreement, they logically have denied the arbitrators the authority to fill those gaps. Second, in many jurisdictions, contracts that deliberately leave material terms open for subsequent agreement are often described as “agreements to agree” that are incapable of enforcement as a matter of substantive law.

Thus, when faced with terms the parties deliberately left open for resolution by subsequent agreement, arbitrators should consider whether the parties intended to retain the exclusive power to fill the gaps. If so, there is a distinct possibility that the arbitrators lack the power to fill the gaps for the parties. However, two theories might permit arbitrators to reach the opposite conclusion.

First, the arbitrators might conclude that the parties intended to fill the open terms by subsequent agreement if possible, but also wanted arbitrators to fill gaps if the parties were not successful at reaching agreement on open terms. Normatively, arbitrators could be encouraged to reach this conclusion by adopting a low threshold for deciding that the parties intended for arbitrators to fill open terms in the event the parties were unable to reach an agreement. This appears to be the strategy adopted by the UNIDROIT Principles for International Commercial Contracts, which favor this conclusion when the parties already began performing the contract or where the open terms are of a character that would naturally have to be decided at a later time. The advantage of this approach is that it saves the contractual relationship. The disadvantage is that it does so by imposing a compromise solution based on very limited supporting evidence and that is in conflict with the parties’ stated intent to fill the open terms themselves.

Not everyone will favor a generalized bias toward acceptance of arbitral gap-filling of deliberately open terms. For those who believe the parties truly intended to reserve the exclusive right to fill open terms, there still is a basis for arbitrators to fill open terms when the parties are unable to do so. If the claimant is willing to accept it, the tribunal should be able to fill gaps with the reasonable terms most favorable to the respondent. The justification is that the claimant consents to the arrangement and, while the respondent has the power to veto unfavorable terms, the respondent can have no logical objection to an award that fills gaps on the reasonable terms that are most favorable to it. The advantage of this approach is that it both preserves the contractual relationship and respects the parties’ intent to retain a veto over unfavorable terms. While not previously discussed in the literature on international arbitration, this approach has been proposed by a well-known scholar of contract law and appears to have been applied in the practice of some courts.

In short, determining the authority of arbitrators to fill genuine gaps in international contracts can be complex because it requires application of the lex arbitri and lex causae. Because filling genuine gaps arguably serves a purely contractual function, there were historical debates about whether gap-filling involves the adjudication of legal disputes for purposes of arbitration statutes. More recently, it has become generally accepted that arbitrators have the authority to fill genuine gaps in international business contracts, at least in popular arbitration venues. However, gray areas remain. For example, if the parties have deliberately left a material term open and agreed to fill it through subsequent negotiations and agreement, they have arguably rejected the possibility of compromise gap-filling by third parties and retained a veto over any terms they do not like. But even in this case, one might still find that arbitrators have the authority to fill genuine gaps based either on (1) a low evidentiary threshold for determining the parties wanted arbitrators to fill gaps in the event they were unable to agree, or (2) an award filling gaps on the reasonable terms most favorable to the respondent.

IV. Execution

Assuming that arbitrators have the authority to fill material gaps in contracts, the question becomes how should they do so? The literature on arbitration has little to say on the topic. While recognizing a range of options, this Part discusses the role played by the lex causae, identifies two of the most common guiding principles, and explores the challenges for arbitrators in applying each.

Although the lex arbitri is relevant to determining the authority of arbitrators to fill gaps in contracts, there is no indication that national arbitration statutes provide any guidance on how arbitrators should exercise that authority. On the contrary, one normally looks to the lex causae for guidance on how to fill gaps in contracts. This becomes critically important because most international business contracts expressly select the lex causae. As a result, when the parties select the lex causae, they are selecting the guidance arbitrators will receive on how to fill gaps in contracts. To the extent that gaps are likely to emerge during the course of performance, the parties can use selection of the lex causae to influence how arbitrators will exercise their authority to fill gaps in contracts.

Turning to rules on how to fill gaps in contracts, one can imagine at least three different approaches: selection of a gap-filler that systematically favors one party, selection of a gap-filler that gives effect to the intentions of the parties, and selection of a gap-filler that is objectively reasonable. Although less familiar with civil law jurisdictions, the author has seen these approaches in common law jurisprudence and in codifications designed for transnational practice, including the UNIDROIT Principles.

A. Gap-Fillers That Systematically Favor One Party

Starting with the first option, it is possible to imagine situations where it is necessary or desirable to fill gaps with terms that systematically favor one party. As already mentioned, one might fill gaps with the terms most favorable to the respondent if necessary to sustain the authority of arbitrators to supply terms that the parties deliberately left open. Likewise, it can be desirable to fill gaps in a manner that encourages disclosure of material information known only to one party. One can do this by supplying a term favorable to the party that was not aware of material information, thereby creating incentives for disclosures by the better-informed party. However, the selection of gap-fillers that systematically favor one party are not common. On the contrary, they seem best suited to very particular situations where gap-filling seems impossible, or undesirable, on other terms.

B. Gap-Fillers Based on Actual or Presumed Intent

More frequently, one encounters rules that encourage adjudicators to fill gaps in contracts by supplying terms that reflect the intent of the parties. To the extent one adopts the broad understanding of gaps discussed above, this guidance seems appropriate because it is often possible to fill contractual silence with implied-in-fact terms based on concrete evidence of actual or likely intent, including a constellation of express provisions, course of performance, course of dealing, or usage of trade. But to the extent that one adopts the narrower understanding of genuine gaps preferred by this author, the guidance seems unsound because genuine gaps occur only when the contract is silent on a material term and there is no objective evidence of intent. Under these circumstances, the direction to fill gaps based on the intent of the parties makes little sense.

When it is not possible to determine the actual or likely intent of the parties based on evidence, many jurisdictions apply the rule that one should fill gaps in contracts based on the presumed intent of the parties, meaning the terms they would have chosen if they had thought about the issue. This approach has the virtue of preserving formal adherence to the tenet that parties make their own contracts, and that adjudicators do not make contracts for them. But the problems with this approach are manifold. For situations in which the parties deliberately omitted material terms due to the excessive costs of reaching agreement, it is not logical to speculate on the terms they would have chosen. The whole point is that they never would have attempted to reach agreement on the relevant terms.

For situations in which transaction costs are not an impediment to negotiations, it is still often naïve to assume that arbitrators can determine how the parties would have dealt with the issue given the opportunity. In fact, the inquiry into presumed intent becomes a largely hypothetical exercise because there is no evidence of custom within the relevant trade and, therefore, no objective evidence of what similarly situated parties were likely to do.

Also, to the degree that the gap involves an issue that was not reasonably foreseeable, the hypothetical character of the exercise becomes even more pronounced. How can one determine what the parties would have done if they considered the issue, when the unforeseeable nature of the event means that no parties would have considered the issue? Given the hypothetical nature of the inquiry, adjudicators end up making the contract for the parties while claiming to do the opposite.

Also, if one faithfully performs the task of discovering a hypothetical agreement based on predictions about what the parties would have done, there should be no expectation that the result would be a fair or even a reasonable agreement. Differences in bargaining power often drive parties to conclude agreements that are objectively unfair to one side. In some cases, one party may feel the need to make concessions that are objectively not reasonable. Yet, within the broad limits of unconscionability, parties are free to conclude such agreements and adjudicators will generally enforce them. This may be acceptable in a context where the parties have consciously accepted unfair or unreasonable terms. But in a context where arbitrators are filling gaps based on the sort of hypothetical exercise described above, why should they have a license to roam outside the constraints of fairness and reasonableness?

A reply may be that arbitrators do not actually give much weight to bargaining power when filling gaps in contracts. Instead, they simply assume the parties would have dealt with each other fairly and reasonably. But to the extent adjudicators are informally treating fairness and reasonableness as the outer limits on speculation about hypothetical bargains, why not designate fairness and reasonableness as explicit guideposts that adjudicators must follow when filling gaps in contracts?

C. Gap-Fillers Based on Principles of Fairness and Reasonableness: The Justice-Based Approach

Given the problems associated with hypothetical searches for the presumed intent of the parties, other rules direct adjudicators to fill gaps in contracts by supplying terms that align with principles of fairness and reasonableness. For example, in the event that adjudicators cannot determine the intent of the parties, the UNIDROIT Principles call on them to fill gaps with terms that are “appropriate,” taking into account “good faith and fair dealing,” as well as “reasonableness.” The reference to “good faith and fair dealing” is somewhat puzzling. To be sure, the commentary to the UNIDROIT Principles clarify that this phrase incorporates principles of good faith and fair dealing widely accepted in international trade without regard to the particular understandings of those principles under domestic law. Also, the requirements of good faith and fair dealing are mandatory and apply at every stage of the relationship between the parties.

However, as understood in the UNIDROIT Principles, the requirements of good faith and fair dealing apply only to the actions or behavior of the parties. Given the focus on behavior, it is difficult to understand how principles of good faith and fair dealing would regulate the permissible content of substantive terms. In fact, the commentary to the UNIDROIT Principles emphasize that the requirements of good faith and fair dealing could be only exceptionally invoked to strike down abusive or unconscionable terms.

Given the extremely narrow application of good faith and fair dealing to substantive terms, the commentary to the UNIDROIT Principles identifies only one situation where principles of good faith and fair dealing would require the addition of a substantive obligation not stipulated in the contract. Unsurprisingly, it involves the addition of a term regulating behavior: where two parties agree to a lengthy and complex feasibility study while also negotiating a larger cooperation agreement, and one party decides at an early stage not to go forward with the cooperation agreement, good faith creates an implied obligation to notify the other party of that decision without delay. In other words, good faith and fair dealing might provide the basis for filling gaps in contracts, but only in the limited range of cases in which the omitted terms involve questions about the manner in which the parties perform their obligations.

As a final backstop, the UNIDROIT Principles direct adjudicators to consider reasonableness when filling gaps in contracts. However, the UNIDROIT Principles provide no guidance on how to determine reasonableness. Although not stated in connection with the UNIDROIT Principles, the United States Court of Appeals for the Fifth Circuit has indicated that a contractual provision is reasonable if it would be satisfactory to the so-called “reasonable man” in like circumstances. But how does one judge what would be satisfactory to reasonable parties in like circumstances? In some cases, one can make the determination based on evidence of market behavior in the trade. For example, a reasonable price might be set by reference to the relevant market price. However, that solution works only in situations where one can rely on evidence of market behavior, meaning usage of trade, to supplement the parties’ agreement. The problem is that a genuine gap exists only when there is no usage of trade to support an implied-in-fact term.

In the absence of information about market behavior, how can one identify terms that would satisfy reasonable parties in like circumstances? Lacking objective evidence of the parties’ intent or even industry custom, must one fall back on intuition about the sorts of terms that might satisfy reasonable parties in like circumstances? Would the process of filling gaps in contracts based on vague intuitions about reasonableness constitute a legal dispute for purposes of the lex arbitri, especially if performed without any basis in text or objective evidence? Unfortunately, the UNIDROIT Principles and their commentary raise these troubling questions but provide no guidance on their resolution.

Fortunately, renowned contracts scholar Allan Farnsworth offered an insight that permits consideration of the “reasonable man” as a legal construct even in the absence of evidence regarding the market behavior of similarly situated parties. According to Farnsworth, when there is no reliable evidence of actual expectations, one may seek guidance from the “fair and reasonable man,” not as the product of objective information about human behavior in the aggregate, but as “the anthropomorphic conception of justice.” Extrapolation of terms from basic principles of fairness and justice can fairly be described as a legal process, and controversies about the proper extrapolation of those terms can fairly be described as legal disputes. This solves the problem of how to preserve the status of gap-filling as an inherently legal process even in the absence of a textual basis in the agreement or objective evidence regarding usage of trade.

The American Law Institute’s Restatement (Second) of Contracts is an influential source of rules that supports a justice-based approach to gap-filling and has been followed by courts in several U.S. jurisdictions. According to Section 204 of the Restatement, if the parties intended to be bound and if their agreement is sufficiently definite to be a contract but omits a term that is essential to a determination of the parties’ rights, courts may fill the gap by supplying a term that is reasonable in light of “community standards of fairness and policy.” Arguably, the grounding of the inquiry in “community standards” ensures that the terms supplied by adjudicators will not reflect their subjective views of fairness and policy, but will be grounded in widely accepted principles that can be verified through objective inquiry. Examples of relevant principles might include the idea that there should be a rough equality of economic exchange, so that neither party is at the mercy of the other. They may also include preferences for predictability, convenient rules of thumb, and the allocation of risk to the party that is best-positioned to deal with that risk.

Setting aside concerns about subjective notions of fairness and policy, some might criticize the justice-based approach to gap-filling on the grounds that the state ends up imposing terms on the parties, who cease to be the masters of their bargain. But this perspective is vulnerable to the counterargument that the parties will have the opportunity to make submissions on the selection of relevant principles and their application to the facts of the case. Also, in the context of international arbitration, the terms will not be imposed by state actors, but supplied by the experts the parties have chosen to resolve their disputes. Finally, it is hard to understand the basis on which the parties would object to terms that are objectively fair.

Of course, the parties can reserve to themselves the exclusive right to supply open terms by subsequent negotiation and agreement. But choosing that option can mean the contract will fail if the parties do not reach agreement on open terms. While that may be acceptable or even desirable for some parties in some situations, it is difficult to see why parties to long-term contracts would expose themselves to the failure of projects in which they have already invested years of effort and tens or hundreds of millions of dollars.

D. Challenges in Applying a Justice-Based Approach to Gap-Filling

Looking beyond concerns about the loss of control and autonomy, there can be difficult questions about how to define the “community” that provides the applicable standards of fairness and justice. For relationships involving a single jurisdiction, identification of the relevant community does not seem particularly difficult. Conceivably, there might be questions about whether to define the relevant community by reference to a trade or the larger social collective. However, if the relevant trade already had its own standards of fairness and policy, they would likely amount to usage of trade. And if there was a relevant usage of trade, any silence could be filled by implied-in-fact terms, with the result that there would be no genuine gap and no need for arbitrators to supply the omitted terms.

For relationships involving multiple jurisdictions, the difficulty of identifying the relevant community can depend on the facts and circumstances. For example, some concession contracts are executed by government actors in the host state, are performed in the host state with substantial social and economic consequences in the host state, are governed by the laws of the host state, and are subject to arbitration in the host state. In these situations, it seems evident that the relevant “community standards” of fairness and policy would be those that prevail in the host state.

In other contexts, different aspects of contracts could be connected with three or more jurisdictions. For example, a contract involving a large-scale project between U.S. and Nigerian parties might be governed by English law, with performance to take place in Nigeria and arbitration to take place in Switzerland. If called on to fill gaps in the contract, which jurisdiction should arbitrators recognize as the relevant “community” for the purpose of articulating standards of justice and policy? Is it Nigeria because that is the place of performance and, thus, the place where important social and economic consequences would be most directly felt? Is it England because the parties have chosen that jurisdiction’s laws to govern their rights and obligations? Is it Switzerland because the parties have chosen that jurisdiction’s laws to regulate the arbitral process?

When contractual provisions on choice of law, place of performance, and place of arbitration are connected with different national jurisdictions, one might be inclined to apply standards of fairness and policy widely shared in the international community when supplying terms to fill gaps. This approach can have some appeal, provided that shared standards are easy to identify and are similarly applied in all relevant jurisdictions. But the task of establishing that the same standards exist and are applied similarly in all relevant jurisdictions can become a time-consuming process that increases the cost and duration of arbitrations. Those consequences are not desirable in a practice environment already rife with complaints about the expense and duration of the arbitral process.

Also, to the extent that one can prove the existence of shared standards in three or more jurisdictions, it seems likely there will be times when the coincidence of norms is apparent only at a high level of generality. This can lead to two additional problems. First, to the extent that recourse to objectively verifiable standards of fairness and policy operates as a safeguard against subjective decision making by arbitrators, framing those standards at particularly high levels of generality will increase the room for discretion and, thus, for subjective decision making. Second, if the coincidence of standards exists only at a high level of generality, it seems likely that the details of their application may not coincide across national jurisdictions, with the result that a choice still needs to be made among the relevant jurisdictions.

For all of the reasons stated, the better path may be to make a clear choice among the jurisdiction that supplies the applicable substantive law, the jurisdiction where performance occurs, and the jurisdiction in which the arbitration has its seat. As a first step, one may exclude the place of arbitration as the relevant community for purposes of identifying the standards of fairness and policy needed for filling gaps in contracts. The parties often choose the place of arbitration for its neutrality and not for any reason connected to the substance of their bargain. Also, while the place of arbitration supplies the norms that regulate the arbitral procedure (and thus may supply fundamental standards of justice and policy relevant to the process of adjudication), it typically does not supply the applicable substantive law. Under these circumstances, the parties likely would be surprised to find the arbitrators selecting the place of arbitration as the relevant “community” for purposes of identifying the standards of fairness and policy used to fill gaps in contracts.

As a second step, one can understand the pull to consider the place of performance when filling gaps in contracts, particularly if the selection of gap-fillers would have significant social and economic consequences for communities in that jurisdiction. However, there are good reasons not to treat the place of performance as the relevant community when identifying the standards of fairness and policy used to fill gaps in contracts. If the parties have chosen the laws of another jurisdiction to regulate the substance of their contract, they have chosen not to have the laws of the place of performance determine their substantive rights and obligations.

But one can still understand the pull to consider how different ways of filling gaps in contracts might affect communities at the place of performance. While this cannot justify treating the place of performance as the relevant community for purposes of selecting the relevant standards of fairness and policy, arbitrators should be able to consider the social and economic consequences of gap-filling when applying the relevant standards of fairness and policy.

As should be evident from the foregoing discussion, it makes the most sense to treat the jurisdiction that provides the lex causae as the relevant community for purposes of identifying the standards of fairness and policy used to fill gaps in contracts. The parties will have chosen that jurisdiction as the source of law for purposes of determining their substantive rights and obligations. Also, as suggested by the author’s hypothetical fact pattern, the parties will often choose a jurisdiction with a more developed legal system—not in the sense that it is normatively superior, but in the sense that it has a body of law widely recognized as suitable for regulating commercial relationships, widely available and known to practitioners, and well adapted to transactions likely to occur in the international space.

Summarizing the foregoing discussion, the execution of the authority of arbitrators to fill genuine gaps in international business contracts has not been extensively discussed. Where the parties have reserved to themselves the exclusive right to fill gaps by subsequent agreement, the authority of arbitrators may be limited to supplying the reasonable terms that are most favorable to the respondent. In other cases, the approach to gap-filling appears to diverge into two streams. First, one might fill gaps based on the intent of the parties or their presumed intent based on the deal they would have reached had they considered the topic. The problem with this approach is two-fold. First, genuine gaps occur when there is no objective basis for determing the actual or likely intent of the parties. In other words, there is no express provision, no implied-in law provision, and no way to find an implied-in-fact provision based on the inherent logic of the agreement, a constellation of textual provisions, course of performance, course of dealing, or usage of trade.

Although one might then engage in a hypothetical search for the parties’ intent based on the agreement they would have reached if they had thought about the issue, it is often naïve to think that arbitrators can make such predictions, particularly when there is no objective factual basis on which to make that determination. To the contrary, arbitrators are likely to engage in a hypothetical process animated by intuition and subjective thinking. In the end, they may simply impose their will on the parties while purporting to so something else.

As an alternative, arbitrators might fill gaps with objectively reasonable terms. While attractive in principle, the problem is that the relevant sources may not provide guidance on how to identify reasonable terms. Although it may be conceptually possible to define reasonable terms by reference to options that would be satisfactory to reasonable parties, and although it may be conceptually possible to make such determinations based on market behavior, this may not be possible for genuine gaps, which presume the absence of evidence regarding usage of trade.

The question then becomes how to maintain gap-filling as an objective and inherently legal process in the absence of any textual basis or evidence of market behavior. One may accomplish this by defining terms that are reasonable because they comport with objectively verifiable community standards of fairness and policy. For the reasons set forth above, it can be attractive to look for standards of fairness and policy widely recognized at the international level. But this approach often will not be feasible and has a number of potential drawbacks. The better approach would be to identify community standards of fairness and policy as understood in the jurisdiction that provides the applicable substantive law. However, in applying those standards of fairness and policy, one might also consider important social and economic consequences for the place of performance.

V. Application to Infrastructure Concessions in Latin America

Parts II to IV of this article stand alone as a valuable contribution to the literature on how to define gaps in international business contracts, the authority of arbitrators to fill gaps in contracts, and the execution of that authority. However, as also stated, the author developed this article in the context of a conference on how to fill gaps in infrastructure concession agreements in Latin America.

A. The Infrastructure Gap

To put things in perspective, economic development requires a certain level of infrastructure: roads and rails to transport people and goods, digital networks that make communication possible, urban transportation to bring people to and from work, and energy distribution networks to keep homes, offices, and factories running. Unfortunately, the highly urbanized population of Latin America lacks access to adequate infrastructure. In human terms, this means workers have to spend half as much time commuting as they do working. More than 60 percent of roads in the region are unpaved. Two-thirds of sewage is not treated. In economic terms, Latin America spends a smaller proportion of GDP on infrastructure than almost any other region in the world. The gap between existing and needed infrastructure in the region amounts to roughly $150 billion per year. No matter how one looks at the question, the quality of infrastructure in Latin America places significant limitations on the region’s prospects for development.

Latin American countries need to substantially increase investment in infrastructure. However, governments in the region often lack the fiscal resources to do so, with the result that public-private partnerships involving concessions have become a critical tool for making the required investments in infrastructure. Examples include projects relating to highways and bridges, rail and subway lines, water and sanitation, hospital construction, and electricity transmission. Obviously, the concessions involve long-term projects, sometimes in politically unstable jurisdictions, where the time scale means that some gaps will appear unexpectedly and some terms will be deliberately left open because they deal with topics that will become clear only with the passage of time.

B. Application of Gap-Fillers to International Concession Agreements

The author is not an expert in the domestic laws of Latin American jurisdictions and, therefore, cannot say whether they would support the approach to gap-filling endorsed by this article. However, the author believes the approach provides a useful starting point for thinking about gap-filling by arbitrators in international business contracts. Under these circumstances, this Part offers preliminary views on how the approach might play out in the context of concession agreements in Latin America.

1. The Authority of Arbitrators to Fill Gaps

Starting with the question of authority of arbitrators to fill gaps in international business contracts, the authority exists only if supported by both the lex arbitri and the lex causae. There used to be lively debates about whether gap-filling involved a legal dispute for purposes of the lex arbitri and was even possible for omitted material terms under the lex causae. But those debates appear to have been resolved in the affirmative in popular venues for arbitration and in many jurisdictions with well-developed commercial laws. To the extent concession contracts provide for arbitration in popular venues subject to the laws of countries known to permit gap-filling as a matter of contract law, one might not expect to encounter much controversy about the authority of arbitrators to fill gaps in concession contracts. One would hope this trend would be welcomed by the legal systems of Latin America, but it cannot be taken for granted and would have to be examined in particular jurisdictions.

Although the authority of arbitrators to fill gaps in contracts may not be controversial in general, it becomes an issue in one situation likely to arise in concession agreements. The parties may deliberately leave terms open to be filled by the parties themselves by subsequent agreement in light of conditions that will become clear with the passage of time. If the parties have in fact reserved to themselves the exclusive right to fill open terms (and thus individually retained the right to veto the imposition of any terms they do not like), there is a real question about whether arbitrators have the authority to fill those gaps.

For the situations just described, the author’s view is that arbitrators still have authority to fill gaps with the reasonable terms that are most favorable to the respondent. However, the influential UNIDROIT Principles avoid the problem by setting an extremely low bar for proof that the parties intended to attempt to fill gaps themselves, but for arbitrators to supply reasonable terms if the parties are unable to agree. For example, the UNIDROIT Principles permit this conclusion if the open terms relate to items that could be determined only at a later stage or if the parties have already carried the agreement into partial execution.

2. Selection of the Approach to Gap-Filling: Intent vs. Reasonableness

Assuming that arbitrators have the authority to fill gaps in concession contracts, one might select gap-fillers based on the presumed intent of the parties or one might select objectively reasonable terms. As explained above, a search for the agreement the parties would have reached had they considered the issue seems problematic in general. It becomes even more problematic in long-term concessions where the parties have been unsuccessful in reaching agreement on how to fill open terms. Simply put, if the parties actually attempted to fill the gap and were unable to reach agreement, the search for the terms to which they would have agreed is not realistic.

In these situations, it becomes far more realistic to use objectively reasonable terms to fill gaps in contracts. The problem is how to identify the universe of reasonable terms. Unfortunately, the influential UNIDROIT Principles do not provide helpful guidance. But if one is to avoid impressionistic and subjective decision making, the process of identifying reasonable terms should be grounded in objective and verifiable facts. Of course, one might conduct an inquiry into terms that would satisfy reasonable parties in like circumstances. In the abstract, one could then identify the sorts of terms that prevail within the trade. But for genuine gaps, that may not be possible because their existence presumes the absence of any evidence regarding usage of trade.

Even in the absence of information about the market behavior of similarly situated parties, one can preserve an objective and law-based inquiry into reasonableness by treating the so-called reasonable person as the anthropomorphic manifestation of justice. Thus, terms become reasonable not because they reflect the intent of the parties or of similarly situated parties. On the contrary, terms become reasonable because they comport with community standards of fairness and policy. The existence of these standards can be objectively verified, their extrapolation involves a legal process, and controversies about their proper extrapolation constitute legal disputes capable of settlement by arbitration.

3. The Challenges of Applying a Justice-Based Approach to Gap-Filling in Infrastructure Concession Agreements

In an internationalized context, there may be room for debates about how to define the relevant “community” for purposes of identifying the standards of fairness and policy used to fill gaps in contracts. Some concession agreements are regulated by the substantive law of the host state, are performed in the territory of the host state, and are subject to arbitration in the host state. In these situations, it seems evident that the relevant community will be the host state. But for situations where the applicable substantive law, the place of performance, and the place of arbitration each involves a different national jurisdiction, the author submits that the jurisdiction that provides the applicable substantive law should be the relevant community for purposes of identifying the standards of fairness and policy used to fill gaps in contracts. However, in applying those standards, arbitrators may wish to consider significant social and economic consequences likely to be felt at the place of performance.

In short, concession contracts have become an important tool for addressing an extremely large infrastructure gap in Latin America. Unlike many types of contracts, the time scale required for infrastructure concession contracts and the fluid political context in some Latin American countries means that genuine gaps are relatively more likely to appear. Parties can increase the likelihood that arbitrators will have the authority to fill those gaps by providing for arbitration in a popular arbitration venue and the application of a substantive law that is well-known and well-suited to modern international commerce.

Deliberate gaps arguably restrict the gap-filling powers of arbitrators when paired with the understanding that the parties themselves will fill open terms by subsequent agreement. However, the UNIDROIT Principles seem to presume the parties want arbitrators to fill gaps as a last resort, at least in many situations. Even if one does not accept this presumption, it should be possible to fill gaps with the reasonable terms most favorable to the respondent.

How to fill gaps in infrastructure concessions can be tricky. At a recent conference in Argentina, the author heard speakers offer solutions that seem oversimplified. For example, one speaker suggested that discussion of the topic was overly complex. In practice, the parties had agreed on a process that permits gap-filling, which that speaker viewed as solving the problem. Another speaker expressed the view that one could fill gaps by determining what the parties likely would have done based on industry practice. In the author’s view, the first perspective was not helpful because it addresses only the issue of whether arbitrators will fill gaps, but ignores the more difficult question of how they will fill gaps. It is hard to believe that rational parties would be enthusiastic about a process that leaves the approach to gap-filling undefined or relegates it completely to a tribunal’s discretion. Likewise, the second perspective was not helpful because the speaker referred to a situation that did not in fact call for gap-filling. Simply put, if there are relevant industry standards, there is no genuine gap.

In the context of infrastructure concessions, it will often be impossible to rely on intent-based approaches to gap-filling. If the parties deliberately left a term open to be filled by subsequent agreement, it means the parties had no mutual intent on the point at the time of contracting. Although it can be attractive to fall back on notions of presumed intent, the definition of genuine gaps means there is no evidence of custom or usage in the relevant trade. Consequently, there is no basis to predict what the parties would have done based on industry practice. As a result, discussions about presumed intent descend to the level of hypothesis and intuition. Given the economic and social significance of infrastructure concession contracts, it seems unlikely that rational parties would be satisfied by such an approach to the resolution of material terms.

If one considers the economic and social significance of infrastructure contracts, it makes much more sense to root the gap-filling process in principles of reasonableness derived from objective evidence about community standards of fairness and policy. In the international context, this can raise questions about identification of the relevant community. However, while these questions are often interesting, they are not insurmountable.

VI. Conclusion

The power of arbitrators to fill gaps in international business contracts, and the execution of that power, remain important and undertheorized topics. As a general proposition, modern practice supports the power of arbitrators to fill gaps in international business contracts. But the literature is remarkably silent on a number of related issues, including the proper definition of gaps in contracts, the existence of situations in which there may be residual concerns about the power of arbitrators to fill gaps, and the manner in which arbitrators should execute their authority to fills gaps in international business contracts. This article enhances the state of knowledge by addressing all three topics.

First, the author defines genuine gaps to include only those situations where the express terms of contracts are silent on a material issue and filling that silence with implied-in-law or implied-in-fact terms is not possible. This will encompass only a narrow range of situations. However, genuine gaps are more likely to arise in long-term contracts where the parties deliberately leave terms open for resolution by subsequent agreement, and where fundamental shifts in technology or political context can produce unforeseen consequences.

Second, there is a general agreement that arbitrators should have the power to fill gaps in international business contracts. However, when the parties have deliberately left material terms open and reserved for themselves the right to fill those terms by subsequent agreement, there may be legitimate doubts about the authority of arbitrators to fill those gaps. Potentially, those doubts could be resolved in one of two ways. For example, a low evidentiary threshold could be adopted for determining that the parties wanted arbitrators to impose a compromise solution in the event the parties fail to reach agreement on how to fill open terms. Alternatively, if the claimant is open to it, gaps could be filled with the reasonable terms most favorable to the respondent. Although the UNIDROIT Principles appear to support the first option, the author prefers the latter.

Third, how arbitrators exercise their authority to fill gaps will depend on the lex causae. Practice reveals three sources commonly prescribed for guidance when exercising the power to fill gaps: the intent of the parties, the presumed intent of the parties based on what they would have done if they had thought about the issue, and the selection of reasonable terms based on community standards of fairness and policy. Given the narrow definition of gaps, the search for intent makes little sense. Because genuine gaps occur only when there is no objective evidence of intent, the exercise would be fruitless.

Inquiries into the presumed intent of the parties should also be approached with caution. At best, they become hypothetical exercises because there is no evidence of custom within the relevant trade and, therefore, no objective evidence of what similarly situated parties are likely to do. At worst, inquiries into presumed intent can become nonsensical. If the parties deliberately left a term open, attempted to fill it by subsequent agreement, and failed to reach agreement, it makes no sense to ask what the parties would have done if they had thought about the issue.

Unless grounded in something objectively verifiable, instructions to supply a reasonable term are prone to invite reliance on intuition. That concern can be overcome by requiring selection of terms that are reasonable in light of objective criteria, such as community standards of fairness and policy. This approach ensures that gap-filling remains an inherently legal process despite the lack of any basis in text, the intent of the parties, or the general practices of similarly situated parties.

Although the selection of reasonable terms may trigger complaints about the imposition of contracts on the parties, those concerns can be alleviated by recalling that parties will have the opportunity to make submissions on the relevant standards of fairness and their application to the case. Also, the terms will not be supplied by state actors, but by arbitrators the parties have chosen for their expertise in the relevant trade.