The Art and Science of Structuring International Contracts
The practice of international contract drafting has become increasingly sophisticated, yet the failure rate of cross-border commercial relationships remains stubbornly high. This paradox suggests that sophistication in form does not guarantee effectiveness in function. The most elaborately drafted contracts often fail precisely because their drafters focused on legal technicalities rather than economic realities.
Contracts as Economic Instruments
A contract is fundamentally an economic instrument. It allocates risks between parties, creates incentives for performance, and establishes mechanisms for resolving disputes. Every provision should serve one of these functions; provisions that serve no function are not merely superfluous but potentially harmful, as they create ambiguity and increase transaction costs.
Consider the choice of governing law. Lawyers typically approach this as a legal question: which jurisdiction's law is most favorable to our client? But the economic question is different: which jurisdiction's law will minimize the total costs of the contractual relationship, including the costs of disputes that may arise? A governing law that favors one party in litigation may increase the probability of litigation, destroying value for both parties.
The Problem of Incomplete Contracts
All contracts are incomplete. No drafter can anticipate every contingency, and even if they could, the costs of addressing every possibility would exceed the benefits. The question is not whether contracts will be incomplete but how to manage incompleteness effectively.
The traditional legal response to incompleteness is to draft more comprehensively—to add provisions addressing additional contingencies. But this approach faces diminishing returns. Each additional provision increases drafting costs, negotiation time, and the probability of internal inconsistencies. At some point, additional drafting destroys more value than it creates.
The economic response is different: design contracts that perform well across a range of contingencies, rather than attempting to specify outcomes for each contingency individually. This requires understanding the underlying economic relationship and structuring provisions that align incentives regardless of how events unfold.
Risk Allocation Principles
Efficient risk allocation assigns each risk to the party best positioned to bear it. This is not necessarily the party with greater bargaining power; it is the party who can most cheaply prevent the risk from materializing, insure against it, or absorb its consequences if it occurs.
In international contracts, this principle has specific implications. Currency risk should typically be borne by the party with natural hedges or superior access to hedging instruments. Regulatory risk should be borne by the party with greater knowledge of and influence over the relevant regulatory environment. Performance risk should be borne by the party whose actions most directly affect performance outcomes.
Enforcement Considerations
A contract is only as valuable as its enforceability. In domestic transactions, enforcement is typically straightforward: courts apply the governing law and issue judgments that can be executed against the losing party's assets. In international transactions, enforcement is far more complex.
The choice of dispute resolution mechanism affects enforceability directly. Arbitration awards are enforceable in over 170 countries under the New York Convention; court judgments have no comparable international enforcement regime. This practical reality should inform the choice between arbitration and litigation, regardless of other considerations.
Conclusion
International contract drafting is both art and science. The science lies in understanding the economic principles that govern contractual relationships. The art lies in applying those principles to specific transactions, balancing competing considerations, and crafting provisions that serve their intended functions.