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European Legal Harmony: Goals and Milestones

ISBN 9985-870-20-4

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Damage arising from Defect in Object of Contract to Creditor’s Absolute Legal Rights: Contractual or Delictual Liability?

1. Damage to creditor’s absolute legal rights
by defect in object of contract

During the performance of a contract, the creditor’s interests can suffer damage in a number of ways. For example, the debtor can be late with a delivery of raw materials, which could obstruct the activities of the creditor’s entire enterprise. Or, the debtor can fail to supply any raw material at all, and the creditor will have to procure it from other sources for a higher price. In such cases, the creditor will be entitled to claim compensation for damage from the debtor under § 115 of the Estonian Law of Obligations Act. Furthermore, damage can also be caused if the debtor sells to the purchaser a car with faulty brakes, repairs the brakes deficiently or provides a leased apartment in a condition which is hazardous to health. Such defects can damage creditors’ absolute legal rights, and particularly their life, health or property. It would be traditional to assert that any such damage to the other party’s absolute legal rights can also be covered by the creditor’s contractual claim for compensation for damage. *1 Nonetheless, this article is aimed at demonstrating that such an assertion is no longer absolutely valid in the context of the Law of Obligations Act *2 (LOA), which is presently applicable in Estonia. Rather, on the contrary: on the basis of the following examples we shall have to admit that as a rule, prevention of such damage is not the purpose of the debtor’s contractual obligation (LOA § 127 (2)) and therefore, such damage is not compensable under the contract. Inasmuch as this regards legal rights that are absolute and are therefore protected by the law of delict, the debtor will be liable under LOA §§ 1043 et seqq.

In order to explain this conclusion, which may seem surprising at first sight, I should like to describe two hypothetical cases. Let us suppose that an appliance shop sells to a purchaser an extension lead for a price of 50 krooni, and a latent defect in the extension lead causes a short circuit, which results in a fire accident in the purchaser’s house leading to a damage of 500,000 krooni. Should the shop compensate for the damage caused to the purchaser’s property regardless of the fact that the defect in question was not detectable upon external inspection and it would be unreasonable to expect the shop to separately test or disassemble each item on sale?

Or, let us take another example in which an elderly lady lets out a house inherited from her sister. Unfortunately, substances which are poisonous and hazardous to health have been used in the construction of the house. The lessor is unaware, and even cannot be aware, of that since it is not reasonable to assume that an ordinary lessor would order, before letting out a house, a general technical expert analysis to make sure that the house has been built completely safely. The lessee moves in and suffers damage to health, and maybe even dies, because of the poisonous substances. Should the lessor compensate for the funeral expenses, pay support to the lessee’s dependants (LOA § 129) and additionally satisfy the Health Insurance Fund’s recourse claim to the extent of the medical treatment expenses under § 26 of the Health Insurance Act?

In both of these cases, the debtors have breached their contractual duty to deliver a thing which conforms to the contract. *3 Characteristically of both cases, the creditor’s absolute legal rights have been damaged by a defective object of contract while the debtor was not, and did not have to be, aware of such defect. We also saw that such damage can be extremely large and, in the author’s opinion, it is questionable in terms of legal policy whether a debtor can be expected to take such risks for e.g. a purchase price of 50 krooni or a monthly rent of 3000 krooni. This is particularly questionable in a situation in which all provisions regarding legal remedies available to the weaker party (i.e. the consumer or the lessee) are absolutely imperative: under Estonian law, neither the seller nor the lessor may contractually subject their liability to a condition of fault or limit their liability with regard to certain types of damage (LOA §§ 237 (1) and 275). *4 It would also be unreasonable to expect lessors to insure their possible liabilities before concluding a residential lease contract — all the more so as, to the author’s knowledge, conclusion of such insurance contracts in Estonia is presently not possible. But how then can such claims for compensation be avoided or limited?

2. Preclusion of claims for compensation
on grounds of force majeure?

In the search for limits of contractual compensation for damage, the question of the existence of debtor’s liability as such will inevitably come up: a distinction should be made between the question of the extent of the debtor’s liability and the question of whether the debtor is liable at all. *5 Even in the above-described cases, the question of the debtor’s liability in general will be the first to arise. *6 The sale of a defective thing or the delivery of a deficient work or defective object of lease may indeed be excusable by LOA § 103 but the question lies in whether the excusability can arise solely from the fact that the debtor was not, and did not have to be, aware of the defect in the object of contract.

In order to answer that question, the difference between fault-based liability and a stricter *7 , excusability-based type of liability must be explained in the first place. In Estonian legal literature, justified positions have been expressed that the practical difference between those concepts becomes apparent, first of all, in the case of ‘result-oriented obligations’ (i.e. obligations de résultat known in French law) referred to in LOA § 24 (1) (the first alternative). *8 Both of our cases deal specifically with result-oriented obligations, in which the debtor can be exempted from liability only by proof that the defect in the object of contract was caused by force majeure. In order to decide when a defect in the object of contract may be regarded as due to force majeure, let us take a look at the practice of interpreting article 79 of the Vienna Convention on Contracts for the International Sale of Goods (CISG), as the concept of strict liability provided in Estonian LOA § 103 has its origins right there.

In creating the CISG, the common-law concept of seller’s absolute liability was not incorporated into the convention. *9 However, at the same time, the principle of fault-based liability was also knowingly left aside. *10 Therefore, correct interpretations of LOA § 103 should not be based on the principle, prevailing in German law, whereunder a seller is not liable for damage caused by selling a defective item to a purchaser if the seller was unaware of the defect, had obtained the sold item from a trustworthy source and would not have detected that defect even by such methods of examination as could have been reasonably expected from the seller in such situation. *11 The general position regarding CISG art. 79 is that the seller is liable even for such a thing the defects of which are hidden from the seller, and that is the case both when the sold item has not been manufactured by the seller but, rather, purchased from a third party (e.g. importer) *12 and (or particularly) when the sold goods have been manufactured by the seller. *13 A few exceptions, e.g. if the defect is caused by terrorist act, are conceivable but extremely rare in real life. *14  

As demonstrated above, a defect in a sold thing belongs to the risk sphere of the seller, who thus cannot use LOA § 103 as an excuse. *15 In the case of a residential lease contract, it must similarly be admitted that the lessor is practically always liable for damage caused by a defect in the object of lease under LOA §§ 276 (1), 115 and 103. *16  

3. Preclusion of claims for compensation
under the foreseeability rule (LOA § 127 (3))?

Compensation for damage in the above-described cases could actually be precluded for the reason that the damage could not be reasonably foreseen by the debtor at the moment of concluding the contract (LOA § 127 (3)). It is often stressed in legal literature that strict liability and the foreseeability rule are closely or even inseparably interrelated. *17 However, upon closer analysis it can be noted that the foreseeability rule is not very suitable for application in the case of damaged absolute legal rights. *18 Namely, for the foreseeability of damage under LOA § 127 (3), it is not material whether or not the debtor foresaw or must have foreseen the breach of contract or, in other words, that the object of contract delivered by the debtor did not conform to the contract within the meaning of LOA § 217 (1) or § 276 (1). Hence the foreseeability of damage does not depend on whether the debtor was aware of the defect in the delivered thing: the only matter of relevance here is whether the debtor foresaw or must have foreseen that the defect in question could result in such damage. *19  

Therefore, in the described cases, we must ask the question of whether the lessor would have foreseen the damage to the lessee’s health caused by the defect in the house if she had known of such defect at the time of concluding the contract. However, it is obvious that if the debtor had known that living in the house could be hazardous to health, she would have certainly, or at least must have, foreseen that this could result in health damage and medical treatment expenses. The same applies to the seller of the extension lead. Thus the foreseeability rule provided in LOA § 127 (3) will not enable, within its empirical sense, to reasonably limit a claim for compensation for damage since such damage is very often objectively foreseeable.

Commentaries on the CISG express the position that in such cases, the question is whether the damage has resulted from the realisation of the risk which has been caused by the seller by delivery of the defective thing and which must be borne by the seller. *20 Therefore this requires an assessment of which damage risks the seller was, by default, ready to be liable for upon concluding the contract. In other words, we must be ask whether the breached obligation (i.e. the duty to deliver the thing without any defects) was aimed at protecting the creditor against such damage as has been caused by the defect (LOA § 127 (2)).

4. Preclusion of claims for compensation through
the purpose of breached obligation (LOA § 127 (2))?

Under LOA § 127 (2), damage will not be compensated for to the extent that prevention of damage was not the purpose of the obligation due to the non-performance of which the damage arose. This so-called theory of the purpose of breached obligation *21 not only determines the extent of any claims for compensation for contract damage (LOA § 127 (2)) but in addition, the cumulation of contractual and delictual claims is thereby also precluded (LOA § 1044 (2)). Namely, damage to the other party’s absolute legal rights will give rise to the question of whether the creditor can claim compensation for such damage on the grounds of contractual liability (LOA §§ 100 et seqq.) or the provisions on non-contractual liability (LOA §§ 1043 et seqq.). *22 In Estonia, the principle of non-cumul contained in LOA § 1044 (2) precludes, as a general rule, any delictual claims if a contractual claim exists, i.e. the free concurrence of claims cannot occur. *23 This is non-applicable only in the event of health damage (LOA § 1045 (3)).

Hence, if the duty to deliver an extension lead which conforms to the contract were primarily aimed at enabling the purchaser to use a thing matching his or her expectations, and not to protect the purchaser against any damage that may be caused to his or her property (LOA § 127 (2)), a contractual claim by the purchaser would lapse and a delictual claim would become an option (LOA § 1044 (2)). *24 This would mean that the protection of the debtor’s absolute legal rights would not be included in the purpose of the lease or sale contract, which, in turn, would result in a situation in which those legal rights would be protected not by contractual but only by non-contractual liability.

The answer to the question of when the duty to protect the other party’s absolute legal rights is encompassed in a contract will, first of all, require an explanation of the functions and purposes of contractual and non-contractual liability, the differences between, and the interests and values protected by, those functions.

4.1. Functions of contractual and non-contractual liability

The law of delict provides rules of conduct which must be observed by everyone in respect of everybody else, i.e. which are ‘generally and always applicable to interpersonal relations’ *25 , and violations of which result in liability under the law. It is the function of the law of delict to protect persons’ interests in that their legal rights may not be violated by other persons. *26 Hence the law of delict is directed to maintaining the status quo of a person’s legal rights. By its very nature, the regulation of compensating for damage caused to absolute legal rights belongs specifically to the area of the law of delict (including, often, the liability of producer). *27  

Contract law, on the contrary, is aimed at effecting the transfer something of value from one person to another by means of the conclusion of contracts. Usually, the purpose of concluding a contract is to increase one’s wealth *28 and not to protect one’s existing legal rights, which the parties, as a general rule, do not even think of in the case of normal economic transactions. Nor has the risk of such damage been included in the contract price as a rule. Moreover, in most cases, only the object of contract and, often, the time and place of performance are expressly agreed in everyday transactions. Everything else is derived from either the law or interpretations of the contract or e.g. the principle of good faith. This means that through extensive interpretation, and interpretation based on the hypothetical intention of the parties, of the contract, its content is regarded as inclusive of also such terms that were never actually negotiated. *29 At the same time, the debtor’s liability is thereby extended to include such risks of damage that have not been taken into account by the debtor at the time of concluding the contract. This is particularly problematic in a situation in which a mere fact of a breach of contract (delivery of a thing which does not conform to the contract) is sufficient to give rise to a claim for compensation for damage, without any need for the debtor’s fault to be the basis of liability. *30  

4.2. Protection of creditor’s life and health
as purpose of contractual obligation?

Certainly, there are contracts the purpose of which is specifically to protect the creditor against damage to health: for example, medical services contracts, contracts concluded with babysitters or contracts for the carriage of passengers. However, for the reasons set out in the preceding paragraph, protection of the creditor’s life and health is, as a rule, not the purpose of the debtor’s (principal) contractual obligation. *31 Although the debtor’s principal obligation may be constituted by the duty to deliver a thing which conforms to the contract, the purpose of this obligation is nevertheless to protect the debtor’s so-called interest in equivalence, i.e. the interest in receiving goods or services which are equivalent to the consideration paid, rather than to protect the debtor’s absolute legal rights. *32  

Could protection of the debtor’s life and health be, however, the purpose of a contractual collateral obligation or an independent protection obligation? Or would this, depending on the situation, be simply a delictual duty of care *33 which is applicable erga omnes and which would give rise to liability only under the provisions of LOA §§ 1043 et seqq.? *34  

German law is of the position that in addition to the parties’ duties of performance, an obligation also contains protection duties, which are not aimed at carrying out the duty assumed in the contract but, rather, at protecting the other party’s absolute legal rights (see BGB § 241 (2)). It is, though, arguable, whether such protection obligations are contractual collateral obligations *35 derivable from the principle of good faith or independent obligations arising out of law. *36 In any case, breach of such a protection obligation in Germany results in contractual or quasi-contractual but not delictual liability.

Should the existence of such collateral or protection obligations, aimed at protecting life and health, also be approved of in Estonian law? Their existence could be derived from LOA § 2 (2), whereunder the nature of an obligation may oblige the parties to the obligation to take the other party’s rights and interests into account in a certain manner. *37 At the same time, it is questionable, given the structure and conceptual solutions of the Estonian law of obligations, whether or not such protection obligations, breach of which would result in liability under LOA §§ 100 et seqq., i.e. liability without fault, could anyhow exist in relation to the other party’s absolute legal rights. The author of this article is of the opinion that this should be negated.

In general, it can be said that the stronger the protection of persons’ legal rights under a state’s law of delict (i.e. the easier it is to receive compensation for damage under the law of delict), the less the existence of such contractual collateral or protection obligations should be expected. *38 The fact that e.g. in German law, many cases typical of what would per se constitute delictual liability have been transferred to the sphere of contractual or quasi-contractual liability, is due to deficiencies in the German law of delict. Problems are caused there particularly by BGB § 831. *39 In so far as the law of delict fails to provide sufficient protection to the aggrieved party in Germany, there is a wish to bring compensation for damage caused by violation of other persons’ absolute legal rights into the scope of contract law by using different legal constructions to vest the right to claim compensation for damage from breach of contract in a person who has not concluded any actual contract with the tortfeasor. This area of application of contractual liability is enlarged through creating extensive collateral and protection obligations, particularly by means of the institutions of culpa in contrahendo and contracts with protective effect for third parties. *40  

However, in Estonia there is no major need to implement such complex constructions, as according to the author’s appraisal, the Estonian law of delict offers sufficient protection to the aggrieved party. Firstly, we have the presumption of tortfeasor’s culpability (LOA § 1050 (1)). Secondly, under LOA § 1054, the service user’s liability for damage caused by the service provider is substantially stricter than under German BGB § 831, covering, under subsection (2), also any damage caused by the so-called independent operators, provided that the service user has used such operators in the performance of its duties and the damage was caused or the occurrence thereof was made possible through the performance of such duty. Moreover, claims for compensation for damage to health will expire at the same time regardless of whether their basis is contractual or delictual (§ 153 of the General Part of the Civil Code Act (GPCCA)). *41  

Therefore the author is of the position that damage caused to a creditor’s health by a defective object of contract must, as a general rule, be compensated for only under the provisions on delictual liability, even if a contract between the parties exists or if the parties are conducting precontractual negotiations. *42 In other words, it can be said, as a general rule, that a contractual obligation does not have the purpose of preventing damage to the other party’s health (LOA § 127 (2)) and hence, a delictual claim is the only option for compensation for such damage.

At first sight, such a position seems to be erroneous with regard to our case of the residential lease contract: how can one state that a duty to deliver non-defective residential premises does not serve the purpose of protecting the lessee against health damage that could result from it? Nevertheless, only this kind of argumentation will eventually lead to fair results: the lessor will not be liable for damage to the lessee’s health on a contractual basis but, rather, only on a delictual basis; a delictual claim would, however, lapse because of the absence of the lessor’s culpability (LOA § 1050 (1)). This will also preclude the unreasonable situation in which the standard of lessor’s liability would depend on whether the lease contract is effective or, for some reason, void. *43  

Also, a contractual claim of the lessee under LOA §§ 115, 276 (1) would not be completely irrelevant, nor would the lessor’s contractual liability be non-existent in that respect. Thus the lessee could claim, on the basis of the contract, compensation for the expenses of moving to live elsewhere or for the price difference if the lessee rents a similar but non-defective house for a higher price (see LOA §§ 115 (2), 135 (1)); likewise, a contractual claim for compensation could cover the expenses of the expert analysis which established that the health damage in question indeed arose from a defect in the object of lease (LOA § 128 (3)). Such damage of a purely economic nature would not be claimable by the lessee under the delictual provisions. Therefore, the described solution has the advantage that it allows to flexibly adjust the compensation for damage. While contractual liability depending on culpability will result in ‘all or nothing’, i.e. the claim for compensation for damage will lapse completely in absence of the debtor’s fault, the above-described solution enables to compensate the aggrieved contracting party for at least one part of the damage, i.e. to the extent that this conforms to the contractual distribution of risks. This means that the creditor will be compensated for the so-called interest in equivalence independently of the debtor’s culpability (under a contractual claim) but compensation for health damage can be effected only under delictual provisions, i.e. generally only if the debtor is at fault. *44  

4.3. Protection of creditor’s property
as the purpose of contractual obligation?

It is somewhat more complicated to answer the question of whether or not the duty to deliver a non-defective object of contract has the purpose of protecting the creditor’s property. In this aspect, problems arise particularly in those cases in which a defective object of contract causes damage to the sold item or the work itself *45 as well as those in which damage is caused to the creditor’s legal rights which were to be protected by the sold item or the performed work or if such item or work, upon its end-use, comes into contact with, and damages, other things belonging to the creditor. *46 Due to the size limit set for this article, I should like to point out, above all, two arguments why damage caused to the creditor’s property by a defect in the object of contract should, in Estonian law, de lege lata, be compensable primarily through delictual liability.

Let us vary our case of the extension lead so that the purchaser did not buy the extension lead from a shop but directly from the factory, and the fire accident took place three years after the purchase of the extension lead. If we said that the damage caused to the purchaser’s house by the defect in the purchased extension lead must be compensated on the basis of the contract, the limitation period of a claim for compensation for damage caused to the purchaser would begin, under LOA § 227, as of the delivery of the thing to the purchaser. This means that in accordance with GPCCA § 146 (1) *47 , the purchaser’s claims would already have expired by the moment of the fire accident and the purchaser would not be able to assert any delictual claims due to the provision in LOA § 1044 (2). However, if the defective extension lead caused damage to the property of a third person, that third person would be in a better position than the purchaser as the third person could make use of the more generous limitation periods of the delictual claim. This result, which is most obviously unfair, can be avoided by the assertion that prevention of damage to property was not the purpose of obligations arising out of the contract of sale (LOA §§ 127 (2), 1044 (2)). By this means, the three-year limitation period of non-contractual liability will be applicable; this limitation period will, differently from that of a contractual claim, begin as of the moment when the entitled person became or should have become aware of the damage and of the person obligated to compensate for the damage (GPCCA § 150 (1)). De lege ferenda, however, it should be reconsidered whether the principle of non-cumul contained in LOA § 1044 (2) should be abandoned and, thus, free cumulation of contractual and non-contractual claims be allowed.

The second argument for the preclusion of such contractual liability, which is not conditional on the seller’s culpability, for damage to the purchaser’s property lies in the obvious disproportion between the consideration and the possible risk of damage. An assertion that every shop selling extension lead is also liable for a possible fire accident in a purchaser’s house would result in a situation in which all damage will eventually be incumbent on the shop if the shop’s right of recourse (LOA § 228) against the producer is precluded due to a contractual limit of liability or the producer’s insolvency, and this could, in turn, lead to the bankruptcy of the shop. In terms of economic policy, this would produce a result where small shops could become extinct, leaving the market to only big store chains, who can afford such risks of liability or insure themselves against such damage. A situation of practice in which the majority of sellers are forced to conclude a liability insurance contract to cover possible compensations for damage exists e.g. in France, where a seller involved in economic and professional activity is liable for all damage, even from latent defects, caused to the creditors, including their absolute legal rights, regardless of whether that seller is a producer or merely a reseller. This means that even a small reseller may be liable for an unexpectedly extensive damage, which, in turn, could result in that reseller’s bankruptcy. *48 Whether such solution is also sought in Estonia or whether such situation would be desirable, will eventually be up to the legislator to decide but in the author’s opinion, such solution should rather be negated.

5. Protection of absolute legal rights
by contracts with protective effect for third parties
(LOA § 81)?

Now let us further suppose that in our case of the residential lease contract, health damage was suffered not only by the lessee but also by children living with the lessee. They had no contract with the lessor and hence, in principle, only a delictual claim is available to them. On the other hand, one could assert that the lease in question constitutes a contract with protective effect for a third party (i.e. the lessee’s family members) under LOA § 81. *49 However, as pointed out above, the fact that in Germany, the institution of contracts with protective effect for third parties is very often used even for the compensation for damage from violation of absolute legal rights, in order to make up deficiencies in the German law of delict, especially those arising from BGB § 831. *50 The same applies to other countries where contracts with protective effect for third parties exist, in particular Austria and France: there, too, the institution in question is aimed at compensating for certain deficiencies in the law of delict. *51 As shown above, such deficiencies practically do not exist in the Estonian law of delict and thus there is no need to protect absolute legal rights through the institution of contracts with protective effect for third parties. All the more so as due to the principle of non-cumul provided in LOA § 1044 (2), serious problems would ensue in Estonia from the fact that the third party protected by the contract will depend on the limit of liability agreed between the parties in the contract. *52 If the debtor’s liability has been e.g. quantitatively limited by the contracting parties, such limit of liability would also apply to the third party, which, in turn, would deprive the third party of a delictual claim in the event of damage to property, due to LOA § 1044 (2). This would produce an obviously unfair result, whereby the third party holding a claim under LOA § 81 would be in a worse situation than a person who is not entitled to a contractual claim and who could therefore assert a claim to the full extent under LOA §§ 1043 et seqq.!

Hence, the above reasons lead to the position that in Estonian law, LOA § 81 as a basis for claims in the event of damage to absolute legal rights will be out of the question and the scope of that institution must be limited to damage of a purely economic nature. *53 For our case of residential lease, this means that the health damage suffered by the lessee as well as the lessee’s children is subject to compensation pursuant to LOA §§ 1043 et seqq., and thus all persons will be treated as equal regardless of whether the injured party has a contract with the debtor or not.

6. As an aside: protection of the other party’s
absolute legal rights through culpa in contrahendo?

Lastly, it would be quite difficult not to touch on the question of the nature of culpa in contrahendo as a legal institution, which has recently been a subject of dispute in Estonian legal literature. The dispute has focused primarily on the question of whether liability arising out of precontractual negotiations should be qualified as delictual *54 or, rather, the contractual legal remedies provided in LOA §§ 100 et seqq. should be applied to it. *55 The author of this article is in favour of the position expressed by J. Lahe that in the event of breach of precontractual duties, LOA §§ 1043 et seqq. should apply, i.e. this would constitute a non-contractual liability. In any event, this is applicable to the duty to protect the other party’s absolute legal rights. Such legal rights must be, and as a rule they are, protected only through the law of delict. If a person opens a supermarket and its visitors happen to be hit by a falling shelf, the liability of the supermarket to those persons who intended to purchase something, i.e. were, so to say, in the process of precontractual negotiations, should not be different from its liability to such persons who did not intend to purchase anything or even could not purchase anything because of their restricted active legal capacity. One should rather take the position that the owner of the supermarket has a general duty of care in relation to all persons present, and upon violation of such duty, the owner’s delictual liability will ensue. *56  

In the author’s opinion, considering the structure of the Estonian law of obligations, liability based on culpa in contrahendo (LOA § 14) should actually be consequent on primarily just those cases for which it was initially developed by R. Jhering, i.e. as a sanction for precontractual negotiations conducted in bad faith. In no case should duties to protect the other party’s absolute legal rights be derived from that obligation through LOA § 2 (2). Such protection obligations are known only in the legal orders of Germany, Austria and Greece, and in all of those countries, the development of such duties has resulted from the deficiencies in the law of delict that have already been mentioned above. *57 Inasmuch as in the Estonian law of delict, absolute legal rights are protected to a sufficient degree, a concept of delictual duties of care should rather be developed by the judicial practice: the need for and possibility of that have already been repeatedly stressed in Estonian legal literature. *58