Tilmann J. Röder:

The Roots of the „New Law Merchant”: How the international standardization of contracts and clauses changed business law¹

I. Introduction
II. Companies “colonizing” private law
III. The example of the “earthquake clause”
IV. Conclusions

I. Introduction

The term “law merchant,” or lex mercatoria, first appeared in medieval and early modern publications on commercial law.² Synonymously used, they referred to an autonomous body of legal customs which had emerged in supraregional commerce and which had become law by consent and by continuous use. Its main fields of application were maritime and banking law, besides the more general commercial strand. The core of the lex mercatoria consisted at the time of a number of legal principles, such as bona fides and rebus sic stantibus.³ They were formulated in a very general way which made them adaptable to changing political and economic circumstances.⁴

Around 1800, the terms lex mercatoria and “law merchant” disappeared from the contemporary legal discourse.⁵ A century later, they reappeared in the writings of authors like the German professor of commercial law, Levin Goldschmidt. But they were not used any longer to describe contemporary phenomena. By Goldschmidt’s time, they had become termini technici of legal history.⁶

The lex mercatoria reappeared as a topos of legal theory as late as the second half of the 20th century.⁷ European and North American jurists who were studying the impact on the law of the globalization of the western economies and the emergence of the European single market discovered a “new law merchant”. However, the meaning of this notion had changed fundamentally. Besides some general principles and legal institutions⁸, internationally accepted standard contracts and clauses were now seen as parts of the phenomenon.⁹ Many authors interpreted them as substantive sources of law.¹⁰

This study is concerned with the period between the disappearance of the “old” and the reappearance of the “new” law merchant. Of course, it would be a mistake to conclude that there had not been any international business law before World War I solely from the terminological history. Rather, it is for other reasons that most legal historians believe this to be the case.¹¹ The existence of an autonomously created, transnational business law in the 19^th and the early 20^th centuries can at first sight barely be imagined. The convoluted regulations of the national states of this period fenced in the sphere of business activity. Especially, in many countries, new commercial and civil codes came into force. Also, international private law was gradually formed by international agreements and could be seen as a useful instrument for international conflicts. Looking back, it seems that decade by decade, the space for the development of non-state law and for autonomous mechanisms of conflict resolution were shrinking.

But is this account correct?

II. Companies “colonizing” private law

Severe legal problems arose with the entry of regional and national economies into the process of industrialization. Under the dynamics of rapid, fundamental changes, national law and economic necessities drifted apart. The notion of “cultural lag”¹² coined by the American legal theorist William Ogburn, precisely describes the situation. Neither the legislators, the administrators, nor the jurists showed themselves capable of following the economic evolution. On the international level, the situation was even worse. Negotiations on conventions for the facilitation of border-crossing business traffic, or for the setting up of common tribunals of arbitration, dragged on slowly. A good example is railway transportation. At state borders, it was not only the change in gauges which hindered the traffic of goods, but also the change in the transportation laws. Where this resulted in delays and impaired delivery, it frequently caused legal complications. This is why in 1875, the Swiss lawyers de Seigneux and Christ began promoting the idea of an international unification of the transportation laws as applied to the contracts (“Transportreglements”). But an international agreement was not reached before 1890, and its complete implementation took another decade.¹³

Since the legal and governmental actors were not adapting the law and legal institutions to the economic realities quickly enough, the businessmen themselves brought their contract law up to date. A central instrument which they used were the so-called general conditions of contract, derogating great parts of national law.¹⁴ The first to begin systematically developing their own rules of contract were the insurance and the transport industries.¹⁵ By as early as the beginning of the 19^th century, these two industries organized their mass contact with customers using contract forms. These contract forms were similar to the forms we use now when renting a car or filling out an application for an insurance policy. During the next decades, many others followed their example: wholesalers¹⁶ and banks¹⁷, shipping companies and warehouses, hotel owners, landlords, employers¹⁸ and so on.¹⁹ The contract forms were an adequate substitute for national and international regulation, because they were flexible and could be changed whenever needed.

It seems that this “colonization” of contract law by businessmen and companies was accepted in all societies on the road to industrialization. The influential bourgeois classes trusted the self-organizing forces of society, the invisible hand, as it were, at least as long as their own class was responsible for the organization. Naturally, this outlook corresponded with the thinking of the classical economic theories.²⁰ In civil law, it was mirrored in the principle of private autonomy.²¹ How widely the legislators and judges gave space for autonomy of contract is well known.²²

On the level of individual states, the expansion of general conditions of contract continued almost without pause until far into the 20^th century. The most important period in the emergence of transnational legal structures begins in the 1870s when the pace of economic internationalization quickened. The question then is whether or not the tendency towards the standardization of contracts in this period tracked the level of the emerging world economy? And if so, whether the autonomous mechanisms of legal regulation which came into existence resembled the law merchant of the early modern era or the international business law of the post-war 20^th century?

A careful answer to these questions may already be given here. Some business branches did indeed try to withdraw their cross-border commercial activities from state regulation. As a substitute, they formed their own transnational legal structures. However, before the beginning of World War I, most of them did not proceed further than to a harmonisation of their contract bases.

Early beginners were again parts of the transport and insurance industries. The performances offered by wholesale companies, marine insurers and re-insurance companies were typically border-crossing.²³ As a result, these industries became experienced in dealing with all the legal difficulties which arose due to the international exchange of goods and services. Since the legislators believed that the businessmen involved in these branches did not need any specific protection, state regulations of the related contract law were almost nonexistent. Thus, as I have noted above, the absence of regulation meant that there was room for transnational legal structures to develop, which soon thereafter took place. From the middle of the 19^th century on, diverse conditions on contracts in the transport and insurance industries were put into place.²⁴ The formation of cartels like the Internationaler Transportversicherungs-Verband (International Transport Insurance Association, founded in 1871) intensified this development. The companies also shifted the mechanisms of conflict resolution away from the state, by agreeing to the formation of non-state arbitral tribunals.²⁵ It seems that many of them were deeply distrustful of the ordinary jurisdiction.²⁶

In the following table I have sketched a brief timeline of the standardization of contract conditions which spread from the middle of the nineteenth century to right before World War I.

International Standardization of contract conditions (selected examples):

It is striking that this kind of cooperation rarely reached beyond certain geographical limits. Agreements on standard contract conditions and clauses were found mostly on the European continent or within North America.²⁸ And the same holds for the legal standardization of other industries which were not international per se, such as the accident, life, and fire insurance industries.²⁹

III. The example of the “earthquake clause”

The possibilities and limits of private legal standardization are perhaps most easily observed in the example of the so-called earthquake clause in the contracts of fire insurance companies.

On April 18^th, 1906, an earthquake and the fire which followed it destroyed the young metropolis of San Francisco. The fire raged for three days, destroying large tracts of the city.³⁰ No incident before had ever caused comparable damages. On the basis of the exisiting fire insurance contracts, the international insurance business was obliged to pay damages in the amount of 330 million dollars. A global discussion ensued in the following weeks, concerning the development of a legally flawless exclusion clause of the earthquake hazard from fire insurance contracts. It was pressed ahead by re-insurers who tried, in close cooperation with each other, to promote this idea.³¹ In fact, it was a very small number of insurance managers who reached out to a virtually global network and tried to influence more than five hundred fire insurance companies worldwide as well as cartels, legislators, and the public. Their aim was a globally uniform solution to the problem of the earthquake hazard in fire insurance contracts. In their view, this risk had to be excluded for two major reasons. First, seismology was not yet able to provide sound analyses of the causes of earthquakes, making any prediction impossible. Thus, many considered inclusion of the earthquake hazard in fire insurance coverage to be tantamount to gambling. Second, it seemed likely to them that another disaster like the earthquake and fire of San Francisco would be sufficient to put many insurance companies out of business.

For these reasons, the re-insurance managers developed a “perfect“ contract clause called the “earthquake clause“.³² This clause was translated into all the important commerical languages of the time and was then circulated worldwide.

Meanwhile, the issue was being discussed wherever fire insurance was commonly in use. The reactions to the re-insurers’ demand were varied.

A number countries, especially in Europe, agreed to the call for an exclusion of the earthquake hazard from all fire insurance contracts. Cartels adopted standard earthquake clauses into their contract conditions, and in some countries even the legislators supported the move, arguing that their laws provided for the exclusion of that risk from any insurance contract.³³ The acceptance of the “earthquake clause“ was not solely based on the experience of the enormous financial loss in San Francisco. For only months after “San Francisco“, similar events occurred in Valparaiso (Chile), Kingston (Jamaica) and Messina (Italy). Also famous earthquakes of the past like those of Basel (1356) and Lisbon (1755) were recalled. It was argued that such events would ruin the insurance industry without providing any benefit to the victims who would barely be compensated due to the general lack of reserves.

Overseas, the question was discussed differently - especially in California and the rest of the United States. After the loss of San Francisco, California was dominated by conflicts between the insurers and the insured whose property had been damaged by the earthquake and resulting fire. The courts judged in favour of the insured. Consequently, some companies tightened their exclusion clauses. But the traumatized public reacted with fierce opposition. On August 1^st, 1909, the Californian Senate enacted the California Standard Form of Fire Insurance Policy. It required that all fire insurers from then on had to use identical policies, word for word. Of course, the stipulated contract did not contain the earthquake-clause. It was clear that the insurers would still be responsible for paying out compensation in the case of fires caused by earthquakes. Here, the attempt at standardization begun by the insurance industry was stopped by standardization on the part of the state. Other earthquake-prone areas followed suit.

The case of the earthquake clause shows in detail how the economic internationalisation of one industry (fire insurance) could result in the standardization of a contract clause. However, similar developments were rare, presumably due to the great efforts which any international standardization required. Still, in this case study at any rate, we can speak of a true harmonisation of fire insurance law in Europe. What is remarkable is that several states actively supported this process by enacting coordinated insurance legislation.³⁴ Furthermore, efforts on the part of some European insurance regulators to establish common rules for the control of the insurance industry³⁵ fit into this picture. All in all one can see that the development of a world economy led to changes in national laws on many different levels – from private contracts between an insurance company and its client to public legislation about the insurance industry as a whole.

IV. Conclusions

Regarding the regulations of the different branches of industry from 1871 to 1914 as a whole, three parallels with the earlier and the later law merchant become evident. First, the law of the border-crossing industries became more and more international. This is most obvious in the cases of shipping and oversea trade, marine insurance and re-insurance industries. The example of the earthquake clause shows that standard clauses also spread in other industries which were not per se international. In both cases, businessmen replaced legislators. Second, the substantive law was subject to permanent changes. Third, non-state institutions for conflict resolution came into existence. In part, one can even speak of an autonomous regulatory mechanism of societal groups organizing their legal affairs more and more on their own.³⁶

But theories which claim that there is an unbroken connection between the old lex mercatoria and the new transnational business law of the 20^th century³⁷ must be contested.³⁸ Perhaps the principal objection lies in the differences between the legal sources. The early modern lex mercatoria was clearly different from state law. Its basis was not much more than a number of legal principles. It did not contain detailed regulation of the diverse subjects that it was applied to. In contrast, we find detailed clauses and contract forms besides legal principles by the late 19^th century which later come to resemble in their form the manner of state regulations.³⁹

The question introduced at the start of this essay can finally be answered: The legal structures which emerged in the world economy before World War I through the standardization of contract clauses were principally new. They formed the roots of the transnational law which has been such an important topic of observation and discussion since the 1960s.

Footnotes