The First Chamber of Mexico’s Supreme Court (the “Court”) issued a decision by which it clarified the limits to the freedom of contract principle in a supply agreement.

A supply agreement entails the periodic delivery of goods by a supplier to a client, in exchange of a consideration in cash.

It is common practice that the parties to supply agreements keep the right to early terminate unilaterally the contract, without the other party’s permission or the need of a court relief. Likewise, clients usually want to leave an open door to replace the supplier in case they find a better offer from another vendor. They do so by including a clause in the agreement allowing clients to terminate it with no penalty.

Those provisions or sections are not limited to supply agreements, other kinds of contracts may also include clauses benefiting the party that has more leverage.

The Court’s decision

The Court studied a case where the terms and conditions to terminate a supply agreement were under review. The contract established that if the client received from a third party an offer to buy raw material at a cheaper price than the agreed with the supplier, then the client will give a notice to the supplier to confirm if the latter was able to match or improve the new offer.

The supplier had a 24-hour term to notify the client of its counteroffer, but if it did not, it was understood that the supplier could not match the offer and the client was enabled to terminate the contract before it expired.

During the constitutional trial the supplier argued that the compliance of the supply agreement was at the will of one of the parties, which is forbidden by the article 1797 of the federal civil code.

Thus, the fulfillment of the parties’ duties arising from the supply agreement was left at the client’s will, including the option for the agreement to be terminated unilaterally.

On the other hand, the Court examined whether the article 1797 might restrain the freedom of contract principle established in article 78 of the commercial code, which grants absolute freedom to the parties in a commercial contract to agree on the terms and conditions that they deem appropriate, without the validity of the agreement depending on specific formalities or requirements.   

The Court determined that the above principle has limits, that is, the respect of third parties’ rights and public order. The parties are free to agree on what is more convenient for their interests if they respect the law, and if their terms agreed are in line with public order as well as with the principle of equality in contracts.

Likewise, the Court confirmed that the section allowing any of the parties to early terminate the agreement was legal, because it did not breach any provision of public order.

On the other hand, the section allowing the client to early terminate the agreement if it found a more convenient tariff put the client in a stronger position with respect to the supplier, which as mentioned above is forbidden by article 1797 of the federal civil code.

The Court explained the scope of the term “informing” in the sense that the client should have let the supplier know all the elements of the new offer, such as the subject and price, who was the offeror, delivery and payment ways, quality of the materials, volume and so on. This with the aim that the supplier could really assess whether it was able to match the new offer.

In addition, the Court concluded that the 24-hour term given to the supplier to match or improve the offer was null and void, because the generic term in commercial law is of three days.

Does the Court’s decision apply to all types of commercial agreements?

The Court’s decision has the force of a jurisprudence, meaning that it is mandatory for federal and state lower courts. Hence, we should take it into account when drafting and interpreting commercial contracts. However, we should also review each business transaction on a case-by-case basis because the Court’s decision will not necessarily apply to all commercial agreements.

The above jurisprudence might apply to certain contracts, like supply contracts, which although they are listed and regarded in the law as commercial acts, unlike other contracts such supply agreements are not fully regulated by the law.

While the jurisprudence refers to all types of commercial contracts and does not mention that it will only cover supply agreements, that was to be expected because it is not the Court’s responsibility to give an opinion on acts that were not reviewed by it.

The Mexican law does completely regulate other contracts, more specifically credit contracts and security agreements. Such regulation includes more favorable rights to creditors than to debtors. In these cases, a contractual imbalance between both creditors and debtors is fully justified.

If the creditor did not have the certainty that in case the debtor defaults, the client could exercise the rights contemplated in the law to recover its investment, I doubt that any creditor would lend money under these circumstances.

Even the law allows to enforce through a summarized and special out-of-court proceeding certain security agreements such as the pledge without transfer of possession and the security trust agreement under specific legal conditions. In general terms according to Mexican law, no person is allowed to take justice into one’s own hands but he or she shall follow a legally established proceeding before a court. Therefore, the possibility to enforce an agreement through an out-of-court special proceeding is a privilege that some creditors have.

Therefore, an imbalance of rights between the parties in those types of commercial transactions is fully justified.

Final remarks

The Court’s decision should not be considered applicable in all types of commercial contracts.

On the one hand, there are business transactions such as supply agreements where the jurisprudence application will be mandatory. On the other hand, there are others where the scope of application of the Court’s decision will be more restricted.

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