Networks of Collaborative Contracts for Innovation 9781509929962, 9781509929993, 9781509929986

Table of contents :
Contents
Table of Cases
Introduction
I. Inter-firm Collaborative Innovation: The Practices, Contractual Models and Legal Challenges
II. The Rise of Collaborative Contractual Networks for the Production of Innovation: Challenges and Opportunities
III. What Role for the Law in Collaborative Contractual Networks?
IV. The Plan of the Book
1. Contractual Networks to Innovate: The Search for a Legal Concept
I. The Business Reality: Contractual Networks Versus the Traditional Legal Concepts
II. Building a Concept of Contractual Networks Adapted to the Distinctive Character of Productive Networks
III. Conclusion: The Working Concept of Contractual Networks for Innovation
2. The Internal Coordination of the Collaborative Contractual Network through Governance of Contract
I. Re-Interpreting Contractual Networks' Internal Challenges for Innovation Practices
II. Governance Mechanisms in Contractual Networks for Innovation
III. Evidence from Collaborative Contractual Networks for Innovation in Brazil
IV. Inter-firm Innovation in England
V. Conclusion
3. Managing the Internal Coordination of the Network: The Role of the Legal Doctrine and the Duty of Loyalty to the Network
I. The Legal Doctrine Regarding Contractual Networks: A Comparative Perspective
II. Duties of the Members of the Network: The Proposal of a Duty of Loyalty or Sincere Cooperation towards the Network
III. Conclusion: Finding a Duty of Loyalty to the Network/Collaborative Project under English and Brazilian Law
4. Legal Interpretation in Contracts to Innovate: Potential Matters of Dispute
I. Duty to Share Information
II. Duty of Non-Discrimination in the Collaborative Contractual Network
III. Sharing of Profits
IV. Termination: Potential Design and 'Fundamental Breach'
V. Conclusions
5. Conclusion
I. The Reverberations of Varieties of Capitalism on Inter-firm Innovation
II. The Relevance of a Comparative Perspective
III. The Role of Legal Studies: Institutional Imagination of Potential Forms of Contractual Collaboration
Bibliography
Index

Citation preview

NETWORKS OF COLLABORATIVE CONTRACTS FOR INNOVATION With the rise of automation and artificial intelligence, the companies that will succeed in the future are those who operate under a constant state of innovation. Not just that, they will often need to ensure that they pursue ‘open innovation’. This book explores the contractual basis for innovation, examining the legal challenges raised by contracts to innovate. Offering a dual perspective, it takes an empirical approach to assess how agreements are structured to overcome the inherent uncertainty implicit in innovative activity. It also presents a legal framework for contracts to innovate, based on the duty of loyalty to the contractual network, which could provide guidance for navigating the uncertainty of these relationships. International Studies in the Theory of Private Law: Volume 14

International Studies in the Theory of Private Law This series of books edited by a distinguished international team of legal scholars aims to investigate the normative and theoretical foundations of the law governing relations between citizens. The context for such investigations of private law systems is set by important modern tendencies in systems of governance. The advent of the regulatory state marks the withdrawal of the state from direct control and management of social and economic activity, and the adoption instead of procedural regulation and co-regulatory strategies that promote the use of private law techniques of ordering and self-regulation in social and economic interactions between citizens. The tendency known as globalisation and the corresponding increases in cross-border trade produce the responses of transnational regulation of commerce and private governance regimes, and these new systems of governance challenge the hegemony of traditional national private law systems. Furthermore, these tendencies towards transnational governance regimes compel an interaction between different national legal traditions, with their differences in culture and philosophy as well as their differences based upon variations in market systems, which provokes questions not only about competing policy frameworks but also about the nature and adequacy of different kinds of legal reasoning. The series encompasses a diverse range of theoretical approaches in the examination of these issues including approaches using socio-legal methods, economics, critical theory, systems theory, regulation theory, and moral and political theory. With the aim of stimulating an international discussion of these issues, volumes will be published in Germany, France, and the United Kingdom in one of the three languages. Editors Hugh Collins, London School of Economics Christian Joerges, University of Bremen Antoine Lyon-Caen, Université de Paris X-Nanterre Horatia Muir Watt, Université de Paris I Gunther Teubner, Frankfurt University James Q Whitman, Yale Law School, New Haven CA Volumes published with Hart Publishing, Oxford 1. 2. 3. 4. 5. 6.

David Campbell, Hugh Collins und John Wightman (eds), Implicit Dimensions of Contract: Discrete, Relational and Network Contracts (2003) Christian Joerges, Inger-Johanne Sand and Gunther Teubner (eds), Transnational Governance and Constitutionalism (2004) Oren Perez, Ecological Sensitivity and Global Legal Pluralism: Rethinking the Trade and Environment Debate (2004) Harm Schepel, The Constitution of Private Governance (2004) Nili Cohen and Ewan McKendrick, Comparative Remedies for Breach of Contract (2005) Marc Amstutz and Gunther Teubner (eds), Networks: Legal Issues of Multilateral Co-operation (2010)

7. 8. 9. 10. 11. 12. 13. 14.

Gunther Teubner (edited and with an Introduction by Hugh Collins), Networks as Connected Contracts (2010) Christian Joerges and Josef Falke (eds), Karl Polanyi, Globalisation and the Potential of Law in Transnational Markets (2011) Poul F Kjaer, Gunther Teubner and Alberto Febbrajo (eds), The Financial Crisis in Constitutional Perspective: The Dark Side of Functional Differentiation (2011) Jean Braucher, John Kidwell and William C Whitford (eds), Revisiting the Contracts Scholarship of Stewart Macaulay: On the Empirical and the Lyrical (2013) Thomas Dietz, Global Order Beyond Law: How Information and Communication Technologies Facilitate Relational Contracting in International Trade (2014) Anna Beckers, Enforcing Corporate Social Responsibility Codes: On Global SelfRegulation and National Private Law (2015) Nahel Asfour, Wrongful Enrichment: A Study in Comparative Law and Culture (2017) Pablo Marcello Baquero, Networks of Collaborative Contracts for Innovation (2020)

Volumes published in German by Nomos Verlagsgesellschaft, Baden-Baden 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

14. 15.

Peer Zumbansen, Ordnungsmuster im modern Wohlfahrtsstaat: Lernerfahrungen zwischen Staat, Geseelschaft und Vertrag (2000) Dan Wielsch, Freiheit und Funktion: Zur Struktur- und Theoriegeschichte des Rechts der Wirtschaftsgesellschaft (2001) Marc Amstutz, Evolutorisches Wirtschaftsrecht: Vorstudien zum Recht und seiner Methode in den Diskurskollisionen der Marktgesellschaft (2001) Christian Joerges and Gunther Teubner, Gunther (eds), Rechtsverfassungsrecht: Recht-Fertigungen zwischen Sozialtheorie und Privatrechtsdogmatik (2003) Gunther Teubner, Netzwerk als Vertragsverbund: Virtuelle Unternehmen, Franchising, Just in Time in sozialwissenschaftlicher und juristischer Sicht (2004) Daniel Dédeyan, Macht durch Zeichen: Rechtsprobleme der Kennzeichnung und Zertifikation (2004) Dietrich Claus Becker, Von Namen und Nummern: Kollisionen unverträglicher Rechtsmassen im Interent (2005) Vagias Karavas, Digitale Grundrechte: Elemente einer Verfassung des Informationsflusses im Intenet (2007) Peter Korth, Dritthaftung von Ratingagenturen (2009) Cordula Heldt, Baukooperation und Franchising als multilaterale Sonderverbindung. Vertragsnetzwerke – Parallelschuldverhältnisse – Personengesellschaften (2010) Jan Lüsing, Die Pflichten aus culpa in contrahendo und positiver Vertragsverletzung (§ 241 II BGB): Über den hybriden Charakter der Schutzpflichten und zur Selbstbindung ohne Vertrag (2010) Moritz Renner, Zwingendes transnationales Recht: Elemente einer Wirtschaftsverfassung jenseits des Staates (2011) Christoph Lüscher, Zur Konzeptualisierung von Verbrauchervertragsrecht unter besonderer Berücksichtigung des schweizerischen und europäischen Verbrauchervertragsrechts. Eine Untersuchung im Schnittfeld von Vertragsrecht, Systemtheorie und Ökonomie (2011) Daniel Klösel, Compliance-Richtlinien. Zum Funktionswandel des Zivilrechts im Gewährleistungsstaat (2012) Chunyi Qi, Rechtstransfer in Chinas Produktionsregime? Zur Kontrolle der ­Allgemeinen Geschäftsbedingungen im deutschen und chinesischen Recht (2013)

iv

Networks of Collaborative Contracts for Innovation Pablo Marcello Baquero

HART PUBLISHING Bloomsbury Publishing Plc Kemp House, Chawley Park, Cumnor Hill, Oxford, OX2 9PH, UK 1385 Broadway, New York, NY 10018, USA HART PUBLISHING, the Hart/Stag logo, BLOOMSBURY and the Diana logo are trademarks of Bloomsbury Publishing Plc First published in Great Britain 2020 Copyright © Pablo Marcello Baquero, 2020 Pablo Marcello Baquero has asserted his right under the Copyright, Designs and Patents Act 1988 to be identified as Author of this work. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publishers. While every care has been taken to ensure the accuracy of this work, no responsibility for loss or damage occasioned to any person acting or refraining from action as a result of any statement in it can be accepted by the authors, editors or publishers. All UK Government legislation and other public sector information used in the work is Crown Copyright ©. All House of Lords and House of Commons information used in the work is Parliamentary Copyright ©. This information is reused under the terms of the Open Government Licence v3.0 (http://www.nationalarchives.gov.uk/doc/ open-government-licence/version/3) except where otherwise stated. All Eur-lex material used in the work is © European Union, http://eur-lex.europa.eu/, 1998–2020. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication data Names: Baquero, Pablo Marcello, author. Title: Networks of collaborative contracts for innovation / Pablo Marcello Baquero. Description: Oxford, UK ; New York, NY : Hart Publishing, 2020.  |  Series: International studies in the theory of private law ; volume 114  |  Based on author’s thesis (doctoral - University of Cambridge, 2018).  |  Includes bibliographical references and index. Identifiers: LCCN 2020015540 (print)  |  LCCN 2020015541 (ebook)  |  ISBN 9781509929962 (hardcover)  |  ISBN 9781509929986 (ePDF)  |  ISBN 9781509929979 (EPub) Subjects: LCSH: Technological innovations—Law and legislation.  |  Business networks—Law and legislation.  |  Contracts. Classification: LCC K487.T4 B37 2020 (print)  |  LCC K487.T4 (ebook)  |  DDC 344/.095—dc23 LC record available at https://lccn.loc.gov/2020015540 LC ebook record available at https://lccn.loc.gov/2020015541 ISBN: HB: 978-1-50992-996-2 ePDF: 978-1-50992-998-6 ePub: 978-1-50992-997-9 Typeset by Compuscript Ltd, Shannon

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Contents Table of Cases��������������������������������������������������������������������������������������������� xi Introduction��������������������������������������������������������������������������������������������������1 I. Inter-firm Collaborative Innovation: The Practices, Contractual Models and Legal Challenges���������������������������������������1 A. Inter-firm Collaboration in the Global Productive Vanguards: Challenges for Legal Studies�����������������������������������1 B. Models of Inter-firm Cooperation: Modular, Relational and Co-creation�����������������������������������������������������������������������6 C. Rethinking Contracting Practices and Private Law for Collaborative Co-creation��������������������������������������������������������9 D. Experimentalism in Contractual Practices�������������������������������12 II. The Rise of Collaborative Contractual Networks for the Production of Innovation: Challenges and Opportunities���������������14 A. The Social Problem: De-verticalisation of Productive Activities in the New Economy�����������������������������������������������14 B. Economic Importance: Overcoming the Stagnation of Productivity Growth and Bridging the Gap between Developed and Developing Economies������������������������������������16 III. What Role for the Law in Collaborative Contractual Networks?�����18 A. The Context: The Challenges for Contractual Networks in an Economic and Sociological Perspective���������������������������18 B. What Role for the Law?����������������������������������������������������������22 IV. The Plan of the Book���������������������������������������������������������������������27 1. Contractual Networks to Innovate: The Search for a Legal Concept�������30 I. The Business Reality: Contractual Networks Versus the Traditional Legal Concepts������������������������������������������������������������32 A. The Phenomena of Contractual Networks: Neither Contract nor Corporation������������������������������������������������������32 B. Between or ‘Beyond’ Contract and Corporation: Other Possible Legal Classifications����������������������������������������35 II. Building a Concept of Contractual Networks Adapted to the Distinctive Character of Productive Networks��������������������������������43 A. Main Features of Productive Networks: Designing a Concept of Contractual Networks������������������������������������������43 B. Legal Constructs Proposed to Govern Contractual Networks: Considering the Reality of Productive Networks����45

viii  Contents III. Conclusion: The Working Concept of Contractual Networks for Innovation�������������������������������������������������������������������������������50 2. The Internal Coordination of the Collaborative Contractual Network through Governance of Contract���������������������������������������������56 I. Re-Interpreting Contractual Networks’ Internal Challenges for Innovation Practices�����������������������������������������������������������������57 II. Governance Mechanisms in Contractual Networks for Innovation�������������������������������������������������������������������������������������59 A. Limitations of Traditional Contract Design����������������������������59 B. The Governance of Inter-firm Innovation��������������������������������62 III. Evidence from Collaborative Contractual Networks for  Innovation in Brazil�����������������������������������������������������������������������85 A. Background to the Empirical Field and Methodology�������������86 B. First Stage of Interviews���������������������������������������������������������88 C. Second Stage of Interviews�����������������������������������������������������91 IV. Inter-firm Innovation in England����������������������������������������������������99 A. Evidence from Legal Studies���������������������������������������������������99 B. Collaborative Arrangements in Construction in the UK: Standard Agreements and Megaprojects������������������������������� 101 V. Conclusion���������������������������������������������������������������������������������� 110 3. Managing the Internal Coordination of the Network: The Role of the Legal Doctrine and the Duty of Loyalty to the Network����������������� 115 I. The Legal Doctrine Regarding Contractual Networks: A Comparative Perspective����������������������������������������������������������� 118 A. US Braiding Theory – ‘Low-powered Enforcement’ and Critique������������������������������������������������������������������������� 119 B. European Private Law���������������������������������������������������������� 122 C. Brazilian Law����������������������������������������������������������������������� 123 D. The Possibility of Low-Powered Enforcement under English and Brazilian Law���������������������������������������������������� 126 E. The Legal Concept of Relational Contract in English Law���� 134 II. Duties of the Members of the Network: The Proposal of a Duty of Loyalty or Sincere Cooperation towards the Network������ 143 A. The Proposal and the Justification of a Duty of Loyalty or Sincere Cooperation towards the Network������������������������ 144 B. Other Distinct Concepts in Comparative Private Law������������ 147 C. A Duty of Loyalty to the Common Objective of the Collaborative Project������������������������������������������������������������ 156 III. Conclusion: Finding a Duty of Loyalty to the Network/ Collaborative Project under English and Brazilian Law����������������� 159

Contents  ix 4. Legal Interpretation in Contracts to Innovate: Potential Matters of Dispute������������������������������������������������������������������������������������������� 162 I. Duty to Share Information����������������������������������������������������������� 163 A. Prelude: Constant Exchange of Information and Heightened Duties of Cooperation in Collaborative Networks����������������������������������������������������������������������������� 163 B. Case Law����������������������������������������������������������������������������� 164 C. English Law������������������������������������������������������������������������� 166 D. Duty to Provide Information under Brazilian Law����������������� 172 E. Identifying Criteria to Assess the Potential Intensification of Duties to Disclose Information under English and Brazilian Law����������������������������������������������������������������������� 176 F. Braiding Responses to Allocation of Information through Governance Mechanisms����������������������������������������� 178 II. Duty of Non-Discrimination in the Collaborative Contractual Network�������������������������������������������������������������������������������������� 181 A. Prelude: Similar Opportunities for Competing Companies in Quasi-organisational Collaborative Ventures?������������������� 181 B. Integrated Distribution Networks with Collaborative Duties and Sharing of Risks and Profits�������������������������������� 183 C. English Law������������������������������������������������������������������������� 185 D. Brazilian Law����������������������������������������������������������������������� 189 E. Criteria to Identify an Unjustifiable Discrimination in the Network��������������������������������������������������������������������� 192 F. Governance to Prevent Abusive Discrimination��������������������� 195 III. Sharing of Profits������������������������������������������������������������������������� 197 A. Introduction������������������������������������������������������������������������� 198 B. Case Law����������������������������������������������������������������������������� 200 C. English Law������������������������������������������������������������������������� 203 D. Brazilian Law����������������������������������������������������������������������� 207 E. The Sharing of Profits: What Role for the Courts������������������ 210 F. Governance Mechanisms: Profit-sharing Agreements, Relational Incentives, Target Costing and Open-Book Management������������������������������������������������������������������������ 211 IV. Termination: Potential Design and ‘Fundamental Breach’������������� 213 A. Prelude: Distinctiveness of Termination in Collaborative Contractual Networks���������������������������������������������������������� 213 B. Contractual Termination and Material Breach in Experimental Innovative Relationships��������������������������������� 215 C. English Law������������������������������������������������������������������������� 217 D. Brazilian Law����������������������������������������������������������������������� 224 E. Criteria of Interpretation and Governance���������������������������� 228 V. Conclusions�������������������������������������������������������������������������������� 229

x  Contents 5. Conclusion������������������������������������������������������������������������������������������ 231 I. The Reverberations of Varieties of Capitalism on Inter-firm Innovation����������������������������������������������������������������������������������� 231 II. The Relevance of a Comparative Perspective�������������������������������� 233 III. The Role of Legal Studies: Institutional Imagination of Potential Forms of Contractual Collaboration�������������������������������������������� 235 Bibliography���������������������������������������������������������������������������������������������� 238 Index��������������������������������������������������������������������������������������������������������� 249

Table of Cases UNITED KINGDOM

Aas v Benham [1891] 2 Ch 244������������������������������������������������������������������� 171 Al Nehayan v Kent [2018] EWCH 333 (Comm)����������������������������� 130, 139–40 Attorney General v Blake [2000] UKHL 45, [2001] 1 AC 2��������������������������� 205 Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10 �������������� 160 Stenhouse Australia v Philips [1974] AC 391����������������������������������������������� 187 Baird Textile Holdings Ltd v Marks & Spencer plc [2001] EWCA Civ 274������������������������������������������������������������������������������138, 177 Banque Financière de la Cité v Parc (Battersea) Ltd [1999] 1 AC 221������������ 204 Banwaitt v Dewji [2013] EWHC 879 (QB) ������������������������������������������������� 170 Barbudev v Eurocom Cable Management Bulgaria EOOD [2012] EWCA Civ 548������������������������������������������������������������������������������������� 128 Bates v Post Office Ltd (No 3) [2019] EWHC 606 (QB)�������������������������139, 141 Boardman v Phipps [1967] 2 AC 46������������������������������������������������������������� 155 Dalkia Utilities Services plc v Celtech International Ltd [2006] EWHC 63���������������������������������������������������������������������������������� 218 Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1967] 1 All ER 699 ���������������������������������������������������������������������������������������� 188 Fortman Holdings Ltd v Modem Holdings Ltd [2001] EWCA Civ 1235����������������������������������������������������������������������������������������������� 218 Glolite Ltd v Jasper Conran Ltd (1998) The Times, 28 January 1998 10������� 218 Hare v Nicholl [1966] 1 All ER 285������������������������������������������������������������� 221 Hodson v Hodson [2009] EWCA Civ 1042, [2009] All ER (D) 168 (Oct)������������������������������������������������������������������� 203 ING Bank NV v Ros Roca SA [2011] EWCA Civ 353���������������������������������� 170 Investment Trust Companies (In Liquidation) v HMRC [2017] UKSC 29������������������������������������������������������������������������������������ 204 Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] UKHL 28���������������������������������������������������136, 159 L Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235���������������� 221 M Young Legal Associates Ltd v Zahid and others [2006] EWCA Civ 613, [2006] All ER (D) 227 (May) ���������������������������������������� 203 Macaulay v Schroeder Music Publishing Co Ltd [1974] 1 WLR 1308������������������������������������������������������������������������������� 188 MRI Trading AG v Erdenet Mining Corp LLC [2013] EWCA Civ 156; [2013] 1 CLC 423; [2013] 1 Lloyd’s Rep 76�������������129, 131

xii  Table of Cases National Power plc v United Gas Company Ltd [1998] All ER (D) 321���������������������������������������������������������������������������� 218 Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535����������������������������������������������������������������������������������187–88 Petromec Inc v Petroleo Brasileiro [2006] 1 Lloyd’s Rep 121�������������������129, 131 Pitt v PHH Asset Management Ltd [1994] 1 WLR 327�������������������������������� 129 Popat v Shonchhatra [1997] 1 WLR 1367 (CA) ������������������������������������������� 203 Printers & Finishers Ltd v Holloway (No 2) [1965] 1 WLR 1����������������������� 187 Ross River Ltd v Cambridge City Football Club Ltd [2007] EWHC 2115 (Ch), [2008] 1 All ER 1004������������������������������������������������ 170 Shell UK Ltd v Lostock Garages Ltd [1976] 1 WLR 1187����������������������������� 188 Staffordshire Area Health Authority v South Staffordshire Waterworks Co [1978] 1 WLR��������������������������������������������������������������������������������������� 223 Stoomvaart Maatschappij Nederlandsche Lloyd v General Mercantile Co Ltd (The Olanda) [1919] 2 KB 728n ������������������������������� 205 Stenhouse Australia v Philips [1974] AC 391����������������������������������������������� 187 Taylor v Motability Finance Ltd[2004] EWHC 2619 (Comm)��������������������� 205 Union Eagle Ltd v Golden Achievement Ltd [1997] 2 All ER 215����������������� 221 United Scientific Holdings Ltd v Burnley Borough Council [1978] AC 904��������������������������������������������������������������������������������������� 221 Walford v Miles[1992] 2 AC 128������������������������������������������������������������128–29 Winter Garden Theatre (London) Ltd v Millennium Productions Ltd [1948] AC 173�������������������������������������������������������������� 223 Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111����������������������������������������� 130, 139–41, 152, 167–69, 171 BRAZIL

Superior Court of Justice, Interlocutory appeal in Special Appeal No 601234, Third Chamber, Justice Marco Belizze, judged on 12/05/2015���������������������������������������������������������������������������� 172 Superior Court of Justice, Interlocutory appeal in Special Appeal No 415244, Fourth Chamber, Justice Minister Antonio Carlos Ferreira, judged on 07/05/2015���������������������������������������������������������������������������� 172 Superior Court of Justice, Special Appeal No 1426857/RJ, Fifth Chamber, Justice Regina Helena Costa, judged on 13/05/2014������������������������������� 193 Superior Court of Justice, Special Appeal No 1259210/RJ, Third Chamber, Justice Nancy Andrighi, judged on 26/06/2012��������������������������������������� 173 Superior Court of Justice, Special Appeal No 1214318/RJ, Third Chamber, Justice Sidnei Beneti, judged on 12/06/2012�������������������������������������������� 174 Superior Court of Justice, Special Appeal No 401.704, Fourth Chamber, Justice Honildo Castro, published on 02/09/2009����������������������������������� 225

Table of Cases  xiii Superior Court of Justice, Special Appeal No 586.316/MG, Second Chamber, Justice Herman Benjamin, judged on 17/04/2007�������� 172 Superior Court of Justice, Special Appeal No 605157, Third Chamber, Justice C. A. Menezes Direito, judged on 07/06/2005����������������������������� 208 Paraná Court of Appeals, Appeal No 0244067-7, Seventh Civil Chamber, Judge Laertes de Oliveira, judged on 18/12/2003������������������������������������ 224 Rio Grande do Sul Court of Appeals, Civil Appeal No 70047383237, Ninth Civil Chamber, Judge. I Nogueira, judged on 14/08/2013������������� 225 Rio Grande do Sul Court of Appeals, Civil Appeal No 1900001297, Third Civil Chamber, Judge Araken de Assis, judged on 28/08/1990 ��������������������������������������������������������������������������� 224 CASES FROM OTHER JURISDICTIONS

Germany BGH (1993) VIII ZR 47/92������������������������������������������������������������������������� 183 BGH (1999) 52 NJW 2671�������������������������������������������������������������������������� 200 BGH (2003) 57 BB 2254 and 2258, and KZR 29/02�������������������������������������� 201 BGH (2002) NJW RR 1554 at 1556������������������������������������������������������������� 202 US Eli Lilly & Co v Emisphere Technologies, Inc, 408 F Supp 2d 668 (SD Ind 2006)�������������������������������� 121, 165, 171, 177–78 In the Matter of Intel Corporation (1999), Administrative Complaint, available at https://www.ftc.gov/enforcement/ cases-proceedings/951-0028/intel-corporation-matter-1999�������������������� 165 In the matter of the Arbitration between Pharmacia & Upjohn Co v Elan Pharmaceuticals, 781 N YS 2d 95 (2004)�������������������� 164 Pharmacia & Upjohn Co v Elan Pharmaceuticals, 781 N YS 2d 95 (2004)��������������������������������������������������������������������������� 164 Static Control Components v Mitsubishi Kagaku Imaging Corp, 2007 WL 586710 (MD NC)�������������������������������������������� 164 European Courts Racke v Hauptzollamt Mainz, C-162/96, EU:C:19�������������������������������������� 157 Case 56/65 STM v Maschinenbau Ulm [1966] ECR 234������������������������������ 186 Joined Cases 56 & 58/64 Consten and Grundig [1966] ECR 299 ����������������� 186 126/80 Salonia v Poidomani [1981] ECR 1563��������������������������������������������� 186

xiv  Table of Cases New Zealand Dymocks Franchise Systems (NSW) Py Ltd v Todd [2002] UKPC 50 (7 October 2002)����������������������������������������������������������������������������������� 206 South Africa Seven Eleven Corporation of SA (PTY) Ltd v Cancun Trading No 150 CC, Case No 108/2004, 24 March 2005���������������������������������205–06

Introduction Indeed, my view is that the competitiveness rules of the fourth industrial revolution economy are different from previous periods. To remain competitive, both companies and countries must be at the frontier of innovation in all its forms, which means that strategies which primarily focus on reducing costs will be less effective than those which are based on offering products and services in more innovative ways … The companies that survive or thrive will need to maintain and continually sharpen their innovative edge. Klaus Schwab, The Fourth Industrial Revolution (Penguin, 2017) 33–34, 51.

I.  INTER-FIRM COLLABORATIVE INNOVATION: THE PRACTICES, CONTRACTUAL MODELS AND LEGAL CHALLENGES

A.  Inter-firm Collaboration in the Global Productive Vanguards: Challenges for Legal Studies

T

he most advanced practices of production in current times find themselves hardly accessible to the majority of the global workforce and firms in the market economy, particularly to those outside metropolitan regions in the world.1 In the firms typical of the so-called knowledge or experimental economy,2 dispersed throughout the world yet connected to each other,3 production has been rearranged to become a practice of constant learning. Faster innovation cycles have rendered higher knowledge and technology unable to sustain competitive advantages over extended periods of time: the ability to learn, to experiment, to innovate constantly, rapidly and reliably has become the central value in the production of advanced innovation in these vanguards.4 1 RM Unger, The Knowledge Economy (Verso 2019) 1 ff; on the adverse economic impact of technological advancements in global value chains for developing countries, see D Rodrik, ‘New Technologies, Global Value Chains, and the Developing Economies’ (2018) 1 Pathways for Prosperity Commission Background Paper Series 1, 8. 2 Examining the contrasting culture and productive practices in two different regions, one more representative of the collaborative knowledge economy (Silicon Valley) and the other of more vertical and competitive traditional production practices (Route 128), see AL Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128 (Harvard University Press 1996). 3 On the dispersion of productive vanguards throughout the world, often connected to each other (through ‘brain circulation’), see AL Saxenian, The New Argonauts: Regional Advantage in a Global Economy (Harvard University Press 2007). 4 C Sabel and M Dorf, ‘A Constitution of Democratic Experimentalism’ (1998) 98 Columbia Law Review 267, 292 ff.

2  Introduction The majority of firms lack the economic and technological capabilities to participate in the practices of the knowledge economy, a segment of the economy operating under constant innovation which thrives in terms of productivity, profitability and creativity. This productive or technological dualism between a vanguard and a rearguard productive sector5 is seen as a crucial reason for the rising inequality and exclusion in the contemporary market economy.6 In this context, it has become a central issue to examine how political, social and legal institutions can promote these vanguardist practices of production in an inclusive way,7 allowing most workers and firms to benefit from them.8 Indeed, we ‘live in an age of paradox’: practices of permanent innovation and emerging technologies (such as artificial intelligence) have escalated advances in production and paved the way for new discoveries. Yet, in many countries, this reality is matched by a decline in productivity growth and by increasing economic inequality.9 This circumstance seems to be growingly explained by an insufficient diffusion of the most advanced practices of innovation and of the capabilities needed to generate benefits from them. While the experimental practices of production for continuous innovation are often observed in the high-technology sectors (such as robotics, nanotechnology or digital technologies), due to the pressing commercial dependence on continuous discoveries, those practices can be replicated in any industry,

5 RM Unger, Democracy Realized: The Progressive Alternative (Verso 1998) 30 ff. 6 D Rodrik, and CF Sabel, Building a Good Jobs Economy (2019) HKS Working Paper No. RWP20-001. 7 This book follows the perspective that political and social institutions have a determining role in shaping how technology will affect the economy rather than viewing technology as an exogenous factor that has an unmediated economic effect, which is independent from the institutional background. In that sense, see Y Benkler, ‘A Political Economy of Oligarchy: Winner-Take-All Ideology, Superstar Norms, and the Rise of the 1%’ (2017) 4 www.benkler.org/Political%20economy%20 of%20oligarchy%2001.pdf. 8 Examining the notion of technology-skill complementarity to explain the sharp rise in wage and income inequality in the past years, according to which ‘technical change favors more skilled (educated) workers, replaces tasks previously performed by the unskilled, and increases the demand for skills’, which would be growingly consensual among economists, see D Acemoglu, ‘Technology and Inequality’ (2003) NBER Reporter. 9 Analysing this issue in the context of the United States, see E Brynjolfsson, D Rock and C Syverson, ‘Artificial Intelligence and the Modern Productivity Paradox: A Clash of Expectations and Statistics’ (NBER 2017) w24001; regarding particularly artificial intelligence (AI) technologies – but with a logic that can be easily extended to many other advanced technology sectors – it has been noted that while AI increases productivity and economic growth, it also generates economic inequality, first, by concentrating crucial knowledge, technology and capital in the hands of a few firms and highly skilled workers; second, by directing most rewards to the top firms and workers that outperform others in the market (winner-takes-all dynamics); and, third, by minimising the number of human workers needed to perform certain activities. These challenges tend to generate scepticism regarding the potential benefits that AI might bring to the general working population. See A Dafoe, ‘AI Governance: A Research Agenda’ (Future of Humanity Institute 2018) 37 ff.

Inter-firm Collaborative Innovation  3 throughout all economic sectors, not only in manufacturing.10 Such practices can be found, for instance, in deep mining and to deploy drones for precision agriculture,11 in traditional industries such as construction12 and automobile,13 in supply chains for producing high-quality refined coffee,14 or in just-in-time distribution systems or virtual enterprises.15 In most economic sectors and industries, however, experimental practices of production represent a fringe of the activities undertaken.16 Even within an innovative firm or supply chain, there is a phenomenon of hyper-insularity of the knowledge economy: ‘[f]or ­example, a few thousand people in California arrange for hundreds of thousands of people in China to execute the routinized parts of their production plan.’17 An innovative company retains control over the most innovative and value-added activities of a production chain and outsources to third companies the least valuable activities, often in developing countries. This book is about how these advanced practices of production are contractually structured and the challenges they present to the field of contract law. More than simply providing a legal account about contractual practices in a narrow and privileged fringe of the productive sector, the book aims to reflect on how the law can contribute to structure an inclusive market economy where the forms of contractual collaboration prone to generate innovation can be extended to more firms and workers. For this practice of constant innovation, the model of a firm embracing most of the activities in the production and distribution chain is no longer suitable.18 In the ‘New Economy’, companies no longer create products and provide services alone.19 Different tasks in the production process are attributed to different

10 C Sabel, ‘The New Organization of Production, Productive Development Policies and Job Creation or Thinking about Industrial Policy as Industry Becomes Less Central to Development’, Relations between productive development policies, jobs, wages and human resources. Brainstorming Session (2016) www2.law.columbia.edu/sabel/papers/Sabel%20New%20organization%20of% 20Production,%20PDPs%20and%20Job%20Creation.pdf. 11 ibid. 12 See ch 2, section IV, on standard collaborative construction contracts and megaconstruction projects in the UK. 13 On the Toyota production system, see W Simon, ‘Toyota Jurisprudence: Legal Theory and Rolling Rule Regimes’ in G De Búrca and J Scott (eds), Law and New Governance in the EU and the US (Hart Publishing 2006) 44 ff. 14 F Cafaggi and others, Accessing the Global Value Chain in a Changing Institutional Environment: Comparing Aeronautics and Coffee (IDB 2012) 52, 60 ff. 15 G Teubner, Networks as Connected Contracts (Hart Publishing 2011) 97 ff. 16 Unger (n 1) 53 ff. 17 ibid 59. 18 The so-called ‘Chandlerian Model’, see the seminal AD Chandler, The Visible Hand: The Managerial Revolution in American Business (Harvard University Press 1977). 19 M Castells, The Rise of the Network Society (2nd edn, Wiley-Blackwell 2009) 77 ff; RN Langlois, Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy (1st edn, Routledge 2014) 9.

4  Introduction independent firms, often located in different parts of the world, collaborating towards a final output. To remain at the frontier of knowledge, firms choose to focus on their expertise and collaborate with other companies to undertake lateral tasks.20 The ordinary, non-innovative tasks, are outsourced to the companies that offer the best cost–benefit ratio, sometimes to be found in developing countries offering little legal protection to workers and to the environment. However, for the development of innovative products and services, a partner with superior knowledge and technology is sought, with whom a process of co-creation of innovation can be pursued. In other words, there are different legal models to structure inter-firm collaboration. In this book, the most advanced form of cooperation is discussed: collaborative co-creation. Under this form of collaboration, often one or more of the following features are combined: companies jointly and constantly revise their conception for production and execution plans, they share technology and know-how, their employees work together directly on the same project and they may share productive capacities. They remain at once competitors in the market and co-operators on certain projects. Companies would not undertake such a complex form of cooperation if it were not for a commercial need. In the most intricate projects of innovation, parties’ chances of developing something truly innovative depends greatly on their ability to combine their expertise, to coordinate performances and to share risks. This form of co-creation is particularly present when the tasks are complex, involve advanced technology and a continuous search for innovation, and the final output and the production processes are often unpredictable at the beginning of the relationship between companies.21 What will be the contribution of each of the partners in developing an experimental pharmaceutical? How will they produce a new aircraft model of uncertain feasibility? The final concept of the product, its productive process, the general feasibility of a project and several terms of the parties’ agreement are open to change as the collaborative endeavour evolves. In different circumstances, distinct legal arrangements may prevail to structure collaborative relationships in a spectrum ranging from the traditional contract to some form of corporation.22 The growing tendency in highly uncertain projects involving co-creation of advanced innovation (not in all innovation projects), however, is to organise such productive activities in an intermediate 20 Reviewing the literature on practices of inter-firm collaborative innovation and peer production, Y Benkler, ‘Peer Production, the Commons, and the Future of the Firm’ (2017) 15 Strategic Organization 264, 270 ff. 21 RJ Gilson, CF Sabel and RE Scott, ‘Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration’ (2009) 109 Columbia Law Review 431, 431 ff. 22 P Krebs and others, ‘The Modular System of Network Activities’ in S Jung, P Krebs and G Teubner (eds), Business Networks Reloaded (1st edn, Nomos Verlagsgesellschaft mbH & Co KG 2015) 108–09.

Inter-firm Collaborative Innovation  5 point of this spectrum through networks of contracts.23 The collaborating companies remain independent, resisting any merger or the creation of a newco (at least initially24), yet collaborate almost as closely as if they were a single corporation. They evade the corporation logic by competing with each other, and often collaborate with other partners on similar projects. At the same time, their close relationship is more than that of traditional contract partners in a market exchange, because of their interdependence. Similarly, traditional forms of unincorporated joint ventures or partnerships, requiring one of the contractual partners to give precedence to his partners’ interests, hardly fit those innovative projects, which demand the freedom to experiment with competitors and outdo partners, if necessary.25 The underlying argument of this book is that the creation of such relationships for deploying advanced innovation depends, among other factors, on the creation of adequate legal institutions to support them. While contractual networks to innovate generate issues in different areas of the law, the focus is on the challenges of structuring inter-firm relationships through contract law. Thus, the objective of this book is to analyse whether and what adaptations the law of contract and contract governance require to deal with inter-firm transactions to collaboratively create advanced innovation, addressing this issue from the background perspective of English and Brazilian law. More specifically, it intends to examine what are the inter-firm contracting practices for structuring collaborations to generate advanced innovation under high uncertainty and whether there is a need to rethink legal doctrine in any sense for the purpose of dealing with these collaborative agreements. There are two main strands in the legal scholarship dealing with this subject. From the United States perspective, there is an emerging literature on contracts for innovation, assessing empirically how these contracts are structured, proposing that governance mechanisms can create and combine incentives to favour the cooperation of the parties in a highly uncertain context.26 An influential view in this strand of scholarship is that the legal doctrine has a limited role, since the parties themselves adopt governance mechanisms that allow for the constant specification of their obligations in these relationships. From the European perspective, a literature on contractual networks analyses how the legal doctrine should be adapted to deal with hybrid business

23 Organization for Economic Co-operation and Development (OECD), Open Innovation in Global Networks (OECD 2008) 9–10, www.oecd.org/sti/openinnovationinglobalnetworks.htm. 24 Often, networks of firms are organised initially under networks of contracts and then evolve into organisational or mixed networks, according to their suitability to fit the parties’ purpose. It is possible that, in evolving to an organisational network, the created new entity may integrate the contractual network. F Cafaggi, ‘Introduction’, Contractual Networks, Inter-Firm Cooperation and Economic Growth (1st edn, Edward Elgar 2011) 1–2. 25 Teubner (n 15) 120–22. 26 Notably, braiding theory, see Gilson, Sabel and Scott (n 21).

6  Introduction relationships, an intermediary category between contract and corporation. This literature proposes that the concept of a ‘duty of loyalty to the network’ should govern these relationships. This book, therefore, seeks to combine (and critically analyse) both perspectives as a way to approach networks of contracts to innovate. On one hand, it acknowledges, as proposed by braiding theory, that governance mechanisms combining formal and informal incentives are the main instrument to rule the cooperation between parties innovating collaboratively. On the other hand, however, it claims that there is a need to develop the contractual doctrine to determine what represents a substantial violation of these agreements, an issue little explored by braiding theory. For this purpose, it relies on studies on contractual networks, rethinking the contributions of this literature for the context of highly uncertain relationships deployed to pursue advanced innovation. This approach seeks to provide a more comprehensive perspective on both how these contracts to innovate are structured (and the governance mechanisms they employ) and how these agreements should be interpreted by potential adjudicators or what ‘shadow’ the law should project over these relationships, constraining or facilitating certain renegotiations between the contractual partners. B.  Models of Inter-firm Cooperation: Modular, Relational and Co-creation The models of inter-firm cooperation established in the context of global value chains are varied. According to the nature of the product being developed and its complexity, different models of cooperation are more suitable. Three main forms of collaboration can be identified: modular, relational and co-design (or iterative collaboration), the latter being the focus of this book.27 In the modular model, each party must provide a certain service or product that will be directly incorporated into the final output. Each company provides its own closed ‘module’, initially determined by the parties and produced independently. In the end, the modules are assembled to form a final product. In this situation, formal contracts will normally be sufficient for the parties to establish cooperation. The specifics of the module are established contractually, with acts of contractual violation detected with reasonable ease and predictable prices and terms. The difficulty with this model is that it may obstruct the parties’ efforts to improve the overall product, tying them to a second-best technology. As the parties are obliged to provide components with fixed features (which will be directly incorporated into the final product), this undermines their ability to improve them along the production process (as they discover better

27 C Sabel and J Zeitlin, ‘Neither Modularity nor Relational Contracting: Inter-Firm Collaboration in the New Economy’ (2004) 5 Enterprise and Society 388.

Inter-firm Collaborative Innovation  7 technologies through their problem-solving activities) or to correct p ­ otential inefficiencies. Thus, this model presents difficulties for parties seeking to innovate ­collaboratively. An alternative is the relational model, where parties establish continuous and more open cooperation, drafting vague and short contracts with few formal enforceable terms. In this situation, there are several uncertainties and contingencies that may arise in the parties’ relationship, which are often not predicted contractually. If controversy arises, most of the disputes among the parties are to be decided informally without judicial enforcement, except in cases of partial or complete breakdown of the relationship. The main incentives against opportunism and non-cooperative behaviour would be the moral concerns, the expectation for future deals with the other partner, as well as concerns as to their reputation in the market, which could be damaged if information about misbehaviour against their contractual partner were spread to other companies.28 While the relational model remains valid and efficient in some kinds of transaction, it is not the predominant model applicable for advanced innovation productive activities. This has been largely acknowledged by several studies, some of them based on empirical evidence to support their assertion.29 A number of reasons justify the inadequacy of the relational model for innovation. First, the fact that, given the significant size of preliminary investments required, parties are reluctant not to establish a more sophisticated legal machinery (including governance mechanisms) to protect their interests. Second, the high uncertainty involved in innovation can lead to misunderstandings regarding the behaviour of the other party (observability problem); it is difficult to determine whether it is duly cooperating (by experimenting) or whether it is defecting (evading its legal obligations).30 Simple relational incentives, which often serve the purpose of repeated rounds of cooperative interaction, may be insufficient when parties regulate relationships where they are constantly creating novel activities, for there will be a greater chance of them mischaracterising each other’s behaviour.31 Third, it is uncertain to what extent the reputational or business sanctions, crucial for the effectiveness of the relational model, remain valid in the context of transactions taking place at a global level, where companies are operating in large markets across different countries. Finally, selfregulation in long-term relationships between partners on the basis of social

28 S Macaulay, ‘Non-Contractual Relations in Business: A Preliminary Study’ (1963) 28 American Sociological Review 55. 29 GK Hadfield and I Bozovic, ‘Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation’ (2016) 5 Wisconsin Law Review 981; L Bernstein, ‘Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts’ (2015) 7 Journal of Legal Analysis 561; M Jennejohn, ‘The Private Order of Innovation Networks’ (2016) 68 Stanford Law Review 281. 30 RJ Gilson, CF Sabel and RE Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (2010) 110 Columbia Law Review 1377, 1392. 31 ibid 1397–98.

8  Introduction norms and reputation fails because it depends on mechanisms of punishment that, by themselves, contribute to destroying the basis of the relationship: trust and cooperation.32 The third model is co-design, or iterative collaboration. According to Gilson et al, contractual transactions to generate innovation share three different features.33 First, the project of an innovative product generated under a continuous process of high uncertainty that has a final output, price and process which are not definable at the outset. Second, the inability of just one firm to produce such innovation, thus requiring inter-firm alliances. Third, an iterative collaboration between members of different firms, working towards the specification, design and development of an innovative product, involving intense communication and sharing of information. Most of the advanced innovation – the focus of this book – is bound to occur through co-design or iterative collaboration. Many companies, no matter how large, do not have the expertise to generate world-class innovation alone, especially in capital-intensive industries. These inter-firm collaborative relationships are different from traditional forms of supplying or outsourcing relationships. They involve a close collaboration between companies with, for instance, an exchange of technology and know-how, the creation of inter-firm joint working teams, online platforms for joint planning and sharing of information and the creation of steering committees across different companies for decision making regarding upcoming disputes and contingencies. They require specific preliminary investments of each of the firms for the joint project, making the partners gradually more valuable to each other, thus shunning the adversarial logic of the market. At the same time, these projects involve high risks which require a high degree of flexibility: if the project seems not to be advancing promisingly, the parties should be free to walk away. Such characteristics generate the need for an ‘experimental’ model of business that calls for two apparently paradoxical demands: full trust and cooperation, coupled with a high degree of freedom and flexibility to change the relationship if there is a need to adapt the project, or even to terminate it, in case the experiment seems to be leading nowhere. The following example illustrates a collaborative network of contracts for innovation. As in other automotive industries, Chrysler undertook restructuring of its commercial relationships with suppliers in the United States during the 1990s.34 The company’s objective was to engage with its suppliers of components in product and process development, seeking to achieve more innovation and cut costs in production. It downsized the number of its suppliers and started developing a closer relationship with a few chosen firms. The selected suppliers were not sought according to the lower prices offered, but according to 32 S Deakin, C Lane and WF Frank, ‘“Trust” or Law? Towards an Integrated Theory of Contractual Relations between Firms’ (1994) 21 Journal of Law and Society 329, 335. 33 Gilson, Sabel and Scott (n 21) 451. 34 JH Dyer, ‘How Chrysler Created an American Keiretsu’ [1996] Harvard Business Review 46.

Inter-firm Collaborative Innovation  9 capabilities which could eventually lead to optimised production. Instead of having short-term relationships involving detailed contracts, long-term open contracts were concluded. The components’ prices were commonly agreed and revised between the parties along the way according to a ‘target costing’, calculating how much the final customer would pay for the product and then calculating the price of components backwards according to the contribution of each supplier to the final product. Chrysler managers themselves, however, acknowledged that the target costing was set ‘somewhat unscientifically and then, when necessary, [we] had the suppliers convince us that another number was better’.35 The plan of production, instead of being imposed by Chrysler on the suppliers, was determined collaboratively between them through the creation of ‘cross-functional teams’, where Chrysler’s technicians and different suppliers’ employees met to plan the optimisation of production jointly. It created a platform programme for communication, where suppliers gave suggestions for the improvements of Chrysler’s processes for which, if implemented, the supplier would receive some reward. The companies became interdependent and their relationship was based on trust and cooperation, yet they maintained independent legal personalities. At the time, Chrysler’s restructuring of its relationship with its suppliers led to significant improvements in its processes of production, leading to greater efficiency and profits. It is important to note that the different contractual models may c­ oexist within activities of the same company. Consider the aerospace company EMBRAER, one of the few companies in the world with the technology to assemble an airplane. It maintains three different kinds of relationship with external companies.36 First, traditional supply relationships with companies that provide tailored products to EMBRAER, receiving support from the company and remaining financially and organisationally captive of this relationship. Second, modular relationships, where external companies supply a closed system to be implemented in the aerospace. Third, risk partnerships, where the firms are involved in experimental projects (the focus of this book), seeking to discover innovations and share profits and liabilities in the process. The experimentalist logic works only in the context of relationships similar to such risk partnerships, where parties are involved in a process of collaborative co-creation. C.  Rethinking Contracting Practices and Private Law for Collaborative Co-creation The instrument for independent companies to institutionalise highly uncertain relationships to co-create innovation is most often the contract, although there may be some variation in practices.

35 Dyer

(n 34). and others (n 14) 14 ff.

36 Cafaggi

10  Introduction There are two specific challenges to contract law studies presented by these relationships. First, the inherent uncertainty of these agreements, incomplete by design,37 which require a constant specification of the duties as the relationship evolves. As will be argued, both the traditional approaches of relational contract theory (as adopted by New Institutional Economics, stating that parties’ disputes will be optimally resolved despite and without the need for legal enforcement), and the approach of having courts imply missing terms without a framework for monitoring and exchanging information, are poorly suited to resolve incompleteness by design in contracts for co-creation of advanced innovation. Second, the challenges of ascribing duties and liabilities in the context of multiparty relationships filled with uncertainty, where different parties in the network may cause damage to each other or (should) owe duties to each other. While this is a common issue for contractual networks, this problem is intensified in relationships that innovate by the need to constantly revise these duties and liabilities and to establish monitoring mechanisms. This book builds on three main assumptions. The first assumption is that the challenges presented by these relationships to co-create innovation under high uncertainty are best addressed through legal experimentalism. This approach proposes creating a continuous and collaborative procedure for learning and for the revision of the parties’ contractual obligations in light of the accumulated knowledge.38 The second one is that, in consonance with braiding theory, there is a need to balance legal formalisation in these highly uncertain collaborative relationships with non-legal (relational) incentives. This is mostly achieved by establishing formal agreements or contextualising regimes that create a contractual landscape suitable for the development of informal incentives for the parties’ collaboration (i.e. trust, business considerations). The third assumption is that these collaborative relationships require a form of contractual interpretation that is receptive to the coexistence of competition and cooperation.39 This should be – not in all, but in most cases – a form of ‘low-powered enforcement’ as proposed by braiding theory (more on this in chapter three). While the doctrinal approach defending ‘low-powered enforcement’ clearly states that reliance damages should be granted for violations of contracts to innovate, it does not clearly articulate what constitutes a substantial violation justifying recovery. Chapters three and four deepen this discussion.

37 On incompleteness by design, see H Collins, ‘Discretionary Powers in Contracts’ in D Campbell, H Collins and J Wightman (eds), Implicit Dimensions of Contract: Discrete, Relational, and Network Contracts (Hart Publishing Ltd 2003) 226–27. 38 For an overview of democratic experimentalism, including its application to private law, see C Sabel and W Simon, ‘Democratic Experimentalism’ in J Desautels-Stein and C Tomlins (eds), Searching for Contemporary Legal Thought (Cambridge University Press 2017). 39 On the importance of the law to foster these relationships, see section III of this Introduction, below.

Inter-firm Collaborative Innovation  11 As an author who undertook extensive empirical research in the subject has remarked, ‘[p]erhaps most striking is the diversity in how [these] agreements are designed’.40 Any attempt to provide a single formula to solve the emerging challenges of these contracts, therefore, would be fruitless. Instead, potential solutions are proposed to address recurrent forms of conflict in these agreements, either by the parties themselves, by adjudicators or by the legislator. In the end, they represent potential avenues to solve these issues, but should not be framed to represent an ideal solution to multi-varied and highly complex relationships such as the ones involving the creation of advanced innovation. The core ideas regarding governance and legal regulation of contractual networks to innovate have already been laid out in previous studies, especially in the US literature on contracting for innovation and in the European literature on contractual networks – the main strands of literature dealing with the subject. This book seeks to advance both of these theoretical strands, proposing in detail how the law of contract and contract governance should allow for these experimentalist relationships to develop. In order to consubstantiate this argument, this study first proceeds to analyse legal concepts available in the comparative legal scholarship suitable for dealing with the phenomenon of collaborative advanced innovation projects. Second, on the level of governance mechanisms established by the parties themselves, it critically analyses the existent potential governance mechanisms applied to deal with various conflicts prevailing in these relationships and seeks to expand the existing repertoire of mechanisms, based on both published case studies and on empirical research undertaken in different countries with companies conducting these forms of experimentalist collaboration. Third, it empirically assesses the contracting practices for inter-firm innovation in the Brazilian context – insofar as such contracting practices have been mainly analysed in the context of the United States. Fourth, regarding the contractual interpretation of incomplete agreements involving high uncertainty and a blend of competition and cooperation between the contractual partners, it seeks to refine the concept of a duty of loyalty to the network proposed by Teubner. More specifically, it examines such issue in the context of recurrent forms of conflict in these relationships, proposing how this duty could materialise and potential criteria for its application. Methodologically, a comparative approach is pursued, for several reasons. Networks of contracts often operate on a trans-national setting, raising similar legal issues across different jurisdictions. The search for locally adequate solutions can be enriched by perspectives from other legal systems, and must take into account the impact that adopting a legal approach may have on one country from the perspective of global value chains.41 A comparative approach is also

40 Jennejohn (n 29) 344. 41 G Gereffi, ‘A Global Value Chain Perspective on Industrial Policy and Development in Emerging Markets’ (2013) 24 Duke Journal of Comparative & International Law 433, 433–34.

12  Introduction relevant because the emergent notion of contract governance, in a ­similar ­fashion to the notion of corporate governance, creates an ‘international discussion platform’ for finding models suitable for inter-firm alliances across industries.42 The choice to examine Brazilian and English law is based on two reasons. First, to compare a civil law and common law system (supposedly) representing a more liberal system to parties’ freedom of contract and a more solidaristic (and interventionist) legal system, respectively, and second, to assess the difference between a developed and a developing country, analysing to what extent the legal differences between them may be significant. D.  Experimentalism in Contractual Practices John Dewey originally developed experimentalism as a political philosophy that proposed to deal with constant change and variation, arguably the main source of problems for public policy.43 As to its significance, Dewey clarified that approaches will be ‘experimental in the sense that they will be entertained subject to constant and well-equipped observation of the consequences they entail when acted upon, and subject to ready and flexible revision in light of observed consequences’.44 In other words, experimentalism establishes a process of continuous learning based on observation, which is then employed to revise established practices. Experimentalism has been claimed to be the approach pervading New Economy forms of production. This book seeks to understand contracts for innovation from an experimentalist logic. In a context of high uncertainty, the parties cannot establish in detail their contractual obligations. Rather they have to structure governance mechanisms to jointly learn from experience and constantly revise their contractual obligations. However, this experimentalist procedure is markedly distinct from other traditional contract mechanisms used to specify uncertain obligations, where there is no room for continuous and flexible adaptation and for learning. The following example can illustrate the difference. A traditional sales contract may determine that the particular price of the product or the quantity to be acquired shall be defined in a subsequent moment to its signature, through a procedure designed by the parties contractually. For instance, an arbitrator nominated by the parties, according to particular criteria, may specify the

42 S Grundmann, Y Atamer and M Yesim, ‘European Contract Law and Banking Contracts after the Financial Crisis: Challenges for Contracting and Market Transactions’, Financial Services, Financial Crisis and General European Contract Law: Failure and Challenges of Contracting (Kluwer Law International BV 2011) 9–10. 43 C Sabel and WH Simon, ‘Minimalism and Experimentalism in the Administrative State’ (2011) 100 The Georgetown Law Journal 53, 78. 44 J Dewey, The Later Works, 1925–1953: 1925–1927 (SIU Press 1981) 362.

Inter-firm Collaborative Innovation  13 price of a product and the quantity to be acquired; or the price may be defined based on a certain price index. Even though these mechanisms are specifying uncertainty, they are neither continuously revisable by the parties nor are they promoting learning. They are rather static: there is a one-time definition of the obligation, based on fixed criteria, which serve as a reliable source to resolve uncertainty. Since there are already reliable criteria, there is no need for a careful and critical observation of the consequences of the contractual cooperation to revise these criteria. They will remain immutable and subject only to disruption by exceptional events (such as impossibility of performance). This is radically different from situations involving contracts for innovation under pervasive uncertainty. In this case, as examined in detail in chapter two, there are no fixed criteria to determine the next steps in the process of production of an innovative output. Rather, there is a flexible and revisable framework. As further examined, a potential form to organise these activities is for the parties to establish an initial schedule of activities, to be revised once a milestone is reached. Then, a committee composed of members of the different companies may carefully observe and convene to deliberate on how the process of production has been evolving and to define the next steps based on the accumulated experience. This definition, however, is not final; it may be revised in the next milestone established in the schedule of activities, when a different route may be taken, based on the observation of the new accumulated experiences through the contractual collaboration. There is an experimentalist process of joint learning, not guided by static criteria, but rather revisable and based on critical observation of experience. An experimentalist architecture shares four main features.45 Public policies, regulatory or contractual frameworks can be designed based on these features. First, general framework goals established by a central body (the leading company in a network chain, an appointed management body or a regulatory/ certification agency), often created through a participatory process involving the regulated entities. In a contract, these framework goals are often established in the contract recitals defining the aims of the contractual collaboration or in clauses establishing duties of collaboration between the parties. Second, discretion for lower-level entities (e.g. the firms in a supply chain) to pursue these general goals as they deem reasonable in the local context. In an inter-firm contractual collaboration, this is the possibility for different firms in the network to have a certain degree of discretion as to how they will pursue the particular goals in the cooperative process. Since the innovative process involves an inevitable degree of uncertainty regarding contractual obligations, this flexibility is necessary for the parties to move forward.

45 C Sabel and J Zeitlin, ‘Learning from Difference: The New Architecture of Experimentalist Governance in the EU’ in C Sabel and J Zeitlin (eds), Experimentalist Governance in the European Union: Towards a New Architecture (Oxford University Press 2010) 3.

14  Introduction Third, monitoring and reviewing of the different local units’ performances based on agreed methodologies and benchmarks, with experiences of success shared between the parties. In a contractual collaboration, this amounts to the monitoring and discussions held in the context of steering committees involving the different cooperating firms and in the inter-firm working teams reuniting to solve a particular problem together. Fourth, the framework goals and the contextual practices are revised by the parties themselves in light of the accumulated knowledge resulting from this experimentalist practice. This crucial step involves a dialogic process between them, where they seek to learn from other entities and improve their own process. Distinct institutional arrangements may be established to pursue this experimentalism.46 Once more, this dialogue may occur through steering committees where decisions as to the next steps in the contractual collaboration are undertaken. In sum, experimentalism creates a revisable procedure rather than static framework and criteria to resolve uncertainty; it establishes joint learning rather than a fixed procedure. Through those features, it distinguishes itself from traditional mechanisms to specify uncertainty in contractual relationships. II.  THE RISE OF COLLABORATIVE CONTRACTUAL NETWORKS FOR THE PRODUCTION OF INNOVATION: CHALLENGES AND OPPORTUNITIES

A.  The Social Problem: De-verticalisation of Productive Activities in the New Economy The collaboration between independent companies for the joint production of innovation is a growing phenomenon throughout the world. Joint ventures in general have long been studied and the tendency in the past has been either for companies to merge or to create new companies (newcos) to pursue their joint activities.47 While those strategies continue to exist, what is rising now is the possibility of collaboration among independent companies (and also with academic and scientific institutions) through networks of contracts.48 While ‘open innovation’49 is not in itself a new phenomenon, it is clearly a rising one.50

46 ibid. 47 On ‘de-verticalisation’, see Gilson, Sabel and Scott (n 21) 431 ff. 48 OECD (n 23) 9–10. 49 HW Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology (1st edn, Harvard Business School Press 2003). 50 OECD (n 23) 9–10.

The Rise of Collaborative Networks  15 Starting in the 1980s, the then dominant mass production paradigm was challenged around the world by the growing de-verticalisation of activities.51 Large firms, previously controlling large portions of industrial production, started to outsource different phases of production and distribution to firms around the world.52 The connections between these different companies have been articulated through different legal forms, and ever more often through networks of contracts.53 Companies all over the world have become connected in global and regional value chains where each of them performs a certain function for the set-up of the final output. The process of production of a commercial aircraft is emblematic of this transnational collaboration. For instance, in the set-up of the Boeing 787, Boeing, the leading company assembling the aircraft, established collaborations with several companies, from different countries from all over the world, each of them with strong expertise on a certain component or service, and all of them collaborating and coordinating their respective performances towards the assembly of the final product.54 Furthermore, this process of globalised de-verticalisation has, especially in the innovative companies, often established a model of production for the rapid detection of defects, with specialisation in the problem-solving abilities to deal with the identified issues and to improve them.55 In the past, the process of mass production in factories was the rule, with an inventory of replacements for inputs or machines once defects were encountered as a way to assuring the uninterrupted functioning of the process of production. Nowadays, it becomes growingly common for companies to adopt the strategy of stopping the process of production once problems are detected, of identifying the bottlenecks, and of investing highly in problem-solving capabilities to solve them as quickly as possible. This procedure has, in many cases, led to better and cheaper production processes and outputs. Moreover, this ‘Toyota system of production’ led to increases in productivity and innovation. Companies adopting practices of continuous innovation in production represent a significant part of the world’s economic activity. Their presence is mostly visible in two settings.56 First, in industrial districts such as Silicon Valley, the

51 MJ Piore and CF Sabel, The Second Industrial Divide: Possibilities for Prosperity (Basic Books 1984) 3–7; see also A Schibany and W Polt, ‘Innovation and Networks: An Introduction to the Theme’, Innovative networks: co-operation in national innovation systems (Organization for Economic Co-operation and Development 2001) 7–8. 52 Gilson, Sabel and Scott (n 21) 438. 53 Cafaggi (n 24) 1–2. 54 M Jennejohn, ‘Contract Adjudication in a Collaborative Economy’ (2010) 5 Virginia Law & Business Review 173, 183. 55 Steven J Spear, Chasing the Rabbit: How Market Leaders Outdistance the Competition and How Great Companies Can Catch Up and Win, Foreword by Clay Christensen (1st edn, McGraw-Hill Education 2008) 159–62; 193 ff. 56 G Herrigel, Manufacturing Possibilities: Creative Action and Industrial Recomposition in the United States, Germany, and Japan (Oxford University Press 2010) 161 ff.

16  Introduction so-called ‘Third Italy’ and West Germany, and, more recently, Shenzhen in China and Bangalore in India. In these vanguards, production is no longer controlled solely by massive corporations but is flexible, reuniting several large, medium and small companies, highly specialised in their fields and often spatially located close to one another, cooperating towards the production of a final product or service, while at the same time competing in different projects or in different markets. Second, productive vanguards are distinguishable in the global (or regional) value chains where, for the attainment of certain complex productive activities, leading companies outsource parts of their activities to several firms around the world. When the activity of outsourcing becomes highly collaborative it no longer follows the script of traditional market exchange relationships. Parties become interdependent despite the fact that they remain legally independent and share profits and risks. The forms of collaboration (or networking) for open innovation practised by such companies are based on interactions that, in the recent past, were thought of as being characteristically intra-firm.57 Common teams of employees from different companies start working together and the companies share technology and know-how, constantly giving feedback on each other for potential improvements. The distinction between the conception and the execution of tasks becomes blurred as they are constantly and jointly revised and the cooperation of the companies evolves. In some cases, they may share productive capacities. They could almost form a single corporation but prefer to stay independent. For experimentalist innovation to succeed, a high degree of flexibility is required to re-arrange production whenever necessary. Companies focus on their core competencies while relying on partner firms for further expertise. These hybrids challenge the legal divide between contract and corporation. The roots of the challenges for legal doctrine, evoking Teubner,58 reflect the difficulty of finding an institutional framework that reflects the paradoxical expectations of members of contractual networks, who join forces to accomplish a common project, while at the same time pursuing their individual interests. B.  Economic Importance: Overcoming the Stagnation of Productivity Growth and Bridging the Gap between Developed and Developing Economies The importance of flexible forms of production for reversing the decline in productivity growth in several economies across the world is not a commonplace argument. It should be understood in light of the saturation of the world

57 For a description of inter-organisational collaborative practices, see Jeffrey H Dyer and Harbir Singh, ‘The Relational View: Cooperative Strategy and Sources of Interorganizational Competitive Advantage’ (1998) 23 The Academy of Management Review 660, 660–61. 58 Teubner (n 15) 122.

The Rise of Collaborative Networks  17 markets for the mass production system, the industrial model prevailing across the world. Mass production industrial organisations produce standardised products on a large scale. For this system to produce economic growth, two requirements must be met: stability of the market conditions and continuous expansion of demand.59 From the 1960s, however, different factors started to destabilise the markets.60 Without stability and market expansion, the world faced a general decline in productivity growth which affected countries to different extents, commensurate to other nationally specific factors. As a strategy to overcome the limitations of the mass production system, developed economies started to adopt forms of flexible production, often instrumentalised through networks of contracts. This collaborative form of production could be particularly relevant for the developing world as a way to improve competitiveness. For domestic companies willing to advance to global productive vanguards, surviving the competition of foreign firms in a context of the global market becomes crucial to improve productivity and innovation capacity, which are arguably facilitated by this organisational form.61 In the past, developmentalist industrial practices prescribed policies where the state would create or support national industrial champions, large national companies able to compete in the global market. The global economy, however, has changed. Sole companies no longer control the entire production chain and production is better understood nowadays in terms of global value chains.62 In developing a product, production and distribution processes are divided in different phases, for which different companies in distinct parts of the world may be responsible. Companies are increasingly seeking to participate in the most complex activities of global value chains, the ones which are most economically valuable, and which require a more educated workforce and innovation. How is the need for regulating contractual networks in the global south different from that in the context of advanced economies? One core difference is the attention that should be given in emerging economies to the need to include the small and medium enterprises (SMEs) in these networks.63 In developing economies, SMEs are largely family owned, technologically backwards and lack the funding necessary to adopt the most advanced technology and organisational practices in the industry. The culture of cooperative competition with large companies or with other SMEs to co-create innovation is still little widespread among them. 59 Piore and Sabel (n 51) 184 ff. 60 ibid 165 ff. 61 Claiming that the capacity to innovate is the main differential between developing and developed economies, JE Stiglitz and others, Creating a Learning Society: A New Approach to Growth, Development, and Social Progress (Columbia University Press 2014) 15. 62 Gereffi (n 41) 433–34. 63 Brasil, Produtivismo Includente: Empreendedorismo Vanguardista (Secretaria de Assuntos Estratégicos 2015) 10–11.

18  Introduction The organisation of production in global value chains points towards the need to re-conceptualise the role of the state in the economy. Instead of directly supporting national champions, it is necessary to provide educational and economic opportunities for firms (especially SMEs) to reach the highest technological and organisational practices required to perform the most valuable activities in value chains.64 Furthermore, it calls for rethinking of the different varieties of institutional arrangements that might serve to foster the success of an economy. III.  WHAT ROLE FOR THE LAW IN COLLABORATIVE CONTRACTUAL NETWORKS?

A.  The Context: The Challenges for Contractual Networks in an Economic and Sociological Perspective There is a set of economic and sociological challenges that this kind of collaborative relationship generates. Such challenges are translated into the legal sphere. From an economic perspective, the central challenge concerning collaboration between economic agents is how to overcome the collective action problem, i.e. how to incentivise parties to cooperate in a context where free riders can act opportunistically and benefit from others’ efforts without contributing to the common aim. The main contribution of New Institutional Economics65 to the study of inter-firm contractual networks is the proposition that there are alternative institutional frameworks (the market, the firms and hybrids) available to establish cooperation between economic agents and that there are different criteria to choose one over another. Two contributions are particularly relevant. First, Coase’s framework to determine whether productive activities would be undertaken in the market or in the firm. Second, Williamson’s expansion of this framework, proposing the coexistence of different models of contract law and the use of governance mechanisms for transactions of different natures. In The Nature of The Firm, Coase examined how rational individuals would analyse the different possibilities available to organise their productive activity, namely, to integrate it in a single firm or to establish it through contracting in the market. According to Coase, the choice between the two alternatives would be based on transaction costs. When the costs of transacting in the market

64 DM Trubek, MG Schapiro and DR Coutinho, ‘Toward a New Law and Development: New State Activism in Brazil and the Challenge for Legal Institutions’ [2012] The World Bank Legal Review 281, 281. 65 On New Institutional Economics, see S Deakin and J Michie, ‘The Theory and Practice of Contracting’, Contracts, cooperation and competition (Oxford University Press 1997) 10–11.

What Role for the Law?  19 are higher than organising production under a firm, there is verticalisation of activities under a single organisation.66 At the same time, however, there are costs in integrating all activities through a firm, the bureaucratic costs which could serve as an incentive to organise production through contracting in the market. This is the traditional approach of the theory of the firm. The search for the cheapest option is compatible with the traditional Neoclassical Economics’ concept of the economic agent as the rational profit-maximising individual. Williamson proposed a more elaborate model, building upon Coase’s work on transaction costs. For him, economising on transaction costs can be summed up by economising in bounded rationality (eg avoiding the costs of drafting a complex contract) and in preventing opportunistic behaviour (eg by adapting performance of a contract as circumstances may require).67 Different governance structures would be more suited to diminish transaction costs in different contractual settings. The author proposed a scheme to classify contractual transactions and to determine which institutional framework would best suit them.68 Williamson’s valuable insight was that different categories of contract law (classical, neoclassical and relational contract law) are not exclusive, but rather coexist in different contractual settings. For instance, in transactions involving non-specific investments, either of recurrent or occasional character, the market is the advisable governance structure to regulate transactions. In the lack of specific investments, parties will be able to buy substitute standardised products in case of default by the contractual partner. Traditional rules based on the notion of a spot/exchange contract are adequate to deal with this situation. On the opposite side, in the case of frequent contracting between parties where mixed or idiosyncratic investments are necessary, the most adequate contractual framework should be that of relational contract law. The frequency of the contract justifies building a more complex model of governance. These developments on contract governance in the economic field found little resonance in legal studies, until recently. Their relevance is to evidence the importance of contractual governance mechanisms in establishing cooperation between contractual partners and in demonstrating that different forms of contract law can coexist in distinct contractual frameworks. Still, these frameworks are presented in an underdeveloped manner by New Institutional Economics. From a sociological viewpoint, in a scenario of high uncertainty, the issue is how to generate the trust (or ‘social capital’) that is necessary to produce successful cooperation between partners. Legal rules and economic incentives per se will not be sufficient to sustain collaboration if there is no trust.

66 RH Coase, ‘The Nature of the Firm’ (1937) 4 Economica 386, 394–95. 67 OE Williamson, ‘Transaction-Cost Economics: The Governance of Contractual Relations’ (1979) 22 Journal of Law and Economics 233. 68 ibid 246.

20  Introduction There are two traditional views as to the role of social relations on individual behaviour and institutions.69 The first view, the ‘under socialised’ conception of human action presented by Neoclassical Economics, considers that social relations have an almost negligible role. The rational self-interested individual presented as the economic agent will be guided by economic profit-maximising considerations, almost disregarding social relations. The invisible hand of the market will be responsible for counteracting opportunism. This ‘disembedded’ view of the economy led Karl Polanyi to critically argue that, in modern market economies, social relations had become a subservient part of the market phenomenon, rather than the market forming a part of society and serving it as a whole.70 This view, however, has lost force in recent years,71 especially in the context of imperfect competitive markets, normally with few individuals and high specific investments. New Institutional Economics provided a re-casted answer to this difficulty (introducing the concept of bounded rationality), by claiming that institutions/social arrangements should be designed to generate efficient economic solutions. The choice of one institutional setting over the other would solve the issue of opportunism and risk of fraud in the markets. As Granovetter rightfully claims, however, this perspective does not serve to create trust, but rather serves as a ‘functional substitute’ for it.72 The second, ‘over socialised’ view, majorly defended by sociologists, historians and political scientists, claims the opposite of the first. Social relations define almost everything and through them all human behaviour and market activities develop. This view is ‘over socialised’ because it presents social influences and roles imposed on the individual by this milieu as having almost inexorable results.73 In the case of business relationships, this means that reputation, informal sanctions and business dealing would substitute legal arrangements and individual morality.74 This book follows a third view, presented by Granovetter, which overcomes the dichotomy between the individualist and the overly social perspectives presented above. The author seeks to find an intermediate position between the ‘over-socialised’ and the ‘under-socialised’ perspective.75 He believes that social relations have a major role in defining the existence of trust but, for two reasons, rejects the idea that social relations alone should be entitled with the role of assuring the development of trust. First, in several instances, social relations networks have a different degree of influence and, in some settings, may not

69 M Granovetter, ‘Economic Action and Social Structure: The Problem of Embeddedness’ (1985) 91 American Journal of Sociology 481, 481–82. 70 K Polanyi, The Great Transformation (Beacon Press 1944) 45. 71 Granovetter (n 69) 488. 72 ibid 489. 73 ibid 485–86. 74 ibid 491. 75 ibid 491 ff.

What Role for the Law?  21 be sufficiently present to develop trust. Second, in some cases, social relations networks not only will not assure trustworthy behaviour, but may even encourage greater conflict.76 Granovetter’s position is that networks of social relations are crucial in the development of trust.77 At the same time he suggests that the concept of the self-interested rational individual should still be used as a working concept; nevertheless, it should consider not only economic variables in the choice of the individual but also ‘sociability, approval, status and power’.78 This discussion leads to the following question: can the trust necessary for collaborative productive relationships be somehow developed through legal structures or do these structures only emerge in the context of already existing relationships of trust? Both positions have been defended in the literature.79 The concept of trust in itself has been ascribed different meanings:80 self-interested, profit-maximising trust, where parties cooperate to the extent of maximising the relationship’s utility to themselves; socially oriented trust, based on shared culture and communal values; and, finally, trust created through processes and institutions developing an environment conducive to cooperation.81 The latter meaning of trust is particularly relevant for the discussion, exploring how legal institutions can create a framework conducive to cooperation, because high uncertainty in relationships of innovation defeats the viability of both selforiented and socially oriented trust. The uncertainty of the project prevents evaluation of its utility. Shared culture and values will not provide answers to guide the parties under complex scenarios, unless they are backed by institutional procedures establishing communication channels, decision-making procedures and, in sum, providing a guideline for the parties to follow under uncertainty. In support of braiding theory, hybrid contracts, with sophisticated instruments of governance, are deemed important elements in contributing to developing trust among firms and business partners, especially for innovative projects.82 Although initial trust itself may be an important element for initiating a relationship between contractual partners, innovation involves too much uncertainty to the point that, without further formal instruments for monitoring and coordination between partners, that initial trust may be lost and the

76 ibid 492. 77 ibid 504. 78 ibid 506. 79 See ch 2, section II.B.i. 80 B Lyons and J Mehta, ‘Private Sector Business Contracts: The Text Between the Lines’ in S Deakin and J Michie, Contracts, Cooperation and Competition (Oxford University Press 1998) 50–54. 81 S Deakin, C Lane and F Wilkinson, ‘Contract Law, Trust Relations, and Incentives for Co-Operation: A Comparative Study’ in S Deakin and J Michie (eds), Contracts, Co-operation and Competition (Oxford University Press 1997) 111 ff. 82 See ch 2, section II.B.i.

22  Introduction parties may become suspicious of each other’s behaviour. This book emphasises neither an ‘over-socialised’ nor an ‘under-socialised’ perspective of the relationship between the contractual partners, but rather a synergic one. B.  What Role for the Law? i.  The Importance of Legal Regulation for Collaborative Relationships to Innovate The discussion above leads to the main legal question: is there a need for rethinking private law to deal with the legal challenges posed by collaborative contractual networks to innovate? Even though the precise role to be played by the law is still a subject of discussion,83 there is a wide recognition about the need of legal studies to promote a greater understanding of how these relationships are structured.84 The prevailing orthodoxy in legal studies seems to favour the view that private law should regulate private relationships only to a minimal level, leaving to the parties the freedom to structure their collaborative relationship to their own design.85 According to this approach, the task of the law should be restricted to ensuring the enforcement of contract and property rights. The importance of moulding private law, and contract law especially, to new forms of economic relationships would thus become almost negligible. One of the few remaining tasks left to legal studies (especially for the subject of this book) would be in the design of adequate governance mechanisms (if one accepts a broad perspective of the law, which encompasses the study of these mechanisms) established by the parties themselves to govern their relationship.86 This perspective underestimates the importance of the law in creating a structure for incentives and discouragement for the parties to cooperate, or, to use economic vocabulary, in the ‘construction of markets’.87 The role of private 83 S Grundmann, ‘The Future of Contract Law’ (2011) 7 European Review of Contract Law 490, 523–25. 84 eg Bernstein (n 29). 85 ‘[C]ontemporary legal consciousness seems increasingly marked by a striking forgetfulness with regard to the early twentieth century’s critique of the use of the public-private distinction to mark the boundaries between the political sphere of the state and the allegedly apolitical private sphere of the market. Instead, all that remains of that critique is today’s favoritism of private ordering over state intervention. The current endorsement of law in the facilitation of processes of societal self-regulation thus preserves only an extremely reduced and formalistic role for law and legal institutions.’ Peer Zumbansen, ‘The Law of Society: Governance through Contract’ (2007) 14 Indiana Journal of Global Legal Studies 191, 232. 86 See the definition of private law as including ‘public legislation as well as private law-making’ in H Muir-Watt and F Cafaggi, ‘Introduction’ in H Muir Watt and F Cafaggi (eds), Making European Private Law: Governance Design (Edward Elgar 2008) 1–2. 87 H Collins, Regulating Contracts (Oxford University Press 2002) 176; see also ch 3 in H Gintis, The Bounds of Reason: Game Theory and the Unification of the Behavioral Sciences (Princeton University Press 2009).

What Role for the Law?  23 law regulation is normally viewed as something that can be deployed solely to accomplish distributive purposes (as in consumer law), ignoring the potential of regulation to enhance economic efficiency. The role of regulation should not be restricted to the legal imposition of a certain behaviour or standards of conduct or (more specifically to contract law) to the implication of terms in contractual relationships. It should also comprise the enlargement of the parties’ capability for designing their own relationship by providing further possibilities for organising their business and providing a form of legal interpretation that considers the self-proposed objective of their deal, especially in situations where high uncertainty might prevent them from establishing ex ante an allocation of risks. Therefore, the importance of legal regulation becomes especially relevant in the context of highly uncertain relationships. Perhaps one of the most emblematic examples of this in the field of contract law is the role to be accorded to preliminary agreements and clauses to negotiate in good faith.88 The traditional common law approach regarding preliminary agreements was the all-or-nothing rule. Either the agreement would be fully enforceable or not enforceable at all. Vague clauses establishing duties to negotiate in good faith would generate a wholly unenforceable agreement. Currently, English law has evolved to a position where, under certain very specific circumstances, such duties to negotiate in good faith may be enforceable.89 In the United States, where the law of some states seems to present wider possibilities of enforcement of such clauses, intense discussions are underway on this topic. In the case of significant sunk investments in contracts expressly establishing a good faith duty, several courts have recognised that violation of the terms of a preliminary agreement or the failure to employ best efforts in negotiating may justify recovering reliance damages (and, in very exceptional circumstances, expectation damages). This has created a ‘middle ground’ between enforcement and non-enforcement, with several approaches presented on how a good faith clause should be enforced, mingling legal and non-legal sanctions.90 The legal approach can be significant in determining the parties’ incentive structure when establishing a highly uncertain collaborative project. On the one hand, the parties cannot specify the whole contract ex ante, due to the high uncertainty surrounding the relationship. They may establish governance mechanisms to calibrate the relationship, but even those may fail in certain cases. On the other hand, they may be unwilling to provide a court with the wide discretion to determine ex post the terms of their agreement, especially due to the

88 A Schwartz and R Scott, ‘Precontractual Liability and Preliminary Agreements’ (2007) 120 Harvard Law Review 661, 663–64. 89 For a detailed analysis of this possibility, see N Andrews, Contract Law (Cambridge University Press 2015) 25–35. 90 AH Choi and GG Triantis, ‘Designing and Enforcing Preliminary Agreements’ (2020), 98 Texas Law Review 439, 481 ff (2020).

24  Introduction lack of expertise and continuous uncertainty of these deals. There is a need for the legal system to recognise a ‘middle ground’, where the parties may establish clauses to negotiate in good faith and cooperation that will be enforceable but only to the extent necessary to undermine certain risks and costs of this relationship (such as opportunism, spillovers and entropy, later discussed in chapter two). Without this framework, parties are likely to be cautious of embarking on projects involving high uncertainty. The task of finding this right balance is a task for legal regulation. Thus, private law must be adapted to create a framework to facilitate collaborative relationships to innovate. ii.  Potential Levels of Legal Regulation of Collaborative Contractual Relationships There are three different levels in which the law may be relevant in regulating collaborative production in contractual networks. First, regarding the private governance arrangements that these companies elaborate to privately regulate their relationship,91 legal studies have a role in identifying the different possibilities in arranging such agreements. An important trend of legal literature in US contract law has focused on the topic of contractual design.92 Private governance may also reflect regulations issued in the context of an industry/trade association that should be followed by the companies.93 While the growing power of private regulators is seen positively by some authors, others have concerns that the excess of private power could be abused on weaker business partners. Second, the legal doctrine has a role in regulating private agreements.94 There are different possibilities, ranging from a very interventionist to a minimalist version of the law, which will focus on enforcing classical contracts and property rights, leaving the parties with most of the task of structuring their relationship. There is a long-standing debate in contract law about the adequate balance between freedom of contract and communitarian principles, but it acquires a new perspective in the context of contractual networks. The specificities of these hybrids, where parties remain independent firms and competitors in the market while they collaborate in the context of the same project, calls for a re-interpretation of the ‘balance’ between contractual freedom and communitarianism. Good faith duties could be better translated, in this context, through the idea of loyalty to the network, seeking to combine a commitment to the project with the flexibility needed in these relationships.95

91 Gilson, Sabel and Scott (n 30) 1377–78. 92 RE Scott and G Triantis, ‘Anticipating Litigation in Contract Design’ (2006) 115 The Yale Law Journal 814. 93 Ch 2, n 42 and accompanying text. 94 Collins (n 87). 95 Teubner (n 15) 190.

What Role for the Law?  25 Third, the law may have a role in moulding through legislation and regulation the possibilities and incentives for collaboration between companies.96 Legal rules may allow, for instance, the creation of joint patrimony funds between independent companies, liable for potential harm generated by the network’s activities.97 However, no general model to regulate contractual networks is advocated. Rather, a legal pluralist perspective is followed, with the analysis of different legal models available for contractual partners to choose the one that may best suit their relationship. In the background, protective rules are essential (especially, the concept of a duty of loyalty to the network), but legal pluralism remains the most appropriate response to regulate these ever-changing and experimental relationships. iii.  The Limitations of Current Legal Concepts Applied to Collaborative Contractual Networks In what follows, an overview of the traditional legal concepts available to govern collaborative contractual networks for innovation between firms is provided; no specific legal system is examined, instead the central question is why the theoretical legal concepts in general fall short of addressing the challenges of these relationships. The extent to which this analysis will hold true will vary according to the context of the legal system studied. Most national legal concepts, however, can be subsumed under the general legal concepts that are discussed below and, for the reasons explained, will reveal inadequacies. Further specificities of these legal concepts under Brazilian and English law are later analysed. As previously mentioned, in an extremely fast-paced technological world, radical innovation can hardly be achieved by firms in isolation and growingly depends on cooperation between companies on common projects.98 Innovation, even in the midst of an inter-firm alliance, however, may be hard to achieve. It requires continuous experimentation with different partners, including many failed attempts before success is achieved and the flexibility for firms to come apart. This need for collaboration with flexibility calls for the design of new organisational forms that escape the traditional form of contract or corporation. These hybrids involve companies that are legally (and, to a certain extent, economically) independent, that compete in the market, but nonetheless cooperate in a common project.

96 PA Hall, ‘An Introduction to Varieties of Capitalism’ in D Soskice, PA Hall and D Soskice (eds), Varieties of Capitalism: The Institutional Foundations of Comparative Advantage (Oxford University Press 2001). 97 See ch 2, section II.B.iv. 98 P Dussauge and B Garrette, Cooperative Strategy: Competing Successfully Through Strategic Alliances (Wiley 2019) 1 ff.

26  Introduction Joint ventures have been largely analysed in legal studies.99 The term ‘joint venture’, however, is loose and encompasses different forms of legal arrangements according to the legal system involved. In general terms, joint ventures are classified either as equity joint ventures or as contractual joint ventures. In legal studies, equity joint ventures tend to be more studied than contractual joint ventures.100 They involve the alliance of two or more companies through the creation of a new legal entity, which may take different legal forms (such as a corporation, a limited liability company or a holding). Each party makes an economic contribution toward the creation of the new legal entity, which will be ideally liable for all duties and will retain all the rights for the activity performed. By previously establishing the level of participation of each of the partners in the venture, it limits the ability of the parties to come apart or to re-design the terms of their relationship as the project evolves. In short, equity joint ventures lack the flexibility needed for innovative projects where uncertainty is pervasive. When the parties need to structure their relationship with such flexibility, they often resort to contractual joint ventures. The common forms of contractual joint ventures, from a comparative perspective, are the different modalities of partnerships. In partnerships, parties do not create a new legal entity, but rather maintain a contractual relationship. In different countries the law will ascribe different rights and duties to members of partnerships. In general, however, it is possible to say that parties will normally owe each other fiduciary duties, that is, the duty to consider the interest of the other partner in all activities. Moreover, it will often establish duties of non-competition with the partner and establish joint liability for the activity performed in the context of the partnership.101 Once again, this model fails to offer the needed flexibility that some innovative projects require. In those, parties should have the freedom to experiment possibilities of creating innovation with different business partners, without being initially bound to any specific one; while cooperation with the partner occurs in one context, in others, competition among them should be allowed. Contract law will give parties more freedom than in the previous contexts. They will be able to contractually establish their obligations in the agreement. They can draft preliminary contracts or memoranda of understanding where they can set out a tentative guide for their relationship, which may not be b ­ inding until certain events come to pass. At the same time, contract law may solve the need for cooperating by establishing duties of good faith or other general standards. The apparent simplicity of this solution hides the real-life dilemmas that are not solved by this approach. At the outset, parties

99 In English Law, see I Hewitt, Hewitt on Joint Ventures. Ian Hewitt (5th edn, Sweet & Maxwell 2011) 10. 100 ibid 11 (mentioning the focus on equity joint ventures). 101 On the inadequacy of the concept of partnership to deal with contractual networks, see Teubner (n 15) 120.

The Plan of the Book  27 are unable to draft contracts predicting how their relationship towards the production of innovation will be. Sometimes, the contracts are short and silent about many aspects of the parties’ relationship because of the experimental character of the project. The inherent incompleteness of contracts has been the subject of several legal studies, particularly in the common law world.102 Solutions will tend to point to one of these sides: either the incomplete contract will be void for lack of certainty or courts will try to impose terms that will be considered reasonable in the commercial context of the parties. In a micro-cosmos, this dilemma recreates the previous aforementioned dichotomy between state interventionism and market liberalism, ignoring the possibility of coupling both in subtler legal arrangements. This dichotomy is clearly reflected in the solutions traditionally proposed by contract law to deal with these collaborative relationships. For example, the traditional all-or-nothing rule of indefiniteness of contracts in the common law, which has recently been revised in US law, with a subtler balance between freedom and solidarity being sought, especially in the context of transactions involving sunk investments. The issue that permeates this study is whether a new balance between freedom of contract and communitarianism has to be drawn in the context of contractual networks for innovation. IV.  THE PLAN OF THE BOOK

The book is structured in five chapters and it deals with the legal challenges for the internal coordination of contractual networks to innovate. In studies dealing with contractual networks it is common to consider that there are two kinds of legal challenge to traditional private law structures:103 internal and external to the contractual network. While the internal issues refer to the concerns of coordination between the members of the network, the external issues concern the relations between members of the network and third parties. The main legal issue regarding the external relations to the network is whether the liability for a jointly conceived product or service causing damages to third parties should be attributed to the network as a whole, to one of the members only or whether a differentiated form of liability should be conceived. While this issue is of foremost importance, it is not peculiar to networks of contracts to innovate. The book focuses on the internal issues that are particularly different in networks designed for continuously developing innovation in its products and 102 R Scott and G Triantis, ‘Incomplete Contracts and the Theory of Contract Design’ (2005) 56 Case Western Reserve Law Review 187. 103 G Teubner, ‘Preface’, Networks: Legal Issues of Multilateral Co-operation (Hart Publishing 2011) vii–viii.

28  Introduction processes. It examines possibilities to structure cooperation between members of an endeavour to co-create innovation and how controversies in this context are dealt with. Chapter one deals with the definition of networks of contracts to innovate and the question of whether they require special legal treatment. This question is complex to the extent that ‘network’ is not a legal concept.104 Nonetheless, different legal constructs have been proposed in comparative law to govern these productive networks. These are critically analysed and the working concept of contractual networks for innovation, employed throughout this study, is articulated. Chapter two focuses on the legal challenges that the regulation of the internal structure of the contractual network to innovate presents to legal studies and the contracting practices employed to deal with them. The issue is how to coordinate the activities of the members of the network in a joint effort to produce an innovative output that is unpredictable at the outset of their relationship, combining cooperation in the realm of a common project with competition in the broader perspective of the market. To be efficient, such networks need to operate in an institutional environment that fosters trust, but at the same time allows a certain freedom for the parties to walk away if their experimental relationship evolves unpromisingly. This combination of cooperation with competition calls for specific mechanisms of coordination (or ‘contractual governance’) between the partners that braid formal and informal incentives to propel the parties’ collaboration and to undermine opportunism. The private arrangements and contractual governance mechanisms that may be deployed to solve coordination problems are examined, as well as the legal theories developed in their background. Based on empirical data collected, the use of such contract governance mechanisms in the Brazilian context is considered. The chapter additionally considers secondary data on inter-firm innovation in England and examines collaborative contractual practices in the construction industry which provide relevant insights to the topic. Chapter three examines how the legal doctrine should deal with internal conflicts between members of a network, defending that ‘low-powered enforcement’ should prevail, if not in all cases, at least as a general rule. The fundamental principle for the parties to advance their innovation project amid high uncertainty is voluntary cooperation, since a high degree of joint learning, joint problem solving and freedom to experiment will be necessary for the project to evolve, which would be unlikely to happen if a court were to dictate terms for the parties’ relationship. The best form to advance their cooperation (as shown in chapter two) is through the braiding of formal contracts that foster informal incentives. This chapter, however, deals with a different situation: once

104 RM Buxbaum, ‘Is “Network” a Legal Concept?’ (1993) 149 Journal of Institutional and Theoretical Economics / Zeitschrift für die gesamte Staatswissenschaft 698, 703–04.

The Plan of the Book  29 the parties have a conflict and their collaboration breaks down, there may be a need to determine whether some violation of the contract has occurred. Once this violation is identified, the sanction for it should not be forcing the continuation of the relationship or imposing expectation damages, but – in most cases  – simply awarding reliance damages that can cover the investments lost due to the lack of commitment of one of the parties to the project. It analyses whether this concept of ‘low-powered enforcement’ could be adopted by English and Brazilian law regarding collaborative relationships to innovate. However, it is not always simple to determine whether a violation of a contract to innovate has occurred. While the issue of damages seems more settled regarding contracts for innovation, the meaning of the substantial duties inserted in these agreements is little explored. The objective of the chapter is to contribute by filling this gap in the literature by analysing and refining theoretically the concept of a duty of loyalty to the network as an interpretative contractual guideline, differentiating it from other private law concepts. However, the extent of this duty should be limited, for its breach should in general only allow ‘low-powered enforcement’. While this chapter delineates theoretically this duty of loyalty, chapter four considers how it would be applied in practice. Chapter four analyses four different kinds of conflict that have been identified as recurrent in the ambit of contractual networks. The conflicts refer to the difficulties of interpreting duties inserted in the background of high risk and uncertain innovation contracts. These four conflicts are: a duty to share information, a duty not to discriminate, a duty to share profits and the possibility of termination of a contract to innovate. In each of these cases, specific legal challenges are presented, with an analysis on how those are being or could potentially be solved by the legal doctrine in case a dispute arises. The chapter considers whether, under current Brazilian and English law, the suggestions advanced would require a legal reform or whether they simply require some sophisticated form of contractual interpretation to be adopted in each legal system. In parallel, it presents and suggests governance mechanisms that could be suited to deal with those challenges, preventing a potential dispute. If successful, these specific governance mechanisms could avoid the need to adjudicate the specific dispute and the doctrinal examination of the specific duty’s meaning. It would braid the formal governance inserted in these agreements to generate informal incentives (trust, relational considerations) that could either prevent conflicts, facilitate their internal resolution or provide information for adjudicators to solve them more easily. Chapter five concludes the book, examining the relevance of adopting a comparative approach to examine the possibilities of regulating inter-firm innovation in different countries. In particular, it analyses the significance of the so-called ‘varieties of capitalism’ approach as a framework to understand the potential variations that may subsist in different jurisdictions. The chapter then closes by discussing what may be the future directions or developments regarding legal studies on inter-firm innovation.

1 Contractual Networks to Innovate: The Search for a Legal Concept

I

n comparative legal studies, contractual networks started to be consistently discussed by the late 1980s,1 reflecting the growing phenomenon of de-verticalisation in company activities. Nevertheless, there is no universally accepted concept for contractual networks. Indeed, despite the recognition of the importance of contractual networks for the transnational commercial ­practice, there is a discrepancy in legal studies regarding the perspective to deal with them, particularly in the contrasting approaches prevailing in the United States and in Europe. In the ambit of legal studies in Europe, there is no consensus as to whether a legal concept of contractual networks would be desirable. For Grundmann2 and Brownsword,3 it should be enough to identify the main issues generated by contractual networks and address them through the current legal approaches and rules available. According to Grundmann, while adaptations may be beneficial, the creation of a new legal concept would be too ‘visionary’. In contrast, Teubner4 and Collins5 claim that contractual networks possess distinguishing features not apprehended by traditional categories of contract and minor adaptations would be insufficient. For them, a fully fledged concept should be elaborated. Collins particularly contends that the notion of ‘productive networks’ of companies simultaneously competing and cooperating could provide a better guidance for interpretation of these transactions.6 1 ‘Much of the debate has been triggered through systems theory and by the ground-breaking analysis of franchise contracts as a form of relational contracts and later on through the financial crisis where the failure of contract law has been identified as one of the key elements in triggering the so-called subprime crisis.’ See R Brownsword, RV Gestel and HW Micklitz, ‘Introduction’ in R Brownsword, RV Gestel and HW Micklitz (eds), Contract and Regulation: A Handbook on New Methods of Law Making in Private Law (Edward Elgar 2017) 17–18. See also n 26 below. 2 S Grundmann, ‘Contractual Networks in German Private Law’ in F Cafaggi (ed), Contractual Networks, Inter-firm Cooperation and Economic Growth (Edward Elgar 2011) 116, 124–25. 3 R Brownsword, ‘Networks of Contracts Revisited’ in G Teubner and Amstutz, M (eds), Networks – Legal Issues of Multilateral Cooperation (Hart Publishing 2009) 33, 47. 4 G Teubner, Networks as Connected Contracts (Hart Publishing 2011) 145 ff. 5 H Collins, ‘Introduction to Networks as Connected Contracts’, Networks as Connected Contracts (Hart Publishing 2011) 1–3, 72. 6 H Collins, ‘Implied Terms: The Foundation in Good Faith and Fair Dealing’ (2014) 67 Current Legal Problems 297, 326–27. ‘In my view, it is not the duration of contracts that provides the key

Contractual Networks to Innovate  31 Based on this perspective, a number of legal concepts and frameworks have been proposed in the European context to deal with contractual networks. It is questionable, however, whether the development of a specific legal framework would contribute to promote inter-firm collaboration. In this sense, the European approach contrasts with the US perspective on this subject. In US legal scholarship, there is an implied acceptance that most specific challenges in contractual networks should be regulated through contractual design and governance mechanisms previously established by the network members – disregarding the need to elaborate a robust concept of contractual networks or systematic doctrinal solutions for them. The initial difficulty in the conceptualisation relates to the fact that different jurists have used the concept ‘networks of contracts’ to label distinct legal structures covering different factual patterns. Likewise, the definition of network in the social sciences has been abused to designate varied phenomena.7 However, in the context of productive relationships, the concept has discernible features, evidenced in studies across economics,8 management9 and sociology.10 These studies have been, for many legal scholars, the departure point in seeking a suitable legal concept for contractual networks.11 That does not mean defending that the concept of network from economics or sociology should be transposed to legal studies, but envisioning the construction of a legal concept from the internal logics of the legal system, while having ‘communications’ with other sub-social systems, as postulated by autopoietic theory.12 In order to address this issue, this chapter initially discusses both the inadequacies of traditional legal concepts to deal with contractual networks and the first legal concepts that have been proposed to cover this phenomenon (relational contracts, linked contracts and symbiotic contracts), without accounting for their features identified in the interdisciplinary literature. Then, the ­chapter discusses the legal concepts specifically proposed to deal with contractual variable in the spectrum of good faith obligations, but rather the incentive structure of the contract, which itself is determined by how the contract fits into relations of production … Contracts that lie well towards the organizational end of the spectrum may be described as contracts that constitute an arrangement for quasi-integration of production, hybrids, or, more snappily, networks. By quasiintegration is meant the idea that though no single legal entity binds the parties together but rather the arrangement is formed by two or more separate organizations that retain their antagonistic interests, the agreement seeks to achieve many features of organizations for the purpose of establishing efficient relations of production.’ 7 For an illustration on the diverse uses of the concept of network, see the Preface to the 2010 Edition of M Castells, The Rise of the Network Society, Vol 1 (2nd edn, Wiley-Blackwell 2010). 8 OE Williamson, The Economic Institutions of Capitalism (Free Press 1998) 158–59, 163 ff. 9 Jeffrey H Dyer and Harbir Singh, ‘The Relational View: Cooperative Strategy and Sources of Interorganizational Competitive Advantage’ (1998) 23 The Academy of Management Review 660. 10 W Powell, ‘Neither Market nor Hierarchy: Network Forms or Organization’ in BM Staw and LL Cummings, Research in Organizational Behavior, vol 12 (JAI Press 1990) 295. 11 For an extended interdisciplinary survey of the concept of network, see Teubner, Networks as Connected Contracts (n 4) 21 ff. 12 G Teubner, ‘In the Blind Spot: The Hybridization of Contracting’ (2006) 8 Theoretical Inquiries in Law 51, 57.

32  Contractual Networks to Innovate networks, considering the peculiarities of the production practices related to organisations mingling competition and cooperation. It concludes by proposing that contractual networks (especially in civil law systems) would be better regulated if a legal concept were developed and refined. While contractual freedom should be embraced – allowing for a variety of tailored governance mechanisms to be designed by the parties into their agreements – at the same time, a minimal ‘trans-typical’ legal concept of contractual networks, building on comparative insights, would represent a useful tool to facilitate the legal treatment of contractual networks. Such a legal concept or framework for contractual networks would provide three main benefits. First, this concept could clarify the validity of certain governance structures in contractual networks which under some legal systems (especially civil law countries) could be barred or at least fall under a grey area of uncertainty as to their validity. Second, these contractual networks would be subject to a distinctive interpretative guideline than most contracts, particularly to a duty of loyalty to the contractual network. Third, these networks of contracts, especially the ones involving small and medium companies, could be subject to more flexible tax and corporate rules, as a form to encourage their activities. I.  THE BUSINESS REALITY: CONTRACTUAL NETWORKS VERSUS THE TRADITIONAL LEGAL CONCEPTS

A.  The Phenomena of Contractual Networks: Neither Contract nor Corporation This section points out, based on examples, that networks of contracts do not fit the traditional categories of contract, corporation or traditional partnerships. The first example referred to Chrysler’s relationship with its first-tier suppliers.13 The second example is the development of the Boeing 787.14 Networks of contracts are markedly present in the aerospace industry due to the inability of one single company to produce a variety of highly complex components. This circumstance leads to the formation of inter-firm alliances where the distinction between the design of the aircraft and the manufacturing of its components give room for integration of the different tasks assigned to different companies in a collaborative process.15 The performance of each of the components or subsystems of the aircraft depends on the other subsystems. One cannot improve the engines without adapting the electric system, the wing

13 For a description of this example, see Introduction, section I.B. 14 See description in M Jennejohn, ‘Contract Adjudication in a Collaborative Economy’ (2010) 5 Virginia Law & Business Review 173, 184. 15 PA Cullen and others, ‘A Critique of Contractual Relationships in the Aerospace Industry: Collaboration v Conflict’ (2005) 1 International Journal of Law in Context 397, 398–99.

The Business Reality  33 technology and so forth. Therefore, the production in each subsystem cannot evolve without coordination with the others. At the same time, this coordination often involves distinct companies because a single company will hardly have the capacity to conduct cutting-edge innovation in each of the subsystems by itself. Such integration results in savings regarding costs, time and the ability to remain at the innovative edge. The downside is the difficulty in coordinating the activities of the different firms and the ensuing risks involved in creating a functional product. This joint production has been called ‘platform’ organisation of production and is observable in other industries, such as the development of computer operating systems or last-generation cell phones.16 From an economics perspective,17 these are hybrid structures located in the intersection between markets and hierarchies. They reveal an ambiguous structure, which does not fit market (contractual) or organisational (company) structures.18 While they do not involve an economic vertical structure, such as a firm undertaking all the risks and investments to develop a product (organisation), neither do they involve simple horizontal contractual exchanges between competing companies (market).19 Rather, they constitute inter-firm alliances (without giving rise to a new entity) with close cooperation towards the accomplishment of a certain project.20 Partners in a network are not chosen randomly according to a cost–benefit analysis, but according to resource complementarity between the companies necessary to achieve a specific goal.21 Thus, networks of contracts can be distinguished from corporations. They do not form a single firm, but rather are composed of legally independent companies contractually connected to undertake a common project. Neither are they part of the same economic group, such as in the case of a parent company producing in connection with its subsidiaries. In that case, it would be possible to classify them as a group of companies, a de facto economic unit. In cases of fraud by one of the companies in the group, different national laws would often provide for the possibility of piercing the veil of one subsidiary company in the group to hold the parent company liable.22 This is not the case presented here: the companies are legally and, de facto, independent, albeit with (partial)

16 RJ Gilson, CF Sabel and RE Scott, ‘Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration’ (2009) 109 Columbia Law Review 431, 440. 17 Williamson (n 8) 158–59, 163 ff. 18 Regarding the classic distinction and criteria to choose over one the other, see RH Coase, ‘The Nature of the Firm’ (1937) 4 Economica 386. 19 E Weitzenboeck, A Legal Framework for Emerging Business Models: Dynamic Networks as Collaborative Contracts (Edward Elgar 2012) 19. 20 Collins, ‘Introduction to Networks as Connected Contracts’ (n 5) 10–11. 21 F Cafaggi, ‘Contractual Networks and the Small Business Act: Towards European Principles?’ (2008) EUI Working Paper 1–2. 22 SK Miller, ‘Piercing the Corporate Veil Among Affiliated Companies in the European Community and in the US: A Comparative Analysis of US, German, and UK Veil-Piercing Approaches’ (1998) 36 American Business Law Journal 73.

34  Contractual Networks to Innovate interdependencies created by the mutual investments. However, each retains its autonomy for making decisions, its own separate budget, they often develop business relationships with other firms that may be competitors of its partner in the network and each will come apart as independent firms if the joint project does not evolve promisingly. The distinction between networks of contracts and traditional contracting practices is not obvious and, for that reason, several authors downplay the distinctiveness of networks. In a sense, most commercial contracts are connected with several other types of contract. A traditional mass production of clothes serves as an example. To set up a piece of clothing, a company may contract with several other companies to have different components supplied (fabric, paint, etc), constituting a ‘network’ of independent companies towards the production of a final product. In another hypothesis, a builder may be hired for the construction of both a shopping centre and a nearby parking lot for its potential customers. If the shopping centre is built but there is a breach in the ability to secure the nearby real estate for the construction of the parking lot, that will obviously affect the value of the shopping centre. For indeed, in both cases, the contracts are linked, and it is arguable that both the interpretation of each contract and the related agreements should be considered in certain circumstances. Nonetheless, these traditional contractual practices are far from the challenges facing actual collaborative contractual networks to innovate. In the previous examples, the task of each of the companies is ex ante, defined with reasonable precision. One will provide fabric or buttons, the other procures the construction of a parking lot. In contractual networks aimed at innovating, there is no such precision. The terms of the contract and the productive process will be constantly re-adjusted as the collaboration evolves; therefore, they have to coordinate their activities. Furthermore, the parties work together, either in inter-firm cross-functional teams, through platforms of production or using other technological forms of communication. In the less intense forms of cooperation, they will at least share technology and know-how for their joint production. They almost function like a single company, although they remain independent and, therefore, there is difficulty in initially establishing the parties’ obligations. Furthermore, there are intense coordination challenges regarding the need to continually adjust the relationship between the parties. These challenges, generated by the strong interdependency between the partners, are not present in the traditional examples above. In a network of contracts, as the term is used in the majority of European legal studies, there is a much stronger economic interdependency between the companies than in traditional contractual relationships.23



23 Cafaggi,

‘Contractual Networks and the Small Business Act’ (n 21) 3.

The Business Reality  35 It has been suggested, but outstandingly rejected, that the possibility of partnership-like institutions could be the basis for joint venture initiatives, as with those undertaken through networks of contracts.24 Under Article 1 of the UK’s Partnership Act 1890, a partnership involves ‘a business in common with a view of profit’. The partnership under English law allows for the undertaking of common activity on a purely contractual basis, without the need for creating a legal entity. Partnerships, however, are inadequate to deal with the kinds of transaction normally undertaken through networks of contracts for innovation. The foremost reason is that they constitute a fiduciary relationship, where one of the partners must give priority to the interests of his partner over his own. One illustration of that is Article 30 of the Partnership Act 1890, establishing for the partners a duty not to compete with each other. One of the main organisational advantages of contractual networks, in contrast, is that it gives the possibility for the partners to cooperate on a single project, while competing in the broader market. In summary, there are difficulties in meeting the demands of networks of contracts under traditional structures of contract, corporation or partnership. It is the role of contract law to face these challenges.25 As a network of contracts does not lead to the incorporation of a company, it becomes impossible to subject networks to company law, whereas contracts might be interpreted in a different perspective to deal with the specificities of the case. The next section examines the concepts recurrently employed to deal with contractual networks and contends that they are limited in apprehending the specificities embodied in the production of innovation. This discussion contributes to shed clarity in the legal world on the distinctiveness of contractual networks as opposed to notions such as relational contracts, linked contracts or symbiotic contracts. B.  Between or ‘Beyond’ Contract and Corporation: Other Possible Legal Classifications During the 1990s the subject of contractual networks has been widely discussed in legal studies.26 Initially, the debates were focused on the legal issues arising

24 Teubner, Networks as Connected Contracts (n 4) 120. 25 This is the strongly majoritarian position adopted by legal scholars on the issue. See G Teubner, ‘Coincidentia Oppositorum: Hybrid Networks beyond Contract and Organization’ in G Teubner and M Amstutz (eds), Networks: Legal Issues of Multilateral Co-operation, vol 3 (Hart Publishing 2011) 14–16. 26 G Teubner, ‘Beyond Contract and Organization? The External Liability of Franchising Systems in German Law’ in C Joerges (ed), Franchising and the Law: Theoretical and Comparative Approaches in Europe and the United States (Nomos 1991); E Schanze, ‘Symbiotic Contracts: Exploring Long-Term Agency Structures between Contract and Corporation’ in C Joerges (ed), Franchising and the Law: Theoretical and Comparative Approaches in Europe and the United States

36  Contractual Networks to Innovate out of franchising systems, especially the question of whether franchisees not contractually connected with other franchisees of the same company could sue them for damages caused to the franchising brand as a whole. Other studies also acknowledged the rise of a new mode of flexible production, involving the need for cooperation between several independent companies for achieving a common purpose.27 At this stage, it was necessary to identify whether there was a legal term that could cover the features of this new form of production. This question was examined in the seminal article of Buxbaum, who claims that ‘“network” is not a legal concept’, although it reflects a distinguishable form of production.28 What distinguishes productive networks, according to Buxbaum, is the search for speed in the production process and exchange and development of know-how. As he argues, ‘[s]peed and know-how are necessary conditions to network initiation; trust a necessary condition to network maintenance’.29 He further points out that these conditions of speed and knowhow create a diffusion of power within the network: each of the partners has specific skills needed for the network and each one’s contribution is equally necessary for the success of the venture. This interdependency would generate a self-equilibrating relationship, with complex and indeterminate forms of communication and adjustment between the companies, hard to understand from an external perspective, and dispensing the need for legal intervention. Thus, he concludes, ‘“network” is not a legal concept’. Buxbaum’s position indicated that self-regulation would be the only possible solution for networks – seemingly, a very influential perspective in the United States, where contract design and governance mechanisms have become prominent in the discussions on how to regulate incomplete agreements. Nonetheless, that position has not dissuaded legal scholars in Europe from searching for actual legal structures to govern them. The attempts resulted in the development of the concepts of (i) relational contracts, (ii) linked contracts and (iii) symbiotic contracts. A discussion about each one of them is presented below. (Bloomsbury Publishing 1991); John N Adams and Roger Brownsword, ‘Privity and the Concept of a Network Contract’ (1990) 10 Legal Studies 12; H Collins, ‘Ascription of Legal Responsibility to Groups in Complex Patterns of Economic Integration’ (1990) 53 The Modern Law Review 731; S Deakin and J Michie, Contracts, Co-Operation, and Competition: Studies in Economics, Management, and Law (Oxford University Press 1997). 27 Collins, ‘Ascription of Legal Responsibility to Groups in Complex Patterns of Economic Integration’ (n 26) 732–34. 28 He argues that network is a relevant concept for the law in two contexts. First, in the context of autopoietic legal theory. Second, regarding ‘production networks’, which he identifies as being interfirm alliances where technology, logistics, administration and time are elements in a ‘social-exchange process albeit one marked by a good deal of adaptive and experimental (fit and mis-fit) behavior’. As in the case of relational contracts or symbiotic contracts, these relationships between the partners require a significant degree of trust for the cooperation to achieve its purposes. RM Buxbaum, ‘Is “Network” a Legal Concept?’ (1993) 149 Journal of Institutional and Theoretical Economics/ Zeitschrift für die gesamte Staatswissenschaft 698, 701. 29 ibid.

The Business Reality  37 i.  Relational Contracts Initially, it is important to acknowledge that there are different versions of the concept of relational contract and most of them, while helpful to guide contractual interpretation, are far from providing practical solutions to different legal problems. For that reason, Eisenberg claimed that ‘there is no law of relational contracts’, but rather specific kinds of contract that become so embedded in a specific reality and relationship between the contractual partners that they require tailored solutions.30 Relational contract law is often interpreted in either of the following irreconcilable ways.31 In the first interpretation, relational contract law would support a non-interventionist contract law that would step in only when the parties are unable to reach an agreement informally. The justification is that the parties tend to solve contingencies and disputes by themselves, and a legal intervention would be disruptive to their arrangements. In that sense, Macauley’s seminal article argues that, in the context of long-term contracts, non-legal mechanisms such as social norms and professional ethics, continuing business relations and risk avoidance strategies are used as alternatives to legal adjudication.32 Parties are reluctant to resort to contract law due to the costs of legal settlement, the social cost of engaging in conflict with contractual partners and also because they do not want to rely on a rigid contract law that prevents them from having the flexibility to adapt their commercial relationship among themselves. They are interested in continuing relationships with the counterparty and cautious about having their reputation damaged in the market. These circumstances contribute to promote cooperation between the firms. In the second interpretation, relational contract law would prescribe the need for a flexible and differentiated contractual intervention by courts in private contracts to account for the social reality in which their relationship is embedded. In other words, there would be a need for the law to correct the ‘dark side’ of the relationship that would remain preponderantly unaccounted for by a rigid contract law. Starting in the 1970s, Macneil published a series of writings that delineated an actual theory of relational contracts.33 For him, contracts could be placed on different positions on a spectrum that gravitates between

30 MA Eisenberg, ‘Why There Is No Law of Relational Contracts’ (1999) 94 Northwestern ­University Law Review 805, 821. 31 S Deakin, C Lane and Frank WF, ‘“Trust” or Law? Towards an Integrated Theory of Contractual Relations between Firms’ (1994) 21 Journal of Law and Society 329, 329–30. 32 S Macaulay, ‘Non-Contractual Relations in Business: A Preliminary Study’ (1963) 28 American Sociological Review 55. 33 IR Macneil, ‘Relational Contract Theory: Challenges and Queries’ (1999) 94 Northwestern University Law Review 877; IR Macneil, ‘Contracts: Adjustment of Long-Term Economic Relations under Classical, Neoclassical, and Relational Contract Law’ (1977) 72 Northwestern University Law Review 854; IR Macneil, ‘Relational Contract: What We Do and Do Not Know’ (1985) 1985 Wisconsin Law Review 483.

38  Contractual Networks to Innovate two poles: the pole of discrete contracts and the pole of relational contracts. The poles are ideal types, as all contracts contain both relational and discrete elements. Nonetheless, it would be possible to locate them closer to one end of the spectrum or the other according to their features and, thus, classify them as either relational or discrete. Discrete contracts are those that ideally involve an immediate exchange between the contractors, abstracted from any social relationships or contexts, in which the express terms of the contract performed by the parties serve as the ‘guide’ to answer all questions.34 At the other end of the spectrum are relational contracts, normally long-term contracts, in which the commercial transaction is embedded by social norms surrounding the relationship between the contractors, such as ethical and professional principles, future interests in the commercial partnership, reputation, interest in the continued and adequate performance of the contract. In such contracts, norms derive not only from the express contract terms, but the relationship between the parties creates, by itself, new norms and legal expectations that should be considered to solve any arising dispute or contingency. Macneil goes on to affirm that the degree of specialisation required in modern production is increasingly leading contractual relations to the relational end of the spectrum, as they demand planning and development of relations of trust between the parties.35 In this sense, he acknowledges the need for special treatment for different forms of flexible production. In explaining the different possibilities for designing the legal regulation of exchanges, Macneil identifies three different models. First, classical contract law, which reinforces discrete contract transactions, advancing two further goals: enhancing discreteness and enhancing ‘presentiation’.36 The classical model is challenged by the fact that, in the context of long-term contracts, gaps are left to be filled as the contractual relationship progresses.37 In many cases, the parties take advantage of flexible contractual techniques to do so. Neoclassical contract law emerged as an adaptation of classical contract law to allow such flexibility, but at the same time was still largely based on the principle of freedom of contract, as the adaptation of the parties’ contractual relationship was still

34 For a detailed analysis of the differences between discrete and relational contracts, see Macneil, ‘Contracts’ (n 33) 856 ff. 35 ibid 861. 36 ‘Presentiation’ means that any possible future effects of a transaction are brought to the present moment, excluding/restricting possible legal consequences of a contract other than those initially considered when the contract was signed. ‘Presentiation’ is enhanced, eg, by equating the effects of a contract to the promise itself or by privileging expectation damages, which ‘bring the future into the present’. Discreteness is enhanced, eg, by ignoring the identity of the parties to the transaction; by commodifying the subject matter of contracts or by limiting the legal sources to be accounted when defining the content of a transaction; ibid 862–64. 37 Such gaps might involve the duration of the contract, economic aspects of the contract (such as price) or uncertainty as to the terms of the contract itself. J Bell, ‘The Effects of Changes in Circumstances on Long-Term Contracts’ in D Harris and D Tallon (eds), Contract law today (Oxford University Press 1989) 199–200.

The Business Reality  39 largely dependent on their own agreements through different techniques.38 Such techniques involve standards (such as Consumer Price Index), Direct Third-Party Determination of Performance, One-Party Control of Terms, the attribution of costs for compensation to one of the parties or agreements to agree. Beyond these techniques, courts may provide for other doctrines, such as impossibility of performance, frustration and mistake, or an even more elaborate contractual interpretation of the offer and acceptance of the parties.39 For Macneil, there is a continued movement of neoclassical contract law towards a greater recognition of relational elements in piecemeal solutions. However, this approach would still be limited by the fact that neoclassical law justifies its solutions and institutions by resorting to the principle of freedom of contract; thus, it is sometimes limited in responding to situations where more complex relational elements creep in.40 Finally, the third model is the relational contract model. In this structure, assent ceases being the core of contract law; ‘the reference point is the entire relation as it had developed to the time of the change in question’.41 It proposes a different model of dispute resolution fitted for the continuation of the contractual relation at the same time that any arising dispute is settled/arbitrated, contrasting with the classical model where normally a dispute leads to the end of the relationship.42 In this model, discreteness and ‘presentiation’ are not eliminated; they are harmonised with the external matrix of the contractual relation (social elements and relationship surrounding the transaction) and the general aim is the conservation of the relation.43 Contractual networks could be broadly classified as relational contracts. The compatibility between the two concepts is apparent. Networks of contracts require a great deal of cooperation between the partners to work, as relational contracts do. Furthermore, they involve the need to adapt the relationship to contingencies and to promote improvements throughout the parties’ alliance without recurring to formal contract law. This implies the need for a specifically designed model of relational governance, as predicted by Macneil. If the theoretical similarities approximate relational contracts (as presented by new institutional economics) and networks of contracts, different critiques have been presented regarding the insufficiency of a general theory of relational contracts to solve the legal issues arising in networks of contracts. As previously stated,44 there are four important objections to the relational model in the context of relationships to develop innovation, which render this model often insufficient to deal with highly experimental relationships: the need for formal



38 Macneil,

‘Contracts’ (n 33) 873. 875. 40 ibid 885. 41 ibid 890. 42 ibid 892. 43 ibid 895. 44 See Introduction, section I.B. 39 ibid

40  Contractual Networks to Innovate legal mechanisms to protect significant preliminary investments, the risks of misunderstandings in the fluid context of innovation undermining the efficacy of relational incentives, the risk of relational punishment destroying the basis for cooperation and the limitations of relational incentives in the global scale.45 Moreover, relational contract law does not provide practical solutions to the particular legal issues in these relationships. Regarding the objection to the efficacy of relational incentives at the global level, there are forms to mitigate these risks. For instance, Bernstein,46 in her article on self-regulation mechanisms in the diamond industry, presents evidence on how certain exchange transactions are being performed with international partners throughout the world, scaling up to a global level, being regulated with the support of informal rules and sanctions, instead of relying on formal sanctions established in contracts. Diamond trade institutions developed forms of monitoring and diffusion of information about the different diamond traders to all affiliated members. This could be a starting point in thinking about institutional mechanisms that could be effective for innovative networks.47 In summary, relational contract law provides a departure point for analysing networks of contracts but falls short on examining the organisational and governance features of contracts that could allow networks to be effectively developed.48 Without those, it is unlikely that mere informal incentives will solve the complex coordination issues arising in networks for innovation. ii.  Linked Contracts The so-called linked contracts, broadly defined as ‘a plurality of separately concluded contracts that are somehow interrelated’, should also be differentiated from networks of contracts.49 Perhaps this is the concept most confused with networks of contracts. Several scholars refer to linked contracts and to networks of contracts interchangeably, as if they were the same.50 It is true that the two main issues that arise in linked contracts are also present in contractual networks. Conversely, contractual networks’ most acute legal difficulties are normally not even mentioned in the studies regarding linked contracts.

45 See Introduction, section I.B. 46 L Bernstein, ‘Opting out of the Legal System: Extralegal Contractual Relations in the Diamond Industry’ (1992) 21 The Journal of Legal Studies 115, 140. 47 Notably, however, the example pointed out (diamond industry) refers to a transaction with less complex coordination than the ones dealt with in this book. In that case, there is simply exchange of goods, with no cooperation in the productive phase; furthermore, there is no transformative/ innovative activity. Parties are selling ex ante defined products (regardless of value variation). 48 F Cafaggi, S Grundmann and G Vettori, ‘The Contractual Basis of Long-Term Organization – the Overall Architecture’ in S Grundmann, F Cafaggi and G Vettori (eds), The Organizational Contract (Ashgate 2013) 3. 49 I Samoy and M Loos, ‘Introduction’ in I Samoy and M Loos (eds), Linked Contracts (Intersentia 2012) 1. 50 ibid.

The Business Reality  41 General examples of linked contracts involve purchase financing, cartel agreements, construction projects comprising a plurality of contracts or a chain of sales contracts between the producer and the end user. In these contracts, there are two main legal issues requiring divergent solutions from mainstream contract law rules. First, the issue of liability for damages arising between two parties not directly connected through contract, but participants in a broader common project.51 Second, the effects that linked contracts may have on one another, for instance, whether the fact that one contract is terminated or breached will imply the termination of the other contract.52 Most civil codes contain no specific provisions on linked contracts and general European legislation contains few rules on them, often stating that the right of a consumer to withdraw from a contract automatically implies the discharge of any connected contracts.53 The Draft Common Frame of Reference contains a limited provision on distributorship agreements and franchising.54 What is the difference between these linked contracts and productive networks organised under collaborative contracts? The core distinction is the kind of interdependence that exists between members of a contractual network, claimed to be a logic of double attribution by Teubner.55 On one hand, there is a deeper level of interdependence and collaboration between its members than in the case of linked contracts. For instance, in a relationship between an aerospace company and its suppliers to develop an innovative product, there is more interdependence than in a credit card chain, where parties provide a service together but are not actually working together to produce something. However, the logic of double attribution in a contractual network goes beyond the level of interdependence. Consider the following situation: one of the companies has produced improvements to the engine of an aircraft that will reduce the final costs of the product by lowering the cost of associated components (wings, semiconductors), that were accordingly adjusted to fit the new model of the engine. Who should benefit from those extra profits that will flow from this improvement

51 ibid; in 1990, Adams and Brownsword argued that privity was too restrictive regarding a set of connected contracts to undertake a common purpose, blocking direct claims among project members, and mentioning English case law recognising exceptions to privity. They proposed the adoption of the concept of a network contract in English law, allowing for direct claims among network members. Their proposal was never adopted. Adams and Brownsword (n 26) 27. 52 Samoy and Loos (n 49) 6. 53 R Uribe, ‘Linked Contract: Elements for a General Regulation’ in I Samoy and M Loos (eds), Linked contracts (Intersentia 2012) 157. 54 See Section II – 5:106 –‘Linked Contracts’ of the Draft Common Frame of Reference on the connection between purchase financing contracts and the underlying purchase contract and the right of withdrawal for the consumer; and Section IV.E. – 2.201, 2.202 and 2.203 creating special duties of cooperation, information and confidentiality in the context of commercial agency, franchising and distributorship agreements. 55 Teubner, Networks as Connected Contracts (n 4) 168, 195.

42  Contractual Networks to Innovate to the engine? The engine designer may have directly built the engine, but the improved model of engine was made possible through the continuous exchange of know-how, technology and collaboration with the other companies in the network. At the same time, it would be unjust to attribute all additional profits to the network as a whole, or to the lead company selling the final aerospace to customers, for that would disregard the engine builder contribution and disincentivise his search for innovation. The division of profits, in this case, would have to balance the share between the engine constructor and the other members of the network. The mechanisms that may be used to perform this division are varied and will be considered later.56 The important point to highlight is the predominant logic in productive networks of double attribution of risks and profits to both the network and to the individual members. This constant tension between the members of a network creates issues of coordination among them that do not arise in the context of linked contracts. Even if, in the context of these contracts, there may be some joint liabilities for services provided, in general the parties know at the outset the extent of the risks and the possibility of incurring these liabilities, but not in productive networks to innovate, where the collaboration is open to re-definition as the production unfolds. iii.  Symbiotic Contracts Schanze proposed the concept of symbiotic contracts, inspired by the notion of symbiosis in biology, where a living organism develops a mutually beneficial relationship with another. Such is the case of ants living inside trees, which take shelter and nourishment from it while defending it against potential predators. In the view of Schanze, symbiotic contracts represent a ‘third order’ of hybrids between contract and firms, where the companies maintain their independence yet have a high degree of economic integration. If, to this point, the description seems to fit the notion of contractual networks, it becomes unfit for that purpose when Schanze states that the parties are ‘typically engaged in an inherently asymmetrical relationship’,57 where they are ‘partially handcuffed, but the handcuffs are golden’.58 Thus, in the typical symbiotic relationship, which for Schanze is represented by a franchising relationship, the parties cannot compete with each other and ‘have to dedicate assets and manpower and accept a long-term exclusion from other market opportunities’,59 in such a way that they are tied to each other for the time of their cooperation.

56 See

below, ch 4, section III.F. (n 26) 60. 58 ibid. 59 ibid 71. 57 Schanze

Building a Concept of Contractual Networks  43 This definition clearly collides with the notion of contractual networks, where one of the main features is the parties’ ability to compete and cooperate simultaneously, as previously argued. The ‘golden handcuff’ placed by the symbiotic contract would deter the parties from that objective, blocking the experimentalism essential to innovate. II.  BUILDING A CONCEPT OF CONTRACTUAL NETWORKS ADAPTED TO THE DISTINCTIVE CHARACTER OF PRODUCTIVE NETWORKS

A.  Main Features of Productive Networks: Designing a Concept of Contractual Networks Jung et al analysed the main features of networks identified in interdisciplinary studies, systematising nine features of these relationships suitable to build a legal concept. These dimensions are critically analysed in what follows. The first is plurality of participants: at least three. According to the authors, with only two participants there are no significant challenges for coordination of activities. Furthermore, the law would already have several mechanisms to deal with bilateral relationships, whereas it remains ill-equipped to deal with multiparty relationships.60 Even if the concept of networks should require a minimum of three participants, it seems possible that similar challenges of coordination can arise in a two-party relationship – for which the law has not yet developed mechanisms to deal with. In innovative projects, several problems of coordination may arise even in a bilateral relationship. As argued in the next chapter, the traditional legal mechanisms are insufficient to deal with this problem. The second feature of contractual networks is that they should be composed of companies. Non-profit organisations are, thus, excluded unless they have an economic aim in the network. The authors rightly argue that the problems of coordination will be undermined whenever non-profits are involved, such as profit sharing and division of liabilities. Moreover, the companies must be both legally and (at least partially) economically independent. This is a crucial point. Sometimes a decentralised organisation may be confused with a network. A single company may organise its activities through different branches or subsidiaries, each with a significant degree of decision-making power and independence. However, if the companies are part of the same legal entity, there will still be a hierarchical power able to command the companies’ behaviour. If liability arises, there will be no doubt as to whom to attribute it. In the same vein,

60 P Krebs, K Aedtner and M Schultes, ‘Company Networks Reloaded: Putting a General Functional Approach to Defining Complex Problems to the Text’ in P Krebs, S Jung and G Teubner (eds), Business Network Reloaded (Nomos 2015) 47–48.

44  Contractual Networks to Innovate even if the companies are legally independent but are from the same economic group, there is one centre of decision. Thus, in neither case will there be real issues of coordination or division of profits and liabilities. Nonetheless, some degree of economic interdependence will always prevail in a joint project. The fact that the parties are working together implies some interdependence. The central point for assessing independence should be the fact that the companies are able to pursue their individual interests in the network, even though they may also pursue some common interests. For instance, a company in a network may pursue a common interest with its partner in developing a certain product; at the same time, however, the company may develop other products to compete with those of its partner in the market. Moreover, even in the joint project where the parties are working together and cooperating, there may be some ‘competition’ as to how much of the profits or the productive activity each of the partners is going to apportion. In the aerospace example, one of the parties may develop a more efficient engine that reduces the need for other complex components, such as electric systems or refrigeration mechanisms, thereby undermining the importance of other partners in the network and their economic share in the project. This form of ‘competition’ inside the network should not only be allowed but encouraged, for it is this freedom that permits innovation and competitiveness to thrive. In other words, this form of activity will be compatible with the third feature of contractual networks, the existence of a network aim; a common interest of the whole network, which is not necessarily equal to the sum of the individual interests of each one of its members. The aim of the network is to create a product with more quality, less cost and more innovation, or to have access to new markets.61 In this cooperative venture, there may be some modification as to the share and responsibilities that may be attributed to each individual. The fourth feature is the existence of coordination of activities, which can be undertaken through an exchange or an association contract, leading to the creation of a legal entity. It can further be conducted entirely informally, with the law of torts ruling the background of this relationship. In some legal systems (as in Germany), the existence of this kind of relationship will give rise to a special ‘accommodation’ relationship, with special duties of protection and trust (as provided for in §242 II BGB (German Civil Code)). The fifth feature is the exchange of partial economic independence for the coordination between the parties to achieve the network aim. The sixth feature is the potential to bundle resources in the common activity, through the possibility of using resources jointly, exchanging technology, know-how, information and organisational skills.62 The seventh feature is the legal voluntariness of the parties in participating in the network. They should not, therefore, be obeying



61 ibid 62 ibid

54. 57–58.

Building a Concept of Contractual Networks  45 some mandatory legal provision when joining the network.63 Feature eight is that the network aim should not contradict the legal system. Lastly, the duration of the networks is often long, although this is not a mandatory requirement, and varies according to the industry involved. B.  Legal Constructs Proposed to Govern Contractual Networks: Considering the Reality of Productive Networks Different concepts have been proposed across comparative law to deal with the two challenges that are accurately directed at contractual networks: the organisational difficulties of coordination and the potential intensification of cooperation duties between parties working together in a collaborative venture. Some of these legal concepts are not comprehensive in systematising all the features of contractual networks but address specific aspects of it. Concepts that have been ostensibly rejected are not considered.64 The search for a legal concept of contractual networks has been more significant in Europe than in the US, where it seems that there is an implied acceptance that most of the specific challenges of contractual networks should be decided on an ad hoc basis, rather than in a systematic fashion. A plausible reason for this is that there is a greater belief among US scholars that contractual networks can be most efficiently self-regulated by their participants, which has led them to focus on the study of private agreement design and contractual governance mechanisms between the contractual partners. In Continental Europe, however, legal scholars have decisively argued that issues (such as profit sharing and network liability towards third parties) where the courts and the legal doctrine have a role to play cannot be sufficiently addressed by contractual governance mechanisms. Below, different concepts developed in the European legal scholarship are analysed: connected contracts, contrats-alliance, network contracts and business networks. i.  Connected Contracts The major contribution of the concept of connected contracts by Teubner is to propose when contracts should be considered connected for legal purposes. From the perspective of German law, Teubner alludes to the concept of connected contracts (Verbundene Verträge), codified in §358 BGB.65 This 63 ibid 58–59. 64 As Rohe’s proposal, in German Law, that companies in the network provide implicitly authorisation (implied agency) for all others to act on their behalf. Teubner, Networks as Connected Contracts (n 4) 140. 65 §358(1) BGB – If the consumer has effectively withdrawn his declaration of intention to enter into a contract for the supply of goods or for the provision of a service by a trader, he is also no longer obliged by his declaration of intention to enter into a loan contract linked to this contract.

46  Contractual Networks to Innovate notion was developed in German case law in response to credit arrangement issues involving consumers. §358.I BGB establishes that consumers who legally revoke a credit contract concluded to finance a separate purchase contract are also allowed to revoke the corresponding ‘connected’ purchase contract.66 §358. III BGB further clarifies that the contracts will be considered connected whenever two requirements are met.67 First, the credit arrangement must have served to finance, partially or fully, the purchase contract. Second, both contracts must form an economic unity. The BGB does not define the concept of economic unity but provides two examples: when the financing party and the seller in the two different contracts are identical and when the financing party allows the cooperation of the seller in the conclusion or preparation of the credit instrument. As Teubner emphasises, the concept of connected contracts in §358 is strongly related to credit transactions involving consumers and there are difficulties in automatically extending its application to all forms of contractual networks. He defends, however, that it could serve as a starting point to define ‘connected contracts’ in a broader sense, respecting, according to him, the internal evolutionary logic of the law.68 The main difficulty would be to clarify that connected contracts do not represent an economic unity, with all parties giving up their individual interests in favour of the collective interests. Rather, the individual interests of the parties would coexist with the collective interests. Teubner proposes overcoming the specificities of credit arrangements by suggesting three cumulative criteria to define whether the contracts are connected or not. First, the existence of mutual reference in bilateral contracts to the connected contracts, either expressly (through a contractual clause) or implicitly (through some reference to cooperative practice (eg manuals of conduct followed by supplier companies).69 Second, the ‘connected’ bilateral contracts must serve a common project. Third, the parties must, in fact, have a working cooperative relationship. The existence of connected contracts would bind the individual bilateral contracts to each other and require joint interpretation of the network aim in the overall transaction.70 ii.  Contrats-Alliance Hamelin defends that the traditional notion of a synallagmatic exchange contract in French law bypasses several types of contract where the parties join forces to undertake a common project. Such different kinds of contract are denominated contrats-alliance (ie alliance contracts) and do not share the same underlying rationale governing exchange contracts: the Aristotelian notion



66 MüKoBGB/Habersack, 67 Ibid.

68 Teubner,

7. Aufl. 2016, BGB §358 Rn. 26.

Networks as Connected Contracts (n 4) 156. 158. 70 ibid 164–65. 69 ibid

Building a Concept of Contractual Networks  47 of commutative justice, the arithmetical correspondence between the goods or services exchanged.71 Rather, the contrat-alliance rests on the notion of distributive justice, ‘to each according to its merit’, of sharing the profits derived from a common project established in contract between the parties according to their contributions. Hamelin identifies two features as peculiarities of the alliance contracts. First, the existence of a common purpose to which all the contractual performances are oriented and second, all the activities performed must be in the interest of all parties to the contract and common interest is to be found in the cause of the contract, in the common activity. He also states that there are alliances that create a new juridical person where the participants maintain distinct legal personalities among them. Two kinds of effect are engendered by the alliance contracts. First, there are the essential effects, necessarily present in these contracts: the aggregation of efforts and performances of the parties in the contract and the distribution of the results of the contract. Second, there are the ‘natural effects’ that can be contractually stipulated: the capability of creating organisational bodies72 and the ability to create a juridical person, which will represent the alliance before third parties. Hamelin’s contribution does not engage with the broad discussion being undertaken in European private law, limiting its analysis to French law. Furthermore, it remains primarily theoretical, mentioning the difficulties but not the issues of network governance, nor analysing in-depth the legal interpretation of these agreements. iii.  Contratti Di Rete It seems that the sole successful attempt at creating specific rules aimed at contractual networks is the Italian Law No 33 of 9 April 2009 introducing the notion of a ‘network contract’.73 This legislation has been successful in promoting the use of this legal instrument between Italian companies: according to a survey of the Italian Economic Development Ministry, until mid-2014 more than 1,643 network contracts had been concluded in the country, involving around 8,000 companies.74 The aim of the legislation is to foster innovation and

71 J Hamelin, Le contrat-alliance (Economica 2012) 1. 72 Either decision-making bodies, through which the members deliberate to make decisions for the project, or executory bodies, nominated by the members of the alliance, which will be independent to perform their job without the need to consult the members for decisions. 73 F Cafaggi, P Iamiceli and G Mosco, Il Contratto Di Rete per La Crescita Delle Imprese (Giuffrè 2012). 74 ‘Il Contratto Di Rete: Analisi Quantitativa – Dati Di Sintesi’ (Direzione Generale per la politica industriale, la competitività e le piccole e medie imprese – Ministero dello Sviluppo Economico 2014) www.mise.gov.it/images/stories/pubblicazioni/Contratti_di_rete_Analisial30giugno2014.pdf.

48  Contractual Networks to Innovate economic growth through inter-firm arrangements, especially between SMEs, the backbone of the Italian economy.75 The legislation provides for financial advantages, simplified administrative procedures and simplified financial access for the networks.76 The core reason for the attractiveness of these networks, however, has not been these benefits, but the flexible structure they provide for the parties that want to cooperate in a project while simultaneously competing in other realms.77 Despite the success of the legislation, the rules on contract law are scant and provide more of a framework for the choices that parties have to make in establishing their contractual network, rather than default rules. In other words, the legislation places emphasis on the parties’ contractual freedom. The specific rules on the network contract are established in Article 3, subsections 4(3), 4(4) and 4(5), Law No 33/2009. The ‘network contract’ is described as a structure for entrepreneurs to collaborate in increasing their competitiveness and innovative capacity on the basis of a ‘common network programme’, involving the exchange of information or performances of a commercial, industrial, technical or technological nature. Furthermore, Article 3, subsection 4(3), deals with the optional possibility of establishing a common board between the companies (organo comune), as well as a common patrimonial fund (fondo patrimoniale comune). The essential elements of the contract are the following. The contract can be either bilateral or multilateral and must state the strategic goals to be achieved, as well as the specific joint activities that the parties plan to perform together, agreeing forms of measuring performance. The parties must set out a ‘network programme’, with a schedule of the joint activities and the duties and rights of each of the parties. The activities must have a functional connection with the business scope of each firm. The parties have the option to establish a common board responsible for overseeing the performance of the network aims, with the power to act on behalf of the network members by concluding contracts with third parties. The parties have discretion to establish the specific governance rules of the board. Firms also have the option to create a common patrimonial fund for the purposes of the network. Their tax benefits, however, hinge upon the creation of such a fund. It is important to point out that the network contract may remain purely contractual. In some cases, the common patrimonial fund may become limitedly liable towards the personal debts of the members of the network and shall become unavailable to the participants for the duration of the contract. In such

75 C Ferrari, ‘The Italian “Network Contract”: A New Tool for the Growth of Enterprises within the Framework of the “Small Business Act”’ (2010) 16 The Columbia Journal of European Law 77. 76 ibid 81. 77 C Mastellone and G Pailli, ‘Contractual Networks between Enterprises: The Italian Experience’ (56th UIA Conference, Dresden, Germany, 2012).

Building a Concept of Contractual Networks  49 cases, the network may acquire a ‘legal subjectivity’, close to that of an independent legal entity, but without an independent legal personality (with a status similar to those of a partnership or non-recognised association in Italian law). In the Italian context, therefore, the network contract represents an experimental attempt at designing a legal institution suited to inter-firm arrangements. The initial results seem to point out a successful outcome, but it is still too early to proclaim that. The main lessons to be taken from this experiment refer to the possibilities of creating a network with a common patrimonial fund with legal subjectivity (but without independent legal personality) and, foremost, the possibility of designing institutions that blend competition and cooperation. iv.  Business Networks In seeking to establish a distinctive legal concept of business networks, ­Aedtner et al78 propose to identify those constitutive issues of network structures, seeking to exclude non-essential features. They discard the issue of distributive equality as an essential feature for, in some cases, the parties may be able to define ex ante the distribution of claims.79 They further argue that rights of claims between members of the network not contractually connected are not specific only to contractual networks.80 They identify only two specific and constitutive characteristics of networks.81 First, the intensified duties of cooperation between its members. The network aim can be achieved only if all parties are actively engaged and cooperating towards the network common activity. Second, the complexity of the project and the multiparty relationships in the network require dynamic forms of organisational adjustment of the members’ activities as their relationship evolves. Both these characteristics, according to them, would be consistently present across different patterns of business networks. The organisational or coordination issues would presuppose enterprises collaborating on an equal footing, rather than hierarchical collaboration imposed by a main company that controls the production process and undermines the coordination problems. Thus, franchising and other hierarchical business arrangements should not be considered business networks for legal purposes. Nonetheless, the authors acknowledge that these other legal constructs may involve network-like features and may provide insights on business networks. By narrowing the concept, a greater conceptual unity can be attained, upon which further legal developments on business networks can be made.



78 Krebs,

Aedtner and Schultes (n 60) 61. 66–67. 80 ibid 63–64. 81 ibid 67. 79 ibid

50  Contractual Networks to Innovate The authors82 sketch what would be a legal model that could consider the distinctiveness of business networks, claiming that general rules are desirable, but warning that these should be adapted to the multi-dimensionality of networks. Thus, they argue that the two main variables to categorise networks should be the kind of activity undertaken (transformative/non-transformative) and the kind of exchange process at stake (exchange of consideration/communisation/informal give and take). Each combination of these variables would result in a specific ‘module’ of network, which would indicate the need for a specific chance and risk structure of the business. This risk structure, in turn, would suggest a legal form to be followed. Among the networks analysed by the authors, only networks involving transformative activities (aimed to innovate) are relevant for this book. As aforementioned, these innovative contractual transactions have three ­characteristics:83 production under continuous high uncertainty; the inability of  one firm to produce such innovations alone; and intense and continuous ­cooperation between the firms towards the production of the final innovative output. What should be considered is their proposed narrower conception of business networks. While agreeing with their definition, it is not entirely convincing that hierarchical networks never involve coordination problems only because there is a leading company controlling the production. As pointed out by the economic studies on long-term contracts, one of the main issues arising from these kinds of structure is the hold-up problem. This type of problem states that the party who made an investment in the joint project can be held captive by the other party who has not made such a significant investment in the common venture. Both the leading company and the other companies in the chain can find themselves in this position. It is not uncommon, in a context of technological sophistication, for large companies to undertake large investments and become captives of their collaborators, even if those collaborators are smaller companies. This is an example of how, even in apparently hierarchical networks controlled by a large company, this company can become captive of other firms by opportunistic behaviour unless coordination structures are established. III.  CONCLUSION: THE WORKING CONCEPT OF CONTRACTUAL NETWORKS FOR INNOVATION

This chapter has examined different legal concepts and frameworks proposed in the European legal scholarship and practice to govern collaborative contractual networks. First, it has discussed how contractual networks are widely 82 P Krebs and others, ‘The Modular System of Network Activities’ in S Jung, P Krebs and G Teubner (eds), Business Networks Reloaded (1st edn, Nomos Verlagsgesellschaft mbH & Co KG 2015) 75. 83 Gilson, Sabel and Scott (n 16).

Conclusion  51 acknowledged as distinct structures in relation to traditional legal institutions such as partnerships, corporations or simple contractual agreements. Besides, it has indicated that the early concepts developed to govern productive networks of contracts – namely, relational contracts, linked contracts and symbiotic contracts – present either limitations or inadequacies to deal with the particular challenges of these relationships. Second, it has examined more recent proposals of legal concepts and frameworks to govern collaborative contractual networks to innovate, tailored to their peculiarities, ie connected contracts, contratsalliance, network contracts and business networks. After addressing the different legal frameworks proposed in the European context to deal with contractual networks, the question to be addressed now is what direction should be followed regarding this issue. That is, whether there is any advantage in adopting a legal framework to govern networks of contracts instead of adopting the prevailing approach in the United States that focuses on contract design and governance mechanisms to regulate inter-firm relationships. As will be seen in the following chapter, several empirical studies provide evidence that contract design and governance mechanisms are the most important instruments to guide the cooperation between the parties and that legal controversies are resolved internally in the network, through procedures or institutional structures established by the parties – discarding or at least undermining the need for court adjudication.84 In this sense, governance mechanisms are a crucial instrument to guide the cooperative side of productive relationships between contractual parties. Nevertheless, there are three notable advantages in establishing a legal framework to govern contractual networks. These advantages would provide functional clarity in the legal treatment of contractual networks across different jurisdictions. While the significance of the common law/civil law divide has been downplayed in comparative law,85 indicating the existence of similarities and functional convergence among different legal systems in many areas (particularly in private and commercial law),86 it seems, in this case, that the benefits

84 ibid; S Deakin, C Lane and F Wilkinson, ‘Contract Law, Trust Relations, and Incentives for Co-Operation: A Comparative Study’ in S Deakin and J Michie (eds), Contracts, Co-operation and Competition (Oxford University Press 1997) 111 ff. 85 Alessandro Somma, ‘Global Legal History, Legal Systemology, and the Genealogy of Law’ (2018) 66 The American Journal of Comparative Law 751, 754 ff; claiming that legal families are  now mostly viewed ‘as ideal types rather than precise depictions of reality’, see Mariana Pargendler, ‘The Rise and Decline of Legal Families’ (2012) 60 The American Journal of ­ ­Comparative Law 1043. 86 Arguing that, even though American law has no concept of good faith in the phase of contract formation, still it has many similar concepts that play a similar function; see the classical study of Friedrich Kessler and Edith Fine, ‘Culpa in Contrahendo, Bargaining in Good Faith, and Freedom of Contract: A Comparative Study’ (1964) 77 Harvard Law Review 401, 449; see also Arthur T von Mehren, ‘Civil-Law Analogues to Consideration: An Exercise in Comparative Analysis’ (1959) 72 Harvard Law Review 1009.

52  Contractual Networks to Innovate mentioned below would be particularly significant in civil law systems. This is due to their distinctive mode of legal thinking, with a ‘tendency to use abstract legal norms, to have a well-articulated system containing well-defined areas of law and to think up and to think in juristic constructions’.87 First, such a framework could allow or regulate the creation of certain governance structures in contractual networks that under some legal systems (especially civil law countries) could be barred or at least fall under a grey area of uncertainty as to the extent of their validity. Some of these instruments are indicated in empirical studies as important mechanisms to facilitate inter-firm cooperation. Consider the case of patrimonial funds liable for the activities of the network or steering committees responsible for making decisions in the network – mentioned as potential governance arrangements in the Italian legislation on network contracts. A steering committee making crucial decisions for the network, where the decision power is concentrated in the hands of a small number of companies in the network, could be potentially contested through private law general clauses regarding abuse of power, lack of good faith or fundamental change of circumstances, for instance. It is also questionable whether a patrimonial fund, established by the parties contractually – absent a specific regulation on this matter – could establish a limitation of liability for the network members towards third parties that contracted with the network. It seems necessary to clarify the possibility/validity of such governance arrangements to guarantee the stable functioning of networks under legal systems where they could be contested. Second, this legal framework could establish that contractual networks would be subject to a distinctive interpretative guideline than most contracts, particularly to a duty of loyalty to the contractual network, discussed in chapters three and four. Teubner advanced this concept, where duties of cooperation and good faith are potentially intensified in some circumstances but not in all, and this concept has been further deepened in different studies on this subject.88 The nature of collaborative relationships presents a need to balance the parties’ allegiance to the purpose of their common project with the freedom to pursue their individual interests. This duty reflects the need to recognise that this is neither an adversary relationship nor a fiduciary relationship, where the parties owe prevalence to their partners’ interest. The duty of loyalty to the network, instead, creates an intensified level of commitment towards the project to which

87 Konrad Zweigert and Hein Kötz, Introduction to Comparative Law (3rd rev edn, Clarendon Press; Oxford University Press 1998) 69. 88 Teubner, Networks as Connected Contracts (n 4) 184–86; Collins, ‘Introduction to Networks as Connected Contracts’ (n 5) 14–15, 43 ff; F Cafaggi, ‘Organizational Loyalties and Models of Firms: Governance Design and Standard of Duties’ (2005) 6 Theoretical Inquiries in Law 463, 518ff (focusing on loyalty inside networks of small and medium companies); also considering the importance of a duty of loyalty in the contractual networks, see Weitzenboeck (n 19) 318 ff.

Conclusion  53 the parties have adhered, but should not be applied indiscriminately, barring the parties from remaining competitors in the market. In common law countries, a clarification about the concept of contractual networks no doubt could be beneficial, but the flexibility of the common law method could also achieve this result through legal interpretation of relational contracts, as can be seen in the discussion in chapter three regarding an emergent legal concept of relational contract in English law.89 In civil law countries, however, where legal norms are usually the departing point in the process of legal interpretation, the existence of a more established concept would be particularly important to clarify the spirit guiding the interpretation of these relationships. After all, they escape both the logic of arms’ length contracts and the logic of fiduciary contracts. They stand somewhere in between. Third, a legal framework governing these networks of contracts, especially those involving small and medium companies, could subject them to more flexible tax and administrative rules, as a form to encourage their activities. This practice can be observed in the Italian legislation on network contracts to foster inter-firm cooperation that can generate economic growth and innovation. In this regard, the benefit of establishing a concept of contractual networks would be outside the specific domain of contract law. These benefits of a legal concept to govern contractual networks would be enhanced in the transnational sphere, where contractual networks may involve entities from different jurisdictions. In this scenario, it might be necessary, at least in some cases, to examine what compensatory rules (both regarding third parties and contractual liability rules between the members of the network) might be applicable to a certain dispute.90 These matters will hinge upon the applicable legal rules to the contractual network – not only upon the inserted governance mechanisms. Therefore, in a transnational context, it would be even more important to clarify whether a certain applicable law has a distinctive treatment for contractual networks. Although that does not mean necessarily that a concept of contractual networks should be established through international

89 See ch 3, section I.E. 90 It has become common to speak of the rise of a ‘global law without a state’, rules that are created outside classical political institutions of the state, by private parties and private institutions (eg, the lex mercatoria or rules created by private associations and private organisations). G ­Teubner, Constitutional Fragments: Societal Constitutionalism and Globalization (Oxford University Press 2012); however, one important theoretical criticism to this concept is that it neglects the importance of the state law (or the classical order) for the functioning of these private orderings. Robert Wai claims that the postclassical literature on global orderings has the drawback of presenting this phenomenon of the post-classical order – all these private transnational orderings – as self-sufficient. It fails to connect these private orderings with the state rules that give it a necessary support. He claims that the literature on transnational private orderings focuses only on how the private parties consensually and cooperatively create themselves the rules that will govern their future relationships; but it fails to analyse the importance of rules of the state regarding the compensatory and regulatory functions of the law, which are crucial for the functioning of the system. Robert Wai, ‘The ­Interlegality of Transnational Private Law’ (2008) 71 Law and Contemporary Problems 21.

54  Contractual Networks to Innovate agreements, model laws or legislative guides, this procedure would certainly ensure greater consistency in the treatment of this subject. Even if the significance of these benefits is acknowledged, there is still the question of how to establish a concept of contractual networks to which this special framework would apply. This should be a minimal and ‘trans-typical’ concept of productive contractual networks or collaborative contractual networks to innovate. The concept would be minimal because it would not intervene in the parties’ freedom to insert in their agreements the governance mechanisms they see fit, but only set minimal requirements for certain legal relationships to be considered contractual networks. It would be trans-typical, in the line suggested by Cafaggi, because it would apply in principle to different kinds of contract (eg, sales contracts, distributorship contracts, research and development agreements), if they fulfil certain requirements. The identification of a contractual network should depend on the three requirements proposed by Teubner.91 That is, the existence of mutual reference in bilateral contracts to the connected contracts, the existence of a common project that the ‘connected’ bilateral contracts must serve and a de facto working cooperative relationship. These would guarantee that only actual working partners willing to form contractual networks are able to do so. Such requisites could be bypassed if legislation is enacted requiring the parties who want to form a contractual network to register their contract as such, as in the case of the Italian legislation. In practice, however, many productive networks seem to involve a multiparty contractual or regulatory framework, often overseen by a leading entity or firm, discarding the need to apply these criteria to create a network de facto and determine what parties are members of the network.92 The more appropriate route to address both the private governance and the legal doctrine side of contractual networks would be to develop a legal concept of contractual networks in the civil law systems. This specific legal concept, however, should not be envisioned as a new kind of contract, ie a sales contract. It should be envisioned, as Cafaggi proposed, as a ‘trans-typical category’ (trans-tipicittá).93 This category would neither represent general civil code rules on contract law, to which all commercial agreements are subject, nor would they be applicable only to specific categories of contract. Rather, it would work as a ‘meta-category’ that provides further rules and interpretative tenets to be applicable across different specific forms of contract that share some fundamental similarities. It is especially important to develop this concept in the civil law

91 See section I.B.i, this chapter. 92 In other words, contextualising regimes are created; see C Sabel and W Simon, ‘Contextualizing Regimes: Institutionalization as a Response to the Limits of Interpretation and Policy Engineering’ (2012) 110 Michigan Law Review 1265, 1266. 93 F Cafaggi, ‘Il Contratto Di Rete Nelle Prassi: Verso Il Consolidamento’ in F Cafaggi, P Iamiceli and G Mosco (eds), Il Contratto di Rete per la Crescita delle Imprese (Giuffrè 2012) 156.

Conclusion  55 countries because, to address the issues of contractual networks, it may be necessary to deviate, partially, from some of the rules contained in the general parts of civil codes regulating contracts or obligations. In the common law systems, a general law of obligations is not contained in a written code. It is not imperative to statutorily define the differences between the general rules applicable to contracts from those applicable to contractual networks. The common law’s own flexible logic makes it easier for the courts to make this adaptation which, in the civil law systems, seems to require a greater effort. Thus, the creation of a concept of contractual networks in the common law systems would not be imperative, although it would be helpful for interpretative purposes to articulate the typical ways these contracts are treated, providing clarity for legal studies, through a trans-typical category of contractual networks. Having discussed the potential legal concepts to govern contractual networks, it is crucial to survey the governance mechanisms designed by the parties to coordinate an innovation project. This is the topic of the next chapter.

2 The Internal Coordination of the Collaborative Contractual Network through Governance of Contract

W

hen contractual partners undertake a collaborative venture to innovate, several difficulties ensue as their project unfolds. While contingencies, unpredictability and defection are common to all business relationships, they are even more so in the uncertain context of innovation, especially where a project is developed through a series of interdependent performances by a plurality of independent companies. On the one hand, difficulties of coordination are magnified in the contractual setting because, in contrast to the setting of the firm, there will be no superior hierarchical manager entitled to impose top-down orders for all the partner firms to follow. On the other hand, the pervasive uncertainty of the relationship (in addition to high transaction costs) generates incomplete contracts that often do not provide enough guidance to the relationship. As the difficulties appear, decisions will have to be made by the parties in conjunction, either informally, through a previously contractually established procedure, or, perhaps in certain circumstances, by a court ordering a specific outcome. When an experiment has failed, are the parties obliged to continue cooperating and, if so, under which terms? How do they distribute surplus when one of the parties makes a significant discovery/contribution to the project, disrupting the economic balance of the relationship? Such are examples of the so-called internal issues of a collaborative network. To address these issues, this chapter is divided into five sections. Section one examines the challenges to the internal coordination between the members of the network and how they translate into legal problems in innovative practices. Section two analyses the repertoire of practices available to address these challenges through contractual governance mechanisms. Section three presents the results of empirical research conducted in Brazil on the design of contracts structuring inter-firm innovation. Section four analyses secondary sources on inter-firm innovation in the United Kingdom, with a particular focus on megaconstruction projects, which provide relevant insights on the topic of management of uncertainty. Section five concludes the chapter.

Re-Interpreting Internal Challenges  57 I.  RE-INTERPRETING CONTRACTUAL NETWORKS’ INTERNAL CHALLENGES FOR INNOVATION PRACTICES

Cafaggi, Grundmann and Vettori, summarising the legal and economic literature on the subject of contractual networks,1 identify five internal legal challenges faced by them.2 These challenges will be reinterpreted in the light of practices to innovate. First, there is the inherent uncertainty in all long-term contracts relating to the impossibility of predicting contingencies that may arise in the long run of the contract performance.3 Networks of contracts are often formed by longterm contracts, as opposed to spot contracts.4 However, in radical innovation projects, these same features are usually present, regardless of the contract duration.5 In the field of innovation, it is common that even in the initial stages it may be impossible to predict the parties’ obligations.6 An illustration of that is a computer manufacturer regularly buying circuit boards from another company.7 While there may be an initial description of the product, the buyer expects to cooperate closely with the partner company to constantly produce innovations in the components, which otherwise will rapidly become obsolete due to the changing nature of the field. Uncertainty generates incomplete contracts, where the parties’ obligations cannot be predicted accurately at the outset of the relationship. Second, there is the need to prevent opportunism facilitated by specific investments in particular contracts.8 In preparation for a contractual agreement or for its performance, one contractual partner has to make investments tailored to the project at hand. In innovative projects, these preliminary investments may refer to the initial experiments to assess the feasibility of undertaking the venture. 1 F Cafaggi, S Grundmann and G Vettori, ‘The Contractual Basis of Long-Term Organization – the Overall Architecture’ in S Grundmann, F Cafaggi and G Vettori (eds), The Organizational Contract (Ashgate 2013) 9 ff; 19 ff. 2 Adopting this distinction between internal versus external issues in networks, F Cafaggi, ‘A  Research Agenda for European Contract Law’ in F Cafaggi (ed), Contractual Networks, Inter-firm Cooperation and Economic Growth (Edward Elgar 2011) vii, viii, xii, xiv. 3 J Bell, ‘The Effects of Changes in Circumstances on Long-Term Contracts’ in D Harris and D Tallon (eds), Contract law today (Oxford University Press 1989) 198–200. 4 Traditional contract law rules are usually modelled for spot contracts and, therefore, often present inadequacies to deal with contractual networks. R Macedo, Contratos Relacionais e Defesa Do Consumidor (2nd edn, Revista dos Tribunais 2006) 123. 5 Governance aspects then sometimes become necessary to address discrete exchanges and markets. S Grundmann, F Möslein and K Riesenhuber, ‘Contract Governance: Dimensions in Law and Interdisciplinary Research’ in S Grundmann, F Möslein and K Riesenhuber (eds), Contract governance: dimensions in law and interdisciplinary research (Oxford University Press 2015) 3, 4. 6 RJ Gilson, CF Sabel and RE Scott, ‘Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration’ (2009) 109 Columbia Law Review 431, 431 ff. 7 ibid 465. 8 OE Williamson, ‘Transaction-Cost Economics: The Governance of Contractual Relations’ (1979) 22 Journal of Law and Economics 233, 239, 241.

58  Internal Coordination They will be specific when the generated products/services are not marketable to third companies. For instance, a component produced specifically for a model of machine used only by the contractor cannot be sold to third-party companies. The non-marketability of these products creates a vulnerability for the party who made the investments vis-à-vis its contractual partner (hold-up problem). When the investments are considerable, and the other party has not undertaken the same level of investment, this creates a risk for the non-investing party to act opportunistically, proposing to renegotiate the contract and asking for inadequate advantages. Third is the incentive structure of long-term contracts, which should be markedly different from spot contracts due to the parties’ repeated dealings.9 In long-term contracts, parties are continuously performing their contractual obligations. It is crucial to create ‘warning’ mechanisms that permit a contractual party to immediately sanction the inadequate performance of the contract by the other party, rather than wait for the end of the contractual term. Similarly, in innovative ventures, even if not long-term, such warning and communication mechanisms may be necessary to assure that the parties are mutually understanding of each other’s behaviour in a complex setting. Likewise, the termination mechanisms have to be calibrated. Sometimes, allowing an inadequate performance to result in termination may favour the party who invested less in the project to exit or to blackmail the other party. The incentives could also be structured in a positive way. For instance, financial rewards could be awarded for parties whenever certain objectives are achieved.10 In innovation, these ‘warning’ and ‘monitoring’ mechanisms are important to improve the communication between the partners, for often the experimentalism of the relationship can induce misinterpretation of the partner’s motives. Fourth is the need for flexibility of privity of contract in the context of those networks.11 Under this principle the effects of a contract will apply only between those who signed it and agreed to be parties to it; it will not extend to third parties. It is questionable, however, how far this is adequate for contractual networks, where relevant economic relationships are formed between parties who are not directly connected through formal contracts. In practice, many innovation projects seem to create a contractual framework or bureaucratic structure involving the multiple parties to the project, for instance, through framework agreements or supplier codes establishing rules relevant for the whole network.12 Fifth is the division of additional profits or risks arising out of the collaborative activity.13 In innovative projects these issues can be magnified. The project is

9 Cafaggi, Grundmann and Vettori (n 1) 11. 10 See ch 4, section III.F. 11 H Collins, ‘Introduction to Networks as Connected Contracts’, Networks as Connected Contracts (Hart Publishing 2011) 15. 12 See section II.B in this chapter. 13 Cafaggi, Grundmann and Vettori (n 1) 23.

Governance Mechanisms  59 still being conceptualised as the parties’ relationship evolves, so the underlying economic structure of the deal and the importance of the contributions of each of the partners in the venture may move in unexpected directions. Jennejohn pointed out the existence of two additional transaction costs to explain the variety of contractual governance design verifiable in contractual networks. The first are spillovers, ie the difficulty of defining ex ante the value of assets (especially intellectual property (IP) rights) that may emerge as an outcome of the contractual collaboration.14 The parties need to spend resources on establishing the concept of these assets and on policing their boundaries. If a new technology process has been developed in a rapidly developing field, such as the software industry or the semiconductor industry, it becomes necessary to spend resources on identifying that specific technology’s value, labelling it, and policing its use, lest it may be traded deceitfully by one of the partners in the collaborative venture. The second cost is entropy, ie the costs to ‘synchronize efforts and learning processes among team members’.15 In complex projects, the parties must spend resources on communicating adequately and effectively to achieve a functional final product. These, however, are related to Cafaggi’s concept of incentive structure in contracts, referred to above. II.  GOVERNANCE MECHANISMS IN CONTRACTUAL NETWORKS FOR INNOVATION

Traditional forms of private design are usually insufficient to deal with the challenges involved in the governance of inter-firm innovative transactions (A). There is a need for more complex forms of contractual governance and private ordering, adapted for the parties’ innovative/collaborative transactions (B). The analysis of these more complex forms of contract governance is based on case studies regarding similar ventures, mainly in the US but also from other jurisdictions. A.  Limitations of Traditional Contract Design Traditional contract design mechanisms identified in legal studies present limitations to deal with the inherent incompleteness and uncertainty in inter-firm relationships to innovate. A possibility for dealing with incompleteness would be to design formal contractual clauses protecting specific investments undertaken by each party,16 14 M Jennejohn, ‘The Private Order of Innovation Networks’ (2016) 68 Stanford Law Review 281, 314, 316. 15 ibid 314. 16 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 452–53.

60  Internal Coordination for instance, by compelling the other party to specific performance or to pay a high value of damages for failing to comply with obligations to perform. The problem with this approach is that ex ante clauses protecting specific investments may contradict the ex post need to cancel long-term commitments that may be revealed as commercially unprofitable as time progresses.17 For innovation purposes, upholding the formal contract, even if still profitable for one of the parties, would be unreasonable for the other party and discourage experimentalism. Such approaches prevent future projects being developed given the impossibility for parties to disembark from an initially uncertain venture that is clearly leading to an economically unsatisfactory result. A better design could be achieved through formal hard rules that could predict possible outcomes and devise ex ante solutions through a thoroughly drafted contract and precise clauses.18 The inherent uncertainty of the project, however, makes this prediction impossible or too costly, due to information costs to predict contingencies or to prove the occurrence of certain facts. A further solution is to allow contract renegotiation between the parties:19 a hardship clause calling the parties to renegotiate a contract that becomes too burdensome for one of them. Renegotiation between the parties, however, runs a high risk of failure in innovation contexts due to the hold-up problem.20 The party who undertook more investment and to whom the project became more economically important will not have the same leverage to renegotiate the contract as the other contractual partner, who may behave opportunistically and blackmail the other to obtain more favourable conditions under the renegotiated agreement. A sophisticated alternative exists:21 in highly unpredictable contractual issues, the parties may impose the future renegotiation of a contract by avoiding an initial consensus on risk allocation, and may implicitly constrain these renegotiations by allocating the control rights between the partners at the outset of their relationship. A particular form of allocating these rights could be conducive for the collaboration to continue and as a constraint for opportunism. For instance, in a biotech collaboration between a private research lab and a pharmaceutical company, the final decision about who will participate in the marketing of a collaboratively funded and developed product could be established as an issue for constant (re-)negotiation between the partners. However, if the contract establishes that one of the parties may have the right to commercialise the technology alone after a certain time if no agreement is reached, this term will then constrain and mark the division of power in the context of the

17 ibid. 18 ibid. 19 ibid 456–57. 20 M Jennejohn, ‘Collaboration, Innovation and Contract Design’ (2008) 14 Stanford Journal of Law, Business and Finance 83, 83, 94 ff. 21 ibid.

Governance Mechanisms  61 renegotiations. The difficulties with this solution are twofold.22 One, the parties may not collaborate due to the incapacity to reach an agreement as to who should retain certain control rights. Second, the constant renegotiation of these rights creates a high transaction cost for the parties. Another alternative would be the explicit allocation of the control rights, where the authority to make certain decisions ex post is directly assigned to one of the partners.23 This logic only works in the context of repeated dealings, where a company would have a higher incentive to act having regard to the common interests of the partners, as continuing the collaboration would be vital to its interests.24 Moreover, the party to whom this explicit authority to make decisions should be attributed is the one with the least incentive to act in a way to renege the collaboration.25 Again, there are limitations to this approach.26 First, as in the relational contracts approach, there are constraints to the incentive of self-enforcement; if information is not available in the market and if there are no repeated dealings, then the parties are not able to evaluate their counterparties’ behaviour and punish them for potential violations in the next round of cooperation. Second, it is very difficult to determine who will be the party with the least incentive to act opportunistically and renege the agreement in the fluid context of experimentalism. Still another possibility27 would be to create a two-tier procedure. First, parties include in their agreement a clause to act reasonably or to make best efforts in the contractual performance. Second, the parties create mechanisms for bonding and monitoring, which will serve as a form of incentive for adequate performance. The parties will then have an incentive to act up to the demands of the circumstances as they do not wish to be held for violating the best efforts clause.28 In practice, courts would be able to assess whether best efforts were duly taken by comparing the joint performance of the companies against the baseline of output in a single vertical company undertaking the same productive activity in the market. As Jennejohn argues, however, based on empirical research, in practice that is not how collaboration between firms is being conducted.29 Under high uncertainty, even for the partners involved in the collaboration, it is difficult to determine whether a certain amount of effort and cooperation is being applied by the other companies. If the standard is unknown, monitoring will not suffice to provide an adequate incentive for proper performance.

22 ibid 96, 97. 23 ibid 104 ff. 24 ibid. 25 ibid 105. 26 ibid 106. 27 CJ Goetz and RE Scott, ‘Principles of Relational Contracts’ (1981) 67 Virginia Law Review 1089, 1089, 1091–93. 28 Jennejohn (n 20) 108–09. 29 ibid 109.

62  Internal Coordination A last possibility, revisiting suggestions aforementioned, would be to conclude a preliminary agreement.30 This would allow the parties to collaborate and invest jointly, having in view determining whether their project is feasible and whether they are compatible partners. At the same time, it would not bind them to a project that later is revealed as unrealistic or unprofitable.31 Rather, parties would remain at the end of the preliminary agreement with the option to conclude the contract or just walk out. Traditionally, preliminary agreements were generally considered to be unenforceable under the common law of contracts due to the doctrine of indefiniteness.32 They create a situation in which the parties are either fully bound to conclude a contract or where they are fully free to reject signing the contract.33 In fact, this framework does not give the parties the support they need to invest in a project in innovative industries. From the outset, they cannot indicate in the preliminary agreement the full conditions of the contract, as the highly uncertain context of innovation does not allow them to do so. Stipulating determinable clauses or conditions precedent in an option agreement would also be cumbersome in this context. At the same time, if one of the parties is allowed to walk out freely, there is no protection for the specific investments undertaken by the other party. In such situations, preliminary agreements are insufficient to facilitate innovation agreements. Traditional contract design, thus, is limited to deal with contractual networks. In the past few years, other contractual practices have emerged for the governance of inter-firm innovation. B.  The Governance of Inter-firm Innovation Inter-firm ‘strategic alliances’ have long been discussed in management and economic studies.34 Particularly in highly innovative ventures, there has been a recognition that, without ‘open innovation’, less advancement can be achieved.35 In legal studies, the interest on contracting for innovation is more recent. Before examining the relevant empirical evidence and the emerging theories explaining the governance of inter-firm innovation, it is important to clarify that, in this particular context, the governance of bilateral contracts and multilateral networks display important similitudes. Despite adaptations that

30 RJ Gilson, C Sabel and RE Scott, ‘Contract and Innovation: The Limited Role of Generalist Courts in the Evolution of Novel Contractual Terms’ (2012) 88 NYU Law Review 170, 189–90. 31 ibid. 32 ibid 193. 33 Under New York law, this rule has given way to a duty to negotiate in good faith. ibid 196 ff. 34 P Dussauge and B Garrette, Cooperative Strategy: Competing Successfully Through Strategic Alliances (Wiley 2019); Michael H Best, The New Competition: Institutions of Industrial ­Restructuring (Harvard University Press 1990). 35 HW Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from ­Technology (1st edn, Harvard Business School Press 2003).

Governance Mechanisms  63 may be necessary for contexts involving multiple parties, there are no fundamental differences regarding the governance mechanisms employed. These similarities seem to be connected to the fact that, even in a bilateral context, the deployment of innovation involves pervasive uncertainty, requiring mechanisms to coordinate and create incentives to move the relationship forward. Interestingly enough, the Italian ‘network-contract’ can be both bilateral or multilateral.36 In fact, a multilateral network can even be structured based on bilateral agreements. It is important to point out that contractual networks involving multiple parties can be potentially structured either through bilaterally connected contracts, through multiparty agreements or through some arrangement combining both models.37 For instance, a multiparty framework or ‘umbrella’ agreement can establish general rules applicable for the transactions between a number of companies, under which specific bilateral contracts are concluded, with more specific obligations regarding the innovative project envisioned.38 Members of the network consider several factors to decide which model to follow in each case. Cafaggi argued that networks of bilaterally linked contracts emerge in inter-firm relationships involving less interdependence, less uncertainty and a willingness to grant the members more autonomy to leave the network.39 For instance, supply chains, where the chain coordinator subcontracts assignments to different companies not connected among themselves. Monitoring of the parties would be decentralised, often with duties to report between members of the network being inserted in the contracts through thirdparty beneficiary clauses. On the other hand, according to Cafaggi, multilateral contractual networks would arise mostly when a higher degree of coordination is crucial, information exchange is centralised and the monitoring of performances of the parties is undertaken through common technological platforms. The typical example is research and development projects, where parties’ complementarities are crucial for the project’s success. In such multiparty contracts, decision-making would be pursued through unanimous vote, majority vote or through the delegation of powers to a designed body. Contracts for innovation, however, require both a high degree of flexibility with heightened interdependence: they do not fit perfectly either of the characterisations above. The option between designing networks of contracts through bilaterally linked contracts or multilateral contracts then may take into account several additional factors, including: uncertainty about the projects’ feasibility and profitability,

36 See ch 1, section II.B.iii. 37 Cafaggi, ‘A Research Agenda for European Contract Law’ (n 2) 91. 38 P Krebs and S Jung, ‘Governance Structures in Business Networks’ in S Jung, P Krebs and G Teubner (eds), Business networks reloaded (Nomos 2015) 129 ff. 39 Cafaggi, ‘A Research Agenda for European Contract Law’ (n 2) 93 ff.

64  Internal Coordination the degree of interdependence among the parties, the regime of ownership over the network resources, the existence of competition between firms to enter the network, the symmetrical or asymmetrical division of power between the members and the governance mechanisms. There is anecdotal evidence of contractual networks to innovate structured according to these different models. For instance, one professional interviewed by the author in Brazil mentioned extensive negotiations between four companies from the cosmetics industry to design a multilateral contract among them to generate a new technology.40 At the same time, in the John Deere supply chain, for instance, bilateral incomplete contracts concluded in the context of the supply chain are complemented by framework agreements establishing that the parties have an obligation to cooperate but not to follow a specific course of action or to attain a particular result.41 Therefore, most of the contract governance mechanisms mentioned by the studies on contracting for innovation and examined below (such as steering committees, financial rewards, the division of the productive phase in different milestones) can be potentially used both in bilateral and multilateral agreements embedded in a context of high uncertainty. It does not seem that the bilateral or multilateral character of a relationship fundamentally alters the nature of such governance mechanisms, although there may be, of course, design adaptations. For instance, as will be examined, in multilateral relationships, sometimes a leading company may have a supplier code that attaches to the contracts concluded with the different companies in a network, determining how financial rewards will be awarded. Several empirical legal studies have considered traditional contextualising regimes established by trade associations and leaders of supply chains, such as the studies by Bernstein on the diamond, grain and cotton industries.42 The most important benefit of this form of private ordering, for Bernstein, would be the creation of a framework conducive to cooperation between the parties. By creating an institution with social relations, ‘networks of gossip’, information about the members flows easily, allowing the bonding between the partners and reputation sanctioning in case of default, encouraging the creation of cooperative partnerships. It encourages the maintenance of these relationships both by clear trade rules and by allowing recourse to a special

40 According to Interviewee 12 (I-12); interview on file with the author. 41 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 459–63. 42 See the seminal articles of Bernstein describing the functioning of private ordering in the context of the diamond, grain and the cotton industries, where state courts have a limited role in both interpreting and enforcing contracts. L Bernstein, ‘Opting out of the Legal System: Extralegal Contractual Relations in the Diamond Industry’ (1992) 21 The Journal of Legal Studies 115; L  ­Bernstein, ‘Merchant Law in a Merchant Court: Rethinking the Code’s Search for Immanent Business Norms’ (1996) 144 University of Pennsylvania Law Review 1765; L Bernstein, ‘Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and ­Institutions’ (2001) 99 Michigan Law Review 1724.

Governance Mechanisms  65 tribunal to solve fact-based misunderstanding among the parties. Furthermore, due to the fact that the parties’ performance is mostly assured by the nonlegal sanctions, flexibility and adjustments of the relationship are facilitated, as those are unlikely to be considered as contractual waivers or modification of rights in the legal framework provided by the associations’ rules. In case of a breach, this framework would encourage restoring cooperation due to the need to demonstrate that one continues to be a trusted partner to escape reputational loss. In a case study regarding the transnational supply sale of software, Dietz similarly argues that formal contract law has a minor role and relational sanctioning regulates these relationships.43 However, the author remarks the use of mechanisms for monitoring, for example, common organisational structures or online portals facilitating information exchange. He also remarks that contract payments are partial and due at the moment when certain ‘milestones’ are achieved. In this model, one can envision elements present in Gilson et al’s account of contracts for innovation, subsequently analysed. In Dietz’s view, these trade institutions are essential to the proper functioning of these relationships. Most contextualising regimes studied in these empirical studies, however, would have to be adapted to deal with high levels of uncertainty, with the creation of particular governance mechanisms and forms of interaction between formal and informal incentives.44 Whichever model is followed, it is common for multiparty contractual networks to establish either contractual mechanisms or a bureaucratic contractual structure to coordinate the parties’ performance.45 According to Porat & Scott, ‘These relationships have a “spider in the web” – a controlling party or hierarchy at the center of the network that facilitates network formation and maintains stability’.46 These mechanisms vary according to the industry, commodity or hazards involved. They can include, for instance, a combination of third-party certificators monitoring regulation compliance, the allocation of responsibility for monitoring potential violations to a supply chain ‘leader’ or peer-to-peer monitoring.47 As remarked by Simon, in the Toyota Production

43 T Dietz, ‘Contract Law, Relational Contracts, and Reputational Networks in International Trade: An Empirical Investigation into Cross-Border Contracts in the Software Industry’ (2012) 37 Law & Social Inquiry 25, 44, 53. 44 In a more recent article, Bernstein examines some of such mechanisms. L Bernstein, ‘Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts’ (2015) 7 Journal of Legal Analysis 561. 45 Ariel Porat and Robert E Scott, ‘Can Restitution Save Fragile Spiderless Networks?’ (2017) 8 Harvard Business Law Review 1, 3. 46 ibid. 47 F Cafaggi, ‘Private Regulation and Industrial Organization: Contractual Governance and the Network Approach’, Contract Governance – Dimensions in Law and Interdisciplinary Research (Oxford University Press 2015) 360 ff. Cafaggi identifies three main criteria to distinguish forms of certification schemes deployed for the governance of a contractual network, providing emblematic examples of how they function in practice.

66  Internal Coordination System, as the different companies involved in the chain start producing something, they will continuously provide information to a specified body about the perceived risks of a certain activity, establish a benchmark of issues to constantly monitor, measure failures and problems, and establish mechanisms for the correction of these issues.48 Exceptionally (but growingly), there may be ‘spiderless networks’ between companies, lacking a coordinating entity or procedure, but incentivised by a high degree of social capital and by the parties’ interest in learning and in interacting and identifying potential new partners to innovate in a group context.49 i.  Braiding Theory, Structural Social Capital and Multi-valent Contracting The empirical analysis of legal agreements involving inter-firm collaborative innovation has been more extensive in the US than in other jurisdictions. The work of Gilson, Sabel and Scott in their series of articles on contracting for innovation examines the different mechanisms used by private parties to deal with the challenges of uncertainty and coordination in these relationships.50 Other studies have examined a few contracts as case studies or specifically analysed different mechanisms used in the context of these collaborations, such as the role of steering committees or the calibration of termination clauses. More recently, Jennejohn51 studied a group of 146 ‘alliance contracts’, identifying recurrent patterns and seeking to explain the reasons for variations.52 Based on these empirical studies, different theories have been developed seeking to explain the rationale behind ‘contracting for innovation’, namely, braiding, structural social capital and multivalent contracting theory. In the US legal scholarship, it is possible to identify two crucial moments regarding inter-firm quasi-organisational ventures. First, scholars dealing with corporate governance studies acknowledged that, by focusing exclusively on the principal–agent relationship issue, they were missing other important

48 On the Toyota production system, see W Simon, ‘Toyota Jurisprudence: Legal Theory and Rolling Rule Regimes’ in G De Búrca and J Scott (eds), Law and New Governance in the EU and the US (Hart Publishing 2006) 11 ff. 49 For instance, through strategic alliances in the biotech industry, see Porat and Scott (n 44) 9 f, 11 ff. 50 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6); RJ Gilson, CF Sabel and RE Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (2010) 110 Columbia Law Review 1377; Gilson, Sabel and Scott, ‘Contract and Innovation’ (n 30). 51 Jennejohn (n 14). 52 The access to these forms of contracts in the United States is facilitated as several are publicly available through the US Securities Exchange Commission. Criteria for disclosure of these agreements is in the US Code of Federal Regulation §229.601(b)(10) on ‘Material Contracts’. Online access is available through the EDGAR Search Tools at the Securities Exchange Commission website, see www.sec.gov/edgar/searchedgar.htm. Similar broad disclosure requirements do not prevail in Brazil or in the UK, limiting access to these agreements.

Governance Mechanisms  67 mechanisms being employed in coordinating effective inter-firm relationships.53 Second, legal scholars studied the variety of specific mechanisms, including contract governance, that could be employed to facilitate these relationships. The search for different mechanisms for inter-firm coordination and mitigating opportunism seems to have intensified when forms of inter-firm coordination used in the Japanese Keiretsu were envisioned as a potential model for ­American corporate governance54 – and the American Toyota’s relationship with its first-tier suppliers constitutes an example.55 Nonetheless, the adaptation of the Japanese model to the US required several adjustments. Unlike the ­Japanese correlative, American firms rejected the rigid (locked-in) alliance created by cross-shareholding mechanisms, where partners became tied to each other.56 In the American culture, this would represent an undue restriction to the freedom to undo inefficient deals, leading to the search for more flexible mechanisms to coordinate inter-firm activities. This included, in each case, the choice between a range of alternative legal institutions: contracts, partnerships, different forms of legal entities and corporations.57 Several legal studies ensued, dealing with issues such as the establishment of steering committees (or contractual boards) in the context of strategic alliances,58 financial incentives,59 the role of non-compete clauses in producing innovation,60 the use of advanced technology to foster coordination and collaboration between contractual partners,61 the use of outsourcing relationships to develop specific forms of governance62 and the intertwining of formal and informal law (braiding) in designing collaborative relationships.63 There was a

53 RJ Gilson and MJ Roe, ‘Understanding the Japanese Keiretsu: Overlaps between Corporate Governance and Industrial Organization’ (1993) 102 The Yale Law Journal 871, 871, 882 (discussing the Japanese Keiretsu, a model of business organisation where, to perform a certain productive activity, different firms and its suppliers, as well as banks and other financial institutions, acquire cross-shareholding participation in each other, often imposed top-down by state activity and claiming that this business model serves to undermine the risks of opportunism). 54 ibid 901 ff. 55 Jeffrey H Dyer and Harbir Singh, ‘The Relational View: Cooperative Strategy and Sources of Interorganizational Competitive Advantage’ (1998) 23 The Academy of Management Review 660. 56 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1410 ff. 57 GW Dent, ‘Lawyers and Trust in Business Alliances’ (2002) 58 The Business Lawyer 45, 67–70. 58 DG Smith, ‘The Exit Structure of Strategic Alliances Symposium: Uncorporation: A New Age’ [2005] University of Illinois Law Review 303, 312–17 (on the ‘contractual board’). 59 Dent (n 56) 70–71 (mentioning ‘staged’ financing). 60 Smith (n 57) 53. 61 CJ Circo, ‘A Case Study in Collaborative Technology and the Intentionally Relational Contract: Building Information Modeling and Construction Industry Contracts’ (2014) 67 Arkansas Law Review 873, 881 (discussing building information modelling as a technology facilitating collaboration between construction industry partners). 62 George Geis, ‘The Space Between Markets and Hierarchies’ (2009) 95 Virginia Law Review 95, 132 ff; George Geis, ‘An Empirical Examination of Business Outsourcing Transactions’ (2009) 96 Virginia Law Review, 241. 63 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49).

68  Internal Coordination fragmented account of the different contractual elements to structure collaborative relationships to innovate. These studies culminated with the deployment of an influential theory on contracting for innovation – the ‘braiding theory’ – with a series of articles by Gilson, Sabel and Scott, incorporating some of the different mechanisms of contractual governance previously referred. As explained by Gilson et al, contracts for innovation share three main characteristics: businesses that require more than one company to accomplish their purpose; that cannot define at the outset the final output of the collaboration; and that require continuous adjustments to be made jointly by the partners.64 They claim that their theoretical approach differs from previous contractual studies because it points out that contracts for innovation cannot be explained by relational contract theory or formal contract theory.65 Relational contract theory emphasises informal mechanisms such as reputational sanctions and threats to avoid future business deals to prevent opportunism in these contracts. Formal contract theories focus on legal sanctions to regulate these relationships. The predominant view of academic literature on incomplete contracts, according to Gilson et al, considers formal and informal contract law as alternative approaches that cannot be combined. Either a contract is subject to courts that will enforce the formal clauses or the obligations will be voluntarily complied through reputation constraints in repeated dealings.66 This view that formal and informal sanctions cannot be combined is based on the notion that the formal ‘crowds out’ the informal.67 The justification is twofold. First, formal enforcement affects the parties’ perception about the deal. When the performance is based on trust – without formality – then parties would make considerable efforts and time to honour such performances. In contrast, in relationships based on formalities, the parties would see the possibility of either performing the contract or paying damages for breaching. The formal thus diminishes the parties’ perception about the effort to be poured into the cooperation. Second, the existence of strong formal sanctions turns the parties more cautious about their behaviour, lest their actions might be interpreted as a violation of the contract, thus suppressing actions necessary for exchange of information between highly cooperative partners. These factors undermine their capability of acquiring information about their partners and their interactions – both crucial for successful informal cooperation. This perspective is reinforced by a view that trust is exogenous to contracts,68 which opposes the institutionalist perspective defended by Gilson et al. For them, 64 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 451. 65 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1389 ff, 1392 ff. 66 ibid 1379–80. 67 ibid 1398–99. 68 On the different kinds of trust supporting contracting, see B Lyons and J Mehta, ‘Private Sector Business Contracts: The Text Between the Lines’ in S Deakin and J Michie, Contracts, Cooperation and Competition (Oxford University Press 1998).

Governance Mechanisms  69 contracts can be designed to favour the development of trust and formal and informal sanctions coexist in the context of contracts for innovation in the following manner. The contracts contain a few formal enforceable rules that impose upon the parties participation in processes of cooperation that make the behaviour of each party more observable.69 These processes, or ‘contractual milestones’, are moments where the parties must come together to cooperate, check their compatibility and then decide whether to continue cooperating or not. The contracts will not impose the continuation of the cooperation, but as the parties voluntarily keep on cooperating the costs of switching partners will become higher.70 As the parties have voluntarily continued cooperating, they invested in each other, acquired know-how and expertise related to the other company and developed communication channels. To forgo these advantages would incur significant costs for the companies, especially when compatible partners with expertise may be lacking in the market. The informal side, therefore, gradually creeps in, and serves as a mechanism to undermine opportunism where formal legal sanctions are no longer available. In the case of defection in the initial phases of experimental cooperation (in the ‘contractual milestones’), Gilson et al argue that formal legal enforcement should be restricted to ‘lowpowered enforcement’, ie to the compensation of the incurred costs.71 The assertion that innovative transactions escape both the tenets of relational contract theory and formal contract theory seems to find support among contract scholars in the United States.72 Hadfield and Bozovik73 published an empirical study surveying 29 inter-firm business relations in the US, 12 of them involving non-innovative businesses and 17 undertaking innovative activities. Regarding commercial contracts in non-innovative activities, their results mirrored Macauley’s predictions: formal contracts have little relevance for the resolution of arising disputes between long-term contractual partners, who resort mainly to informal relational mechanisms to solve their controversies.74 In relation to innovative transactions, however, they present a different picture. Parties relied heavily on contract planning (demonstrated by the significant amount of time/effort employed in drafting agreements), using their agreements as guiding plans, revising them when necessary, but still relying on enforcement

69 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 473 ff. 70 ibid 481 ff. 71 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1415 ff. Their proposal as to how the legal doctrine should deal with these contracts for innovation is further discussed in ch 3. 72 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49); Jennejohn (n 14); and Bernstein, ‘Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts’ (n 43). 73 GK Hadfield and I Bozovic, ‘Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation’ (2016) 5 Wisconsin Law Review 981. 74 ibid 11 ff.

70  Internal Coordination through informal mechanisms.75 They present a slightly different viewpoint from that of Gilson et al on the role of formal enforcement. While for Gilson et al, a certain extent of formal enforcement of contracts is important (‘lowpowered enforcement’), for Hadfield and Bozovik, in most cases, compliance and punishment are undertaken through relational incentives, even though they acknowledge that ‘[t]his is not to say that parties writing formal contracts never make use of (the threat of) formal court enforcement’.76 The exact extent to be played by formal enforcement in innovative contracts remains a moving area for any conclusion to be reached; for ‘contractual innovation does not come to courts incrementally … but instead reaches the courts later in the innovation’s evolution’.77 In any case, both viewpoints agree that some limited role is to be played by formal enforcement, even if only to remain as a potential threat. There are a number of contractual governance mechanisms that Gilson et al consider key in structuring these deals. Three main challenges in drafting such agreements are identified by the authors: to incentivise specific investments (essential to generate innovation), to create a framework to facilitate collaboration and to deter opportunism.78 By analysing three specific agreements between American companies that fall under the scope of contracts for innovation, they identify the most common mechanisms utilised to solve the challenges referred to. They observe significant variations between different transactions and the design of governance mechanisms. Additionally, according to Gilson et al, the most important criterion for explaining the variance of these agreements is the duration of the agreement.79 In long-term or indefinite-term contracts, the switching costs themselves, reinforced by the contract governance structure, will deter opportunism. In discrete projects of innovation, with an approximate end date, parties have to design specific mechanisms to counteract opportunism after the cooperation phase, mostly nested options. Initially, a few formal clauses establish processes of interaction80 (contractual milestones), with the enforceable obligation for the parties to cooperate in specific processes involving, for example, sharing of information or joint engineering in a line of production. Such milestones do not impose upon the parties the obligation to pursue their cooperative project to the end. They do create an obligation to seriously cooperate in a learning phase, both to evaluate the project’s feasibility and their compatibility as working partners. The decision to move forward, however, depends entirely upon the parties. The establishment of these processes of interaction is often described in a schedule of activities, annexed to the contract. In the case of large leading companies in the command



75 ibid

15 ff. 7. 77 Gilson, Sabel and Scott, ‘Contract and Innovation’ (n 30) 172. 78 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 472. 79 ibid 473–74. 80 ibid 476. 76 ibid

Governance Mechanisms  71 of the value chain, manuals of conduct often establish companies’ obligations and potential rewards for their behaviour. To be able to make the constant adjustments required by their contract, to monitor each other and to develop the channels of communication that are vital for cooperation to succeed, parties often create steering committees, where representatives of the different companies meet. Companies may establish a variety of committees, each with distinct membership and functions, such as technical committees (or ‘joint research committees’)81 or managerial committees, with a different contractual board governance (eg vote by majority or unanimity). There are two other mechanisms to enhance coordination, transparency and monitoring in these ventures, less recurrent in the US because they serve as forms to interlock the different collaborative companies, thus undermining freedom to experiment and to withdraw from inefficient collaborative relationships. First, cross-shareholding, through which the company(ies) in a network acquire equity participation in its/their working partner firm.82 That gives the company privileged access to the information of the company, as a shareholder, and contributes to undermine the risks of opportunism of both parties. Second, the direct nomination of one company’s member to the board of directors or management of the partner firm. Again, the participation of this representative enhances the capacity to coordinate activities and to monitor performance. The need for transparency and communication is achieved through contract referee mechanisms involving three elements.83 First, an obligation to share information during the collaborative phase. Second, an escalated dispute resolution procedure, initially submitting controversies to steering committees formed by members of the different companies. Third, the nomination of certain senior top members from each of the companies to jointly solve the issue in case the dispute escalates. Often, if the companies themselves cannot reach a solution the contract may still require the parties to seek mediation with an independent third party before they submit the dispute to arbitration/litigation. As previously discussed, during the collaborative phase, where partners are working together in developing a project, the costs of switching partners gradually increases as they decide to continue their cooperation. This would deter opportunism. However, once the project is completed, opportunism may come from a partner who seeks to acquire a share in the surplus of the cooperation that is higher than economically reasonable. If the collaboration between the partners is long term, with an uncertain duration, the high value of switching partners will continue to prevent the opportunistic behaviour of one of the parties. However, in the case of a discrete project, the development of a certain product may put an end to the cooperation between the partners. 81 ibid 469, 478. 82 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1410. 83 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 480.

72  Internal Coordination In this circumstance, Gilson et al claim uncertainty no longer prevails, and the parties should establish in the contract mechanisms for profit sharing or, at least, for minimising the risks of opportunism. A recurrently employed mechanism is nested options, through which one of the parties in the cooperative project, normally the one with the least incentive to act opportunistically, will be granted the option to walk away with the ownership of certain IP rights resulting from the cooperation.84 The insertion of nested options would give the parties assurance regarding the specific investments made for developing innovation.85 Gilson et al’s proposal mingles formal and contract governance mechanisms to create a framework that protects parties from opportunism and fosters cooperation. Several mechanisms presented by the authors have been previously discussed in the legal literature. Nonetheless, their analysis provides a cohesive explanation of the main essential features in contracts to innovate. A distinct analysis – although with similar elements – is proposed by ­Bernstein,86 based on the empirical assessment of procurement contracts in the US. Like Gilson et al, she highlights the importance of formal contracts and ‘administration mechanisms’ in relational contracting as an important means to incentivise a high level of performance between partners in an inter-firm venture87 (rendering relational contracting more expensive than usually assumed).88 However, in her view, normally those mechanisms gradually contribute to build trust between the partners. It is not the governance mechanisms themselves that are generating trust between the firms, they merely contribute to the parties to strengthen the ties and interactions that may allow them to build trust.89 This would be different from Gilson et al’s argument that contracts can endogenously create trust between partners, even in complex innovative transactions where they had no previous relations.90 For Bernstein, the relational aspect predominates in such projects for the joint development of innovation: the partners’ personal relationship allows them to collaborate in a complex scenario. The governance mechanisms only create the circumstances where these bonds might develop. In the procurement contracts analysed, those mechanisms are employed during the performance phase and are often contained within companies’ codes

84 ibid 491. 85 The limitations referred to in this chapter, section II.A to the efficacy of nested options remain relevant, but they are undermined by the general framework created through contracts for innovation and by the fact that they would be applied for concluded performances, where parties already collaborated successfully in developing innovation. Still, the reliability of a nested option to solve the hold-up problem should be looked at in perspective and might be limited in many contexts. 86 Bernstein, ‘Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts’ (n 43). 87 ibid 587. 88 ibid 614. 89 ibid fn 96. 90 ibid.

Governance Mechanisms  73 of conduct.91 These codes, therefore, may be relevant for multiple relationships concluded under the aegis of such codes of conduct. Those mechanisms serve to initially induce trust and cooperation between partners, with contractual provisions establishing obligations to start small acts of cooperation and transparent exchange of information. After cooperation starts, the mechanisms to maintain trust should be focused, she claims, on allowing the parties to distinguish between acts of cooperation and defection.92 However, in the view of Bernstein, those contract governance mechanisms will be less efficient in the innovation-related transactions where there is pervading uncertainty.93 There, the potential to assess the partners’ performance is low and there is greater room for misunderstanding. In traditional contexts, governance mechanisms would foster social capital between the firms through the exchange of information, the personal ties created between their employees, and the experience of jointly facing and solving problems, by reciprocal specific investments and by the observation of norms of reciprocal flexibility.94 In such context, social capital is not an immediate outcome of the contracts, but a gradual process that may take years to develop.95 In contrast, Bernstein contends that ‘structural social capital’96 can be efficiently designed for innovative scenarios when there is no possibility to wait for the gradual development of social capital. This structured social capital refers to the position of firms in relation to its contracting partners within a network of firms. By looking at two examples (biotech alliances and original equipment manufacturers), she proposes that the more central the companies are in a network (ie the more the companies have links to other firms in a network and the more their partners have the same links) and the more proximate they are (ie the less the number of intermediates between two firms), the greater will be the structural social capital between them. Owing to their proximity, more information will be available, and it will be easier to sanction each other in case of misbehaviour.97 Similarly, the central firms in a network have more connections and information about their partners and information about

91 ibid 567–68. 92 ibid 578 ff. The contract governance mechanisms range from simple PowerPoint and webinar presentations, to suppliers’ manuals and development programmes for suppliers, to more formal mechanisms, which involve formal inspections of the other partners’ activities and scoring of the suppliers’ performance, with the establishment of different rankings of suppliers. Suppliers with the best ratings could, for instance, receive benefits in their relationships with the leading company, such as eligibility for new businesses. Underscoring partners would be punished, for instance, ‘with graduated monetary sanctions’ without, nonetheless, leading to the termination of the relationship. 93 ibid 587–89. 94 ibid 592 ff. 95 ibid fn 96. 96 ibid 599. 97 ibid 600–01.

74  Internal Coordination their own misbehaviour travels faster. Thus, parties have an incentive to act less opportunistically.98 There are common points between Gilson et al and Bernstein that need to be emphasised. Both recognise that formal instruments are currently overlooked in relational contracting and that they can be used as forms to generate trust or social capital to innovate. In that sense, both support the position that complex interactions are taking place between formal and informal mechanisms. However, for Gilson et al trust is a direct outcome of the contract governance mechanisms, whereas for Bernstein trust is just being facilitated by the emergence of (structural) social capital in a network. A third position on this matter is presented by Jennejohn in a series of articles, supporting Gilson et al’s core claims, but with important distinctions. The former proposes a theory of ‘generative contracting’99 or ‘multi-valent contracting’100 for agreements where the main objective of the partners is to establish a joint process of learning, with specific forms of governance. The objective of the contract, thus, is to create an ‘architecture’ for the parties’ learning process and set the procedure for potential disputes, ‘decomposing the system’ into manageable steps. In a recent article, Jennejohn endorses some of the core claims of braiding theory, defending that formal and informal complement each other in innovative transactions. Nonetheless, he indicates gaps and limitations in the theory, intending to develop it rather than reject it.101 His main assertion is that braiding theory focuses excessively on opportunism between the partners as a cause for the design of contract governance, neglecting other hazards in the collaborative context, which are important to understand the variety in contractual design.102 He relates that three major issues remain unanswered.103 First, the relevance of veto rights to deadlock steering committees. If, as demonstrated by empirical research, one party in the committee has the power to stop decisions, then those committees would not function to address opportunism in the relation.104 Second, braiding theory would not explore how the IP collaboratively produced (‘foreground IP’) would be assigned. Third, it would present an inaccurate explanation for the wide variety encountered in the design of these contractual alliances. For Gilson et al, the core variant in understanding the

98 ibid 599, 608 ff. 99 Jennejohn (n 20) 111 ff. 100 Jennejohn (n 14) 313 ff. 101 ibid 291. 102 ibid 293. 103 ibid 309 ff. 104 Indeed, if one opportunistic party has the power to veto any decision contradicting its interests (eg renegotiation of the contract due to the discovery of a new technology which undermines the importance of one of the partners in the venture), then the steering committee is unable to address the opportunistic behaviour.

Governance Mechanisms  75 difference between the contractual design of the alliance agreements would be their duration. Jennejohn, based on empirical data, argues that several projects with broad discretion did not present steering committees to solve the issue of uncertainty.105 He concludes, therefore, that a better explanation requires a consideration of a wider number of factors other than opportunism, proposing a theory of ‘multi-valent contracting’. According to him, the main factors to be added are spillovers and entropy, explored earlier.106 Furthermore, he contends that spillovers, ie the specific uncertainty about proprietary rights, has been less explored in the literature.107 This uncertainty varies according to the industry involved.108 Regarding costs of entropy, the author notes that it is not only about aligning the interests (opportunism) of the parties, but also about more fundamental problems of communication, of ‘keeping the partners on the same page’.109 He refers to the belief that vertical integration could address those issues, either by facilitating the transfer of information, by creating ‘social routines’ that allow the transfer of knowledge or by decomposing tasks into different modules interdependent among each other. However, modularisation and the routinisation advantages could also be potentially achieved through contractual relationships by the mechanisms inserted in the contract.110 The implications of this theory are twofold. On one hand, it would provide a more accurate explanation to understand the role of different governance mechanisms. On the other hand, it would propose that the mechanisms of governance are interdependent among each other, and their inclusion should be understood as a trade-off between the different objectives and risks of the relationship. For instance, the insertion of a referee mechanism, where decisions are made collaboratively by committees, may aggravate the risks of opportunism if one of the parties has a right to veto the decisions, as mentioned before. Jennejohn assessed this trade-off through a statistical analysis with 146 alliance contracts. His results confirmed the hypothesis that (consensus-based) steering committees are used where spillover and entropy problems outweigh the hold-up risk.111 That would suggest that those committees would not be

105 Jennejohn (n 14) 312. 106 See this chapter, section I. 107 Jennejohn (n 14) 315–16. 108 In the pharmaceutical/chemical context, uncertainty would be less prominent, with stronger allocation of the ownership rights over IP. In contrast, in areas such as aerospace, software and semiconductors, the uncertainty would be higher, and IP protection would be weaker. Thus, the costs of establishing the boundaries and policing IP rights would be higher. Correspondingly, in the less uncertain contexts, there is a low number of patents related to one product than in the most uncertain contexts (eg, software), where the complexity of one product requires several patents. ibid 318–19. 109 ibid 322. 110 ibid. 111 ibid 346.

76  Internal Coordination designed as coordination mechanisms, but as forms to articulate the boundaries of foreground IP rights and to police them, also defining the boundaries of new tasks.112 The evidence presented by Jennejohn indeed strongly supports the idea that there should be a consideration of different factors beyond opportunism (hold-up problem), often neglected in the analysis of the design of contracts for innovation. It should be remarked, however, that even the existence of particular formal governance mechanisms to address issues such as entropy and spillovers can be combined with informal governance mechanisms to promote their effectiveness in a context of high complexity and unpredictability. In other words, the insight of a combination or braiding of formal and informal incentives can subsist to regulate the other factors mentioned by Jennejohn, not only to address opportunism. Therefore, despite the common points between these three theories, important disagreements are present. Perhaps the most fundamental regards the role of trust in these agreements. This book shares the view advanced by Gilson et al and Jennejohn that these forms of inter-firm collaborative alliances involve a form of institutional trust, contractually created and maintained. This trust seems to be backed more on the incentives provided by the contract through its institutional framework, rather than by structural trust, as argued by Bernstein.113 This position is justified based on three theoretical reasons (further empirical research would be necessary to test them). First,114 while embeddedness in the network would serve to create structural trust between the partners, discouraging them from misbehaving, it would be unlikely that advanced innovation would be developed in this context of proximate, stable relationships. While strong ties in a social network involving stable and multiple connections are important for collaboration and create pressure for enforcement, according to Granovetter,115 if someone is looking for a new opportunity (whether a job offer, new clients, new acquaintances), it is important to have contacts or ‘weak ties’ with parties that may connect one to different networks and opportunities beyond those to which one usually has access. In other words, sometimes the parties to whom one is least connected are those that may offer them more opportunities. This idea could be correlated to innovation: if a firm is building a new product, it normally knows the expertise that partners in its close network have; that is not where it will find innovative ideas. It will have to pursue the ‘weak ties’ to find the different knowledge that may lead to innovation.

112 ibid 350. 113 This could be different in particular contexts, such as ‘spiderless networks’, see Porat and Scott (n 44) 15. 114 This remark has been raised with the author by Professor Charles Sabel. 115 M Granovetter, ‘The Strength of Weak Ties’ (1973) 78 American Sociology Journal 1360.

Governance Mechanisms  77 Second, in innovation, the problems of miscommunication and misinterpretation are significant due to the experimental character of the tasks performed by the parties. When one of the firms is developing a new product or experimenting different technologies, the contractual partner cannot know for sure whether there is actual cooperation or defection. This circumstance undermines the ‘tit-for-tat’ strategies that create trust necessary for the parties to coordinate their actions and, more important, to have incentives to continue their relationship.116 One partner acting faithfully on innovating may be perceived as defecting because his collaborator fails to understand how his experiment will benefit their partnership. Trust would not suffice to support the relationship and may even vanish after a few misunderstandings. The contract itself must create the framework that then allows ‘institutional trust’ to develop, based on procedures establishing communication channels and decision-making processes. Third, in these networks the parties are competitors and collaborators simultaneously. For the network to be efficient it is important that they be so, otherwise they will forgo the advantages of this organisational structure. As the parties remain competitors, it seems logical that the concept of trustworthy behaviour should be understood as one in accordance with the contract procedures. Otherwise, a company may have the unrealistic expectation that its partner will have some fiduciary duty toward itself, missing the logic of competition and cooperation prevalent in networks.117 ii.  A Critique of Theories on Contracting for Innovation from a Contract Theory Perspective While braiding theory and other theories in the United States propose how contracts for innovation work, they do not provide a thorough doctrinal statement of what should be the substantial legal doctrine governing contracts to innovate. Such difficulty suggests that the legal doctrine governing contracts to innovate is underdeveloped. Even though it is to be acknowledged that governance mechanisms represent the central element to coordinate inter-firm cooperation under pervasive uncertainty, as supported by the existence of the few cases litigated/arbitrated, in certain situations such governance mechanisms might be insufficient. In any case, the parties bargain in the ‘shadow of the

116 J Bendor, RM Kramer and S Stout, ‘When in Doubt … Cooperation in a Noisy Prisoner’s Dilemma’ (1991) 35 Journal of Conflict Resolution 691. 117 Even if the parties initially do not trust each other from a personal point of view, if they believe in the institutional system contractually established, if they are benefited by the contractually established incentives and if the contractual matrix strongly discourages defection, still there is a chance for successful collaboration. The partners will then act out of commercial interests in following the procedures of the contract and might eventually develop personal trust. If that does not occur, the loose character of these forms of contract will permit one of the partners to move out of the relationship without much difficulty.

78  Internal Coordination law’,118 with legal rules establishing the limits and possibilities of their private orderings, creating a framework that will serve to clarify, if needed, what are the parties’ rights under particular circumstances.119 Braiding theory acknowledges that ‘red-faced’ violations of the agreement should be remedied with the reliance interest120 but lacks a substantial definition or the development of criteria to identify such violations. Jennejohn defends a more nuanced approach, stating that expectation damages should not be ruled out as the adequate remedy for innovative inter-firm cooperation.121 Chapters three and four attempt to develop a more substantial legal doctrine governing contracts to innovate. Presently, another crucial theoretical clarification is in order, from the viewpoint of contract theory. It refers to the issue whether contracting for innovation (particularly braiding theory) represents a new contractual paradigm or whether it can be understood as a variety of relational contracting. As pointed out by Scott, there are two main approaches to relational contract theory: economic and sociological relationalism.122 When discussing ‘relational contract law’, braiding theory seems to be most concerned with the economic version of the theory. In the analysis of contracts for innovation, braiding theory rejects the explanatory power of informal contracting in the development of novel/innovative activities.123 This informal contracting can be associated with Macauley’s early version of relational contract theory,124 which had its premises adopted by economic studies on informal contracting (ie, the assertion that the parties themselves solve their disputes due to different informal incentives, regardless of the formal contract and court intervention).125 Instead, braiding theory presents contracts for innovation as a

118 See the seminal article examining the concept of ‘shadow of the law’ in the context of divorce law: R Mnookin and L Kornhauser, ‘Bargaining in the Shadow of the Law: The Case of Divorce’ (1979) 88 Yale Law Journal 950, 951–52. 119 Discussing the enduring importance of contract law, even as a background legal regime, see Roger Brownsword, Contract Law: Themes for the Twenty-First Century (2nd edn, Oxford ­University Press 2006) 6–9. 120 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1415–17. 121 Jennejohn (n 14) 354 ff. 122 The economic perspective, mostly based on Macaulay’s seminal article, proposes a more modest contract law, having led the way to new formalism; the sociological relationalism, based on Macneil’s work, proposed the development of a more adapted and contextualist contract law, considering the specificities of different transactions. See Robert Scott, ‘The Promise and the Peril of Relational Contract Theory’, Revisiting the Contracts Scholarship of Stewart Macaulay: On the Empirical and the Lyrical (Hart Publishing 2013) 105 ff. 123 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1398. 124 As articulated in S Macaulay, ‘Non-Contractual Relations in Business: A Preliminary Study’ (1963) 28 American Sociological Review 55. 125 Citing a number of economic studies examining three main informal contracting incentives in incomplete agreements, ie, the interest in maintaining future deals with the contractual partner, moral constraints, and concerns about reputation in the market; see Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1392–98.

Governance Mechanisms  79 new development due to the ability to bridge formal and informal contracting, creating a contractual framework that establishes a procedure that endogenously induces the creation of trust. Perusing economic studies, Gilson et al claim that there is a dichotomisation between formal and informal contracting.126 ‘The theoretical literature on incomplete contracting regards formal and informal contracting as separate phenomena’.127 The implicit message is that the intertwining of formal and informal incentives in contracts to innovate represents an advancement in relation to Macauley’s relational contract theory as presented in his seminal empirical study.128 Macauley’s early approach on relational contracts129 is seen as no longer reflecting the commercial practice because it misses the array of governance arrangements structuring complex commercial contracts in the practice, a critique which is justifiable and strongly supported by more recent empirical studies on contracting practices.130 It is questionable, nonetheless, whether it is possible to claim that relational contract theory has become outdated or that braiding seems to be an entirely new phenomenon in relation to it, particularly if one considers socio-legal relationalism. Braiding theory does not engage with Macneil’s sociological approach to relational contract theory, which is different from the economic perspective of relational contracts. In contrast to the latter, Macneil points out that the reference point of the contract is the entire relationship between the contractual partners, not only the formal instrument, requiring a contextual perspective of the agreement and an understanding of the implicit understandings involving it, but without ignoring the importance of the written agreement.131 In other words, under Macneil’s relational contract theory, there is no such dichotomy between formal and informal contracting. Rather, implicit norms, expectations and the broad context are relevant for all kinds of contracts.132 These ‘relational’

126 ibid 1379–81 and accompanying footnotes. 127 ibid 1379. 128 Macaulay (n 123). 129 The formalist perspective that seems implicit in Macaulay’s seminal empirical study, which has been adopted by economic studies, seems not to be in accordance with his later work, which defends a more contextualist form of contractual interpretation; see particularly S Macaulay, ‘The Real Deal and the Paper Deal: Empirical Pictures of Relationships, Complexity and the Urge for Transparent Simple Rules’ in A Campbell, H Collins and J Wightman (eds), Implicit dimensions of contract – discrete, relational and networks contracts (Hart Publishing 2003). 130 ‘It is in this respect that many of the work-a-day practices in the manufacturing world today echo the findings of Stewart Macaulay’s seminal study, only with a subtle difference: these collaborative relational interactions may look informal, but in reality they are shaped and supported by the provisions of highly formal written agreements, agreed allocations of discretionary authority, and an array of formal contract administration mechanisms.’ Bernstein, ‘Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts’ (n 43) 576; see also Hadfield and Bozovic (n 72) 995 ff. 131 For an account of Macneil’s theory, see ch 1, section I.B.i. 132 ‘[H]e [Macneil] argued that the context of an exchange matters for an understanding of all contracts’; H Collins, ‘Is a Relational Contract a Legal Concept?’ in S Degeling, J Edelman and J Goudkamp (eds), Contract in commercial law (Thomson Reuters 2016) 45.

80  Internal Coordination elements, however, are more present and significant in contracts that are ‘more complex, long-term, transactions that require co-operation and perhaps flexibility’.133 As aforementioned, there is a spectrum of contractual relationships, where in one pole there are agreements where these relational elements have more weight.134 Even in this pole, however, the written agreement continues to be significant, at least to a certain degree. There is no a priori contradiction, therefore, with braiding theory’s claim that formal and informal incentives interact to facilitate contract enforcement. While the formal/informal dichotomisation is present in economic studies relating to contracting in the market economy, this same position is not to be automatically found in sociology and legal theory – and particularly in the context of Macneil’s relational contract theory. Furthermore, even though Macneil’s theory can be seen as a sociological perspective on contracts, it has been used by legal scholars to build a (still loose) legal concept of relational contract.135 In other words, there is no contradiction between the idea that formal and informal contracting can interact in relational contract theory – at least under Macneil’s approach. The overcoming of this dichotomisation seems to be more relevant in the context of economic studies than in the socio-legal realm. It should be elucidated, therefore, what is the relation between braiding theory and sociological relationalism. Braiding theory and other theories on contracting for innovation seem to be a development of relational contract theory applicable to a sector of the market economy involving pervasive uncertainty. It is original by exploring and examining in detail how a designed contract interpretative regime is created for these contexts, with a process-oriented focus, respecting the parties’ autonomy, but allowing for contextualisation to be undertaken through the procedure contractually established.136 The context is inserted into the relationship by the parties themselves through an array of governance mechanisms to constantly specify uncertainty. The formal institutional framework designed into these agreements allows for the contextualisation of the relationship. This ‘institutional’ contextualisation could be understood in an even deeper meaning than that adopted in braiding theory. Through the information generated by the medium of governance mechanisms, courts may be able to interpret more fully what the parties’ deal is about. This does not mean that courts should specify uncertainty and force the cooperation to move forward, but they could assess whether violations have arisen in the relationship and clarify what are ‘red-faced’ violations based on this information generated through these mechanisms. This form of ‘institutional’ contextualism has been noted by other legal

133 ibid. 134 See ch 1, section I.B.i. 135 Collins proposes the development of a legal concept of relational contracts based on the ­analysis of three paradigmatic English cases on this topic, see Collins (n 131) 44, 52 ff. 136 Charles F Sabel, Robert E Scott and Ronald J Gilson, ‘Text and Context: Contract ­Interpretation as Contract Design’ (2014) 100 Cornell Law Review 23, 63.

Governance Mechanisms  81 scholars, recognising that, in certain situations, institutions might be necessary to specify the meaning of the parties’ obligations. Dan Wielsch develops the idea of ‘institution-creating interpretation’ to claim that, under conditions of uncertainty, the practice of contracting itself is forced to become reflective about its social effects. Here, the normativity of contract cannot just be linked to the idiosyncratic perspectives of the parties. The contract must first of all create a shared understanding of the parties in line with the institutional requirements of novel transactions, including their social responsibility. Thus, contract cannot just link up to a convention, but must create it.137

In sum, in socio-legal theory, braiding theory seems to be more an evolution of relational contract theory, especially if understood under Macneil’s approach. It defends that the context must be considered in these contractual relationships, but instead of leaving to the judges the task of discovering what these obligations are, it creates a number of institutional mechanisms that serve to specify the parties’ obligations as their collaboration moves forward. The information generated through these mechanisms could also serve to support courts in the identification of potential violations, in case that may be exceptionally necessary. An important clarification is that braided agreements are not only occurring among a small vanguard of companies in the high technology sector developing technological innovations. Rather they are more widespread throughout the economy in different projects undertaken, even in industries considered to be more traditional (such as the construction industry, with the use of building information modelling), whenever they involve a significant level of uncertainty and complexity. As emphasised by the authors of braiding theory, ‘[t]hese braiding techniques are not limited to collaborations that contemplate technological innovation’.138 As will be seen below, in case studies involving construction mega-projects in the UK, a number of governance mechanisms resembling those used in the context of high-tech innovation contracts are employed to conduct the governance of other commercial relationships. Potential braiding practices, therefore, should also be searched and analysed in the context of more traditional industries. iii.  Building the Picture: The Legal Obligations in Contracts for Innovation There are a number of recurrent contractual obligations in collaborative contracts for innovation.139 Some obligations are inserted by the contractual

137 Dan Wielsch, ‘Contract Interpretation Regimes’ (2018) 81 The Modern Law Review 958, 976 ff. 138 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 49) 1385. 139 Jennejohn (n 14) 297–98.

82  Internal Coordination parties themselves, others might be potentially derived from a contractual interpretation by adjudicators.140 Usually, parties start negotiating by signing confidentiality agreements, committing not to disclose information regarding their negotiations and the technology/know-how they may initially exchange.141 If this confidentiality agreement is not initially signed, a confidentiality clause will probably be inserted in subsequent agreements. Subsequently, they enter into a phase to assess the feasibility of the project and their compatibility as partners, signing some variant of a Memorandum of Understanding (often, a Memorandum of Development Agreement).142 In this Memorandum, they will normally establish some broad duties of cooperation.143 How these duties to cooperate translate into the contract will be contingent to the practical situation. For instance, cooperation may involve a duty for the companies to have a number of employees working on a project for 40 hours a week; it may require them to deliver certain information, technology and knowhow to the other partner until a deadline; they may provide facilities, such as a laboratory,144 for experiments to be tried; and it may also demand that a series of processes or attempts to develop a certain process be undertaken. These duties may also comprise the duty to attend coordination meetings, training sessions, etc., and they are often contained in an annex to the actual contract, such as a ‘Schedule of Activities’. If the parties are satisfied with the beginnings of their cooperation and willing to deepen it, they may sign a contract (often, a ‘Joint Development Agreement’).145 A more detailed ‘Schedule of Activities’146 may be inserted, where different phases of the collaborative project will be set out. The parties will have to comply with the obligations established in a certain phase, often involving duties of cooperation. Once that step is completed, the parties will review whether this phase was met with success.147 Normally, this evaluation will be undertaken by a steering committee composed of members of the different 140 Regarding the latter, the objective here is to point out what these different obligations might be, describing the most commonly occurring in such contracts, both according to the legal literature and empirical data. The role of the legal doctrine is further discussed in ch 3. My description is broad and does not intend to cover all kinds of contracts for innovation. That daunting task would be unachievable given the kaleidoscopic variety of these agreements. 141 T Hall and K Frey, Joint Development Agreements Line by Line: A Detailed Look at Joint ­Development Agreements and How to Change Them to Meet Your Needs (Thomson West 2009) 3–5. 142 This information was provided by Brazilian businesspeople with experience on collaborative innovation and interviewed by the author in the Brazilian context. 143 M Wellenhofer, ‘Third Party Effects in Bilateral Contracts within the Network’ in M Amstutz and G Teubner (eds), Networks – Legal Issues of Multilateral Co-operation (Hart Publishing 2009) 123 ff. 144 Hall and Frey (n 140) 16. 145 According to information provided by Brazilian businesspeople to the author. 146 See interviews below, section III.C.v. 147 Describing this division of cooperation into different phases, in the context of a specific agreement (‘Warner-Limbert-Ligand Agreement’) see Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 468–69.

Governance Mechanisms  83 companies and the decision will allow for some discretion of the parties. In some cases, if the decision requires unanimity, the parties will have freedom to withdraw from the project. In others, the steering committee may not require unanimity or refer to the decision to one party if there is a tie. If that occurs, the party will be obliged to continue cooperating in the next phase of the project, at least until the next review, when a new milestone arrives. In their joint development programme, parties may determine their financial contribution to the project, the preliminary investments each will undertake.148 In some cases, the amount of the contribution will be the same for all parties. There are further possibilities, such as establishing a degree of contribution in accordance with the proportion of profit share each will receive if the project succeeds. When there is public financing involved, the concession of the financial resources may be tied to specific conditions, such as royalties in return for the finance. The contracts often contain clauses establishing the division of the foreground IP, developed throughout the parties’ relationship, perhaps subject to renegotiation. In some cases, it may be difficult to determine the exact scope of the IP and whether certain technological or know-how issues are covered by the contract or not. Whenever possible, the parties might establish the division of profits or royalties each will have as a result of the commercialisation of their joint product. In some cases, however, the clause may use a broad language, calling for revision of this division if there is a change of circumstances, potentially creating an issue to be solved by steering committees (and, perhaps, in some situations, by courts). If the parties decide to terminate the contract, they must comply with termination clauses in the agreement. There is a variety of termination clauses that may be inserted in the contract.149 There may be a duty to exchange of information150 between the parties to report discoveries they have made, to update on the development of their tasks and to provide a realistic perspective of their views on the project. The next duties to be mentioned may not be inserted in the agreements, but there are discussions whether, even if they are not, they can be derived from a contractual interpretation of the agreement by adjudicators. These duties are examined in detail in the next chapters. Especially in civil law systems, there is an ongoing debate on how the good faith principle should translate in the context of contractual networks. The most significant contribution is Teubner’s suggestion that the principle of good faith should be translated into a duty of loyalty or sincere cooperation to the network.151 The notion of loyalty would be able to accommodate the constant tension in the network between competition and cooperation among the firms.152

148 Hall

and Frey (n 140) 16 ff (referring to the division of ‘costs’). 4, section IV.A. 150 Ch 4, section I. Wellenhofer (n 142) 125. 151 G Teubner, Networks as Connected Contracts (Hart Publishing 2011) 184 ff. 152 See ch 3. 149 Ch

84  Internal Coordination Another potential duty is the equality or non-discrimination between the members of the network.153 Equality does not necessarily mean that all the parties will have the same benefits and liabilities, or even the same weight when deciding, but rather that they will be granted the same opportunities and will be given voice in the network through a due participatory process. There are also discussions whether the contractual networks require a duty to share profits154 among its members in certain circumstances, especially when unexpected improvement brings a surplus not allocated by the parties. The contracts may establish more specific obligations, varying according to the industry and contractual partners’ business strategy.155 iv.  Governance Strategies to Apportion Liability for Damages in the Network: Liability of the Chain Leader and Joint Patrimonial Funds Once the collaborative activities undertaken generate damages to network members, despite preventive efforts, there will be a need to determine who is liable for this damage. The traditional legal perspective would be to analyse which party was at fault or who has assumed responsibility for the risk undertaken. Under high uncertainty, however, it may be difficult to identify fault or assumption of responsibility for a productive activity never undertaken without a previous model of expected behaviour. As previously argued, in multiparty networks involving uncertainty, there is evidence that parties employ contractual governance frameworks to coordinate their activities.156 There may be multiple potential strategies to contractually share the risks and the liability involved. Below, two prominent strategies to share the risks involving multiparty activities are examined. First, to establish the network leader as responsible for any damage generated, but then allow him a regressive claim against the specific network member responsible for the violation.157 For instance, a leading car producer is entirely responsible for the safety of its cars towards third parties. Subsequently, however, the producer may claim damages from one supplier which has been found to have been negligent in some component’s production. If more than one network member is responsible, this claim could be directed at more than one party and perhaps could include partial liability on the chain leader itself.158 153 Wellenhofer (n 142) 127. 154 Ch 4, section III; Teubner (n 150) 191–95. 155 Consider the three paradigmatic contracts for innovation analysed by Gilson et al in their seminal study. Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 6) 459. 156 See previous sections in this chapter. 157 According to Interviewee I-7, mentioning that his company, the supply chain leader in the aerospace industry, will be responsible for safety violation, but might regressively have claims against negligent suppliers who gave origin to the issue. 158 This possibility is in line with international hard and soft instruments suggesting that corporations should take responsible measures for avoiding violations of their suppliers. See the OECD

Evidence from Collaborative Networks  85 A second possibility is established in the Italian law on the ‘network contract’.159 The firms in the network may create a common patrimony fund, despite remaining independent partners. According to early empirical evidence collected on network contracts concluded under Italian law, around 90 per cent of them establish a common patrimonial fund, even though its establishment is discretionary.160 This patrimony fund is liable for the damages caused by the activities undertaken by the network members, in the scope of their specific common network project, but not for personal projects. The patrimony fund’s governance is often established contractually, in a variety of forms.161 Often, the common network board (or steering committee) is entitled to manage the fund.162 The initial contribution may be equal for all members, but it may also differ based on the size of the companies or hierarchy within the supply chain.163 While the patrimony fund typically responds to damages caused to third parties contracting with the network, it could respond for damages caused among the network members in their activities. Indeed, the network ‘programme’ may be deployed for the undertaking of purely internal activities between its members (eg exchange of know-how among the participants), without establishing relations with third parties in the market.164 In that scenario, a common patrimonial fund could be liable for damage generated within the network. III.  EVIDENCE FROM COLLABORATIVE CONTRACTUAL NETWORKS FOR INNOVATION IN BRAZIL

A rising number of legal studies on inter-firm collaborations is leading to the emergence of a new area of study, ie comparative contract governance.165 Its main issue of concern is how to coordinate the activities between independent

Guidelines for Multinational Enterprises, at p 12, ‘A. Enterprises should … 12. Seek to prevent or mitigate an adverse impact where they have not contributed to that impact, when the impact is nevertheless directly linked to their operations, products or services by a business relationship.’ 159 On the general contours of this statute, see ch 1, section II.B.iii on ‘contratti di rete’. 160 F Cafaggi, P Iamiceli and G Mosco, ‘Prime Evidenze Sui Contratti Di Rete’, Il Contratto di Rete per la Crescita delle Imprese (Giuffrè 2012) XXXVI–LX. 161 F Cafaggi, ‘Il Contratto Di Rete Nelle Prassi: Verso Il Consolidamento’ in F Cafaggi, P Iamiceli and Mosco, G (eds), Il Contratto di Rete per la Crescita delle Imprese (Giuffrè 2012) 146. 162 Further regulation on the fund management might establish requirements of transparency for creditors’ benefit, the value of the initial mandatory contribution for network members, valuation criteria for assets, among other issues. ibid 146. 163 ibid. 164 M Sciuto, ‘Imputazione e Responsabilità Nel Contratto Di Rete (Ovvero Dell’incapienza Del Patrimonio Separato)’, Il Contratto di Rete per la Crescita delle Imprese (Giuffrè Editore 2012) 65, 68. 165 S Grundmann, Y Atamer and M Yesim, ‘European Contract Law and Banking Contracts after the Financial Crisis: Challenges for Contracting and Market Transactions’, Financial Services, ­Financial Crisis and General European Contract Law: Failure and Challenges of Contracting (Kluwer Law International BV 2011) 9–10.

86  Internal Coordination firms working together but retaining their independence. The forms of governing such alliances present similar mechanisms, used to different extents according to the type of transaction. Seeking to contribute to this issue, empirical research was conducted in the Brazilian context to assess how contractual inter-firm alliances to produce advanced innovation are structured. A.  Background to the Empirical Field and Methodology The productivity of the Brazilian economy has been stagnant for more than 20 years,166 and the past few years have seen an acceleration of a de-industrialisation process.167 Among other factors, the small number of companies possessing high technology and the disregard for the most advanced practices of business management have contributed to this situation.168 Most large Brazilian companies follow a Fordist model, with production of standardised products in large scale, semi-skilled labour, rigid machinery and markedly hierarchical labour relations.169 From those, a few companies have been able to renew their organisational practices and advance to the first levels of Post-Fordism, with flexible and decentralised production focused on the development of innovation.170 Against this backdrop, it becomes evident that a survey involving companies that operate in a constant flux of innovation is not representative of the Brazilian industrial landscape: only 14.3 per cent of Brazilian companies possess collaborative projects in the moulds analysed in this study (especially in the oil industry, followed by the area of services).171 A number of these cases of open innovation have been examined in the legal literature.172 Such Brazilian companies are part of the productive vanguards in the world, adopting the most advanced forms of management. They are usually portrayed as leaders of innovation in the country and have been able to resist downfalls of the economic crisis. Not only should they be emulated, but their advancement to the late stages of Post-Fordism should be fostered.

166 F De Negri and L Cavalcante, ‘Introdução’ in Instituto de Pesquisa Econômica Aplicada (ed), Produtividade no Brasil: desempenho e determinantes, Vol 2 (IPEA 2015) 13–14. 167 Brasil, Produtivismo Includente: Empreendedorismo Vanguardista (Secretaria de Assuntos Estratégicos 2015) 10–11. 168 ibid 8. 169 ibid 11. 170 ibid 12–13. 171 ‘Pesquisa de Inovação (PINTEC)’ (2014) Instituto Brasileiro de Geografia e Estatística 57. 172 For an analysis of the concept of a ‘virtual genomics institute’ in Brazil, reuniting 30 university laboratories collaborating towards sequencing the complete genome of the bacteria xylella ­fastidiosa, see A Octaviani, ‘Biotechnology in Brazil: Promoting Open Innovation’ in L Shaver (ed), Access to Knowledge in Brazil: New Research on Intellectual Property, Innovation and Development (Information Society Project 2008) 133 ff.

Evidence from Collaborative Networks  87 The qualitative protocol with purposeful sampling of 19 subjects was used in the research. Semi-structured interviews were conducted (between 2015 and 2017) in two stages. First, eight interviews with professors, current or former government officials and members of innovation institutes in Brazil were undertaken. The criteria for selecting these interviewees were based on the requisite that they were involved in research or had experience in structuring inter-firm alliances for innovation. These first interviewees referred company executives who could potentially participate in the survey, generating what methodologically is known as the snowballing effect. In the second stage, 11 interviews were conducted with lawyers or businessmen who are/were involved in companies or entities that partner with others to produce innovation. They provided an overview of the status of the subject in the Brazilian context based on the following seven core objectives: (1) to assess the existence of collaborative network relationships to develop innovation in the Brazilian industry; (2) to analyse the relevance of contract law for the development of inter-firm collaborative alliances; (3) to examine how companies deal with the inherent impossibility to plan for all possible contingencies in contractual networks for production of innovation; (4) to examine the existence of non-contractual relationships within the contractual networks; (5) to analyse whether there are non-legal mechanisms to deal with challenges to structure contractual networks; (6) to examine how disputes involving contractual networks are settled, and (7) to analyse the parties’ view about the importance of trust in the contractual network. The empirical research developed in Brazil complements the analysis of the studies on inter-firm innovation previously examined. Being of a qualitative nature, the research does not seek to generalise results.173 Rather, it gives an in-depth view of the phenomenon analysed. The sample of firms is small and the number of companies undertaking this kind of collaboration to innovate equally represents a reduced but privileged minority of companies in the country, considered the most competitive and productive. The purpose was to understand how strategic collaborative contractual alliances are structured in Brazil. The interviews were conducted in person or via Skype and lasted an average of 30–45 minutes. In some instances, the interviewees preferred to reply to the questionnaire in writing, in most cases, remaining available for clarification afterwards. Although most of the questions were common to all the interviews, some of them were designed having in view the specificity of the area of the interviewee. Several companies did not respond to the contact of the author. Those who accepted to participate in the interviews provided information about their

173 On the advantages of this approach, see A Blackham, Extending Working Life for Older ­Workers: Age Discrimination Law, Policy and Practice (Hart Publishing 2016) 32–33.

88  Internal Coordination transactions but preferred not to share their specific agreements for confidentiality reasons.174 Exceptionally, some provided template models. The data collected, considered alongside the current literature review and published empirical studies, contributed to develop a picture of how contracting for innovation is structured in productive vanguards, not only in developed, but also in a developing country such as Brazil. B.  First Stage of Interviews As mentioned, the first stage of interviews was undertaken with eight individuals, either professors, current or former government officials and members of innovation institutes in Brazil. The objective was to understand the context of co-creation of innovation in this country and identify companies developing advanced innovation collaboratively. From the preliminary phase of interviews, three main aspects are highlighted. i.  Contractual Co-Creation of Innovation is an Exceptional but Existing Practice in the Brazilian Productive System Most interviewees agreed on the existence of joint ventures for producing technology in a wide sense in the Brazilian industry.175 However, when asked specifically about the existence of purely contractual joint ventures, without the creation of new corporate entities and involving strong forms of collaboration (such as common teams of employees working together, transfer of technology and know-how, electronic platforms for joint planning, shared productive capacity), most of them were able to identify only a few examples of such interfirm alliances in the country. Interviewee three (I-3, hereinafter, ‘I-n’) said that there were few alliances in that sense in the Brazilian market, mentioning specifically the names of large aerospace and biotech companies. They acknowledged, though, that these were more common in industrial districts among SMEs. I-2 said that those were most common in high-technology fields and I-1 said that those were most visible in Brazil in the industries of oil and biochemistry. I-4 suggested that the concept of ‘open innovation’, with firms searching to develop technology both internally and in collaboration with external entities, was evermore followed by Brazilian companies. As to the form of innovation developed in Brazil, I-9, the chief of a university innovation institute, related that she was unaware of disruptive innovation being developed in the country, identifying, at the utmost, instances of advanced incremental innovation. 174 They also participated in the research on the condition of anonymity. 175 According to interviewee 2 (I-2), with the advancement of technology, companies are less ­capable of producing certain products alone and need to cooperate with other firms.

Evidence from Collaborative Networks  89 I-16, the president of a major governmental entity in support of SMEs, responded that most collaborative co-creation in Brazil can be found not in research and development (R&D), but in the development of products in the context of productive chains, where leading companies and suppliers cooperate for the continuous improvements of their output. Regarding R&D collaborations, I-9 and I-12 indicated that these are most common in the pre-competitive phase, when different companies in the same sector work towards the solution of a common technological issue, but then move on to develop a product separately. I-9 mentioned specifically two cases widely discussed in Brazil in the past years, the development of the networks to code the genome of eucalyptus and to provide services in the oil industry. Regarding strategic alliances in the competitive phase, I-16 mentioned the jets developed by Embraer and other examples in the oil and chemical industry. ii.  Contract Versus Trust to Structure the Co-Creation of Innovation When asked about whether those relationships were primarily based on trust or on contractual instruments the responses varied, but most of the interviewees did not seem to be entirely sure or able to give a specific answer to this question, reflecting the fact that they were not directly involved in concluding such alliance agreements. I-2, who had specific experience only with networks of SMEs, claimed that these relationships were mostly based on trust and contracts were unable to set a plan for the parties’ relationship thoroughly. This trust would give more dynamicity to the network of firms. He pointed out, though, that this could vary according to the context. I-3 shared this opinion but I-1 diverged, stating that the contract always represented the foundation of the relationship. The latter envisaged trust itself as an outcome of the contract concluded between the parties. I-13, who then worked at EMBRAPII (Brazilian Association for Research and Innovation, a public-private mixed association aimed at financing innovative ventures in the country), answered that these were preponderantly commercial relationships, not based on personal trust but on contracts. The fact that there were only few instances of strong collaboration should not be justified due to a lack of maturity of the firms, but rather due to the difficulties in solving the complexity of coordination in these forms of relationship. In other words, these collaborations would depend on adequate incentives. I-1 further pointed out that most of those collaborative relationships between independent companies were self-regulated by the parties through the contractual instruments they would set out by themselves but was unable to clarify how the parties dealt with sunk investments or with the difficulties of dealing with uncertainty. These interviewees stated that the choice to produce internally or in cooperation with other companies involved several variables, to be considered differently in distinct industries. They also clarified that most of these relationships involved a high degree of risk and represented a gamble by the partners as to the probability of success. I-2, clarifying that he had had more experience

90  Internal Coordination with SMEs, asserted that among those, innovation was not as significant in the Brazilian context and important investments were not undertaken consistently. Thus, most investments were undertaken by individual risk takers, who may encourage others to follow suit. iii.  The Relevant Role for the State and the Law in the Development of Innovation Regarding the importance of governmental support for the development of innovation, all interviewees considered it to be important, to different extents. I-1 clearly stated that it was crucial and that in no country in the world, even among the advanced economies, high-technology companies had been able to develop without this kind of support. I-3 stated that, in Brazil, although the support to innovation has existed in the past few years, it was not well structured. He suggested that there are different models for supporting innovation, and countries have used different models in different historic periods.176 I-4 had experience particularly with the oil and gas industry and affirmed that the formation of such alliances involved two phases. First, a pre-competitive phase, normally advanced by the state, with different programmes and initiatives to create an environment conducive to the development of innovation. This involves many steps, including financing of SMEs that were needed in the production chain of the industry and organisational support. In those industries, she also emphasised the importance of the participation of research institutes and universities in developing innovation in partnership with private actors.177 The second phase related to the conclusion of the contracts themselves, the contractual phase, sometimes involving not only private firms, but also research institutes, public universities and public firms (sometimes through public-private partnerships). This appears to indicate that, either through the development of public-private partnerships or through the pre-competitive governmental support programmes, the role of the state in Brazil is considered crucial for the development of innovation in the oil industry. I-2 said that the law could be improved to deal with new organisational forms, signalling that they believed that legal practices have not been adapted in order to follow these new forms of organisational practices. 

176 In Silicon Valley, for instance, he stated that there was a strong direct support to companies in the past, but nowadays this support is minimal. There is support, however, for the creation of an environment where the highly innovative companies could develop – even if there is no direct support to individual firms. 177 He used as an example the case of Petrobras, the leading Brazilian oil company, currently extracting oil from the deep sea. The extraction of oil under such conditions required the development of technology so far unknown by Petrobras and required alliances with several other firms and public universities. In that specific case, universities received significant funding to develop research to that purpose.

Evidence from Collaborative Networks  91 Based on the preliminary stage of the interviews, the main conclusions are the following. Contract-based collaborative relationships aimed at innovation constitute a reduced number of productive relationships in Brazil, are observable often in high-technology sectors and often require the support of government funding, directly or indirectly. In this first phase, the interviewees presented distinct views on the importance of the formal contract for the collaborative relationship. In the next section, the interviews with businesspeople and lawyers involved in structuring these transactions present a more detailed perspective on the features of these contracts to innovate. C.  Second Stage of Interviews This set of 11 interviews was conducted with businesspeople and lawyers that are/were directly involved in companies or other entities (such as mixed companies, involving both public and private capital) engaged in inter-firm alliances for the development of innovation. Most of these professionals were indicated by the first group of interviewees. Ten main findings are presented in the highlighted subsections, below. i.  Working Relationships to Co-Create Advanced Innovation Are not Widespread in the Brazilian Productive Sector The first set of questions sought to examine whether the relevant experience of the interviewed professionals involved actual collaborative working relationships between legally independent firms, and not simply normal business relationships such as traditional outsourcing or modular supplier relationships. For that purpose, they were asked whether the different companies possessed common teams of employees working together in a common project; whether there was exchange of technology and know-how between the partner firms; whether they revised together the production process and/or the final output design/concept as their common project evolved; and whether they sometimes shared productive capacity (such as one company sharing the machinery with the other). All interviewed professionals confirmed that the companies with whom they had been involved had some of the elements of these forms of collaborative alliances with other partners, including private firms, universities or research institutes, but warned that these kinds of relationship are not so common in the Brazilian industry. For I-17, working in an innovation institute located in a university, only a few of its collaborations involved co-creation and most of them involved pre-competitive ventures. Most of the companies possessed internal laboratories with strong research and development departments where different innovative endeavours were started. I-6 still emphasised that several of the projects for development of innovation involved both relations with other private companies, as well as with other research institutes and universities.

92  Internal Coordination I-7 clarified that the choice of the partners depended chiefly on three factors: technical capacity, the history of relationships maintained with the other company and financial capability. I-14 stated that these kinds of partnership are more common with its strategic clients with a higher level of demand, involving more employees, hours of service and partnership history. I-10 stated that most of its partnerships were with research institutions or other subsidiary companies of its parent company, but not with other independent private firms. He alleged that there was a difficulty in coordinating collaborations with other independent firms, especially SMEs, where there are different valuations between the parties as to the feasibility and difficulties of the project, as well as different valuations of the technology and know-how each party has to offer. ii.  Collaborative Working Relationships to Develop Innovation Tend to Be Fixed-term (Either Medium- or Long-term) Most of the interviewees agreed that these alliances are medium- or long-term and most agreements would have a fixed term, devoted to the completion of a specific project. I-5 explained that different industries will have different concepts on what is a long-term relationship. In the area of the company, the chemical industry, one to two years was already considered to be a long-term relationship. I-6 noted that, while most of these projects involved long- and medium-term relationships, there were instances of some small-scale projects for undertaking specific tasks, such as the customisation of a certain machine. I-8 remarked that this collaboration, in the oil industry, sometimes starts in joint bidding agreements and study agreements, through which companies will assess the feasibility of their project and whether they will be able to obtain the needed legal authorisations for undertaking oil extraction. She also mentioned that those hybrid agreements often involve research institutes. According to her, these joint ventures were especially common for the joint development of different kinds of machinery, through different contractual models. Besides, according to an article published regarding Embraer, the contracts are for the scope of a project and involve a determined duration.178 I-18 clarified that his company normally establishes medium-term master agreements for these projects, under which short contracts (‘scopes of work’) are concluded. According to I-15, both master agreements governing shorter contracts and one single contract were possible in these relationships. iii.  Both Bilateral and Multilateral Collaborations to Innovate are Established Questioned whether these alliances involved agreements between only two companies or between several companies in a network, most responded that both 178 F Cafaggi and others, Accessing the Global Value Chain in a Changing Institutional ­Environment: Comparing Aeronautics and Coffee (IDB 2012) 25–26.

Evidence from Collaborative Networks  93 forms of alliance were common. Interviewees I-5 and I-14 said that most of the collaborative agreements performed by their company were with few partners but acknowledged some instances where there were many parties involved. In the case of his company, I-5 clarified that contracts would be directly concluded with all the parties involved, with the company remaining as the ‘commander’ of the production chain. He basically described a star-chain form of network as the main model used in the company.179 I-6 mentioned a similar scenario, with some cases where there was a plurality of companies involved in the collaborative relationship. She remarked that, in many cases, there was no relation of exclusivity between her companies and the suppliers. In other words, they were free to compete while cooperating in the scope of a project. I-7 stated that the development of an aircraft certainly involved a plurality of collaborating partners and I-10 stated that most of their partnerships involved either two or three partners, but no more than that. I-18 claimed that when innovation was organic and gradual, involving a previously known activity, normally only one partner was needed. When the innovation was more radical, a plurality of partners was necessary to develop it. In the case of I-19, however, most alliances were concluded with only one company due to restrictions created by IP to commercially explore a certain innovation. iv.  Formal Contracts Are Seen as Important Instruments in Guiding These Relationships As to the importance of contracts in those relationships, the majority of the interviewees deposited significant weight in the formal instruments for guiding the parties’ relationship. It should be noted, however, that the degree of importance attributed to the contracts appear to vary according to the type of industry involved. Particularly the interviewees involved in the chemical, biochemical, information technology and agroindustry, seemed to attribute significant importance to formal contracts, indicating that trust was something derived from the contractual relationship. In some cases, as I-12 clarified, the relationship involved such complexity, especially in multiparty relationships, that more than one year would be needed to draft a suitable contract for the parties, indicating that contracts were indeed a significant element of the relationship. I-7, from the aerospace industry, also attributes significant weight to the role of trust in the relationship of the companies. He asserted that, in the context of his company, it would be very difficult to abandon a contractual partner, even if there is a breach or some subsequent impossibility to proceed with the joint project for any reason. This appears to be linked to the fact that there are few firms with the capabilities to participate in the aerospace production chain. Thus, it is

179 S Grundmann, ‘Contractual Networks in German Private Law’ in F Cafaggi (ed), Contractual Networks, Inter-firm Cooperation and Economic Growth (Edward Elgar 2011) 114.

94  Internal Coordination very likely that, although contractual partners have been unable to cooperate successfully in a specific case, they will find themselves cooperating with each other again in another project in the future. When questioned about whether the model of joint ventures adopted to partner with other firms was of equity joint ventures (with the creation of a new legal company) or purely contractual joint ventures, the responses varied. I-5, I-10, I-14 and I-19 claimed their respective companies generally concluded only contractual joint ventures. I-5 used to remain as the ‘organiser’ of the production chain of a project and I-6 claimed that both equity and contractual joint ventures were being concluded by their company. In general, they said that contractual joint ventures were mostly adopted in cases where the scope of the project was specific, such as in the development of microorganisms. I-18 suggested that his company would participate in equity joint ventures only in large projects, where both parties would make similar investments. I-8 claimed that most of these collaborative relationships in the oil industry involved contractual joint ventures. Some literature has already been published on the so-called ‘risk partnerships’ that were concluded by Embraer, a leading aerospace company. This literature, based on a specific case study, indicated that the collaborative relationships with highly skilled partners was concluded through long-term contracts (under which Embraer would have discretion to make specific and non-mandatory orders).180 v.  Uncertainty Is Managed Through Steering Committees and the Division of Production into Phases or ‘Milestones’ On the management of uncertainty and the performance of adjustments to the contractual relationship, all subjects referred to the existence of management procedures, normally indicating the existence of common committees between the companies for undertaking decisions, or at least nominating in the contract ‘responsible parties’ for negotiating or implementing the adjustments. Moreover, most of the interviewees mentioned the existence of a schedule of activities establishing, at least in general, the productive activities in different phases and attributing different tasks to each of the parties. Often, the schedule of activities is inserted as an annex to the contract. Regarding the steering committees, I-8 stated that it was common for the existence of more than one committee in the context of a project, one involving study of more specific issues while others dealt with broader issues. This information

180 An interesting remark is that, while in the past such risk-partnerings involved no formal contract, in recent years, formal contracts were being signed. In that specific case, this reflected the existence of a formal clause by the Brazilian National Bank of Development (BNDES) requesting the existence of formal contracts for the concession of finance. See Cafaggi and others (n 177) 25–26.

Evidence from Collaborative Networks  95 was confirmed by both I-5 and I-6, who recognised that the alliances performed by their companies involved the creation of steering committees composed of the members of the different companies in the network. I-6 answered that most alliances comprised the creation of two kinds of committees: one for the definition of technical issues, the other for dispute resolution between the partners. In the case of I-14, however, only technical steering committees prevailed, informally, with the function of coordinating the cooperation and exchanging information. According to I-10, likewise, there were only informal committee meetings, with the nomination of the entitled technicians in the contract between the parties. I-18 stated that these committees were more common in the context of larger projects. Specifically, I-5 explained how the steering committees operate in the context of his firm. A schedule is established for the project between the partners, defining technical milestones that have to be accomplished for the project to continue. They called such milestones ‘go/no-go’ moments. If the technical milestones are not achieved, the partners will not move on with their joint project. Sometimes, the milestones for the continuance of the project may be financial and not technical. If they are achieved, the project will continue. If not, the parties will agree to walk away and abandon the project. When asked to detail this question, they clarified that the achievement of these milestones was a topic of discussion for the steering committees and the issues were not always entirely objective, but rather involved some degree of discretion for the partners. This model is essentially corroborated by the other interviewees. A diverging opinion was given by I-14, for whom the decision to move the cooperation beyond the milestones was entirely in the partner’s (clients’) hands. I-12 stated that termination between milestones tended to be more possible when the parties were developing incremental innovation, whereas, in the course of developing more radical innovation, termination was more restricted. I-18 and I-19, however, claimed that those milestones were primarily used as moments of monitoring activities, instead of opening an automatic possibility of termination. I-5 elucidated that, in his company, most of the adjustments involved the production process rather than the design or the concept of the final product. The majority of the adjustments were agreed through contractual additives that had to be approved in the steering committees. These committees would then present the proposed change to the individual company members of the alliance, which would be free to accept them or not. I-15 and I-19 added that technical groups would routinely monitor activities and report them back to the steering committees. vi.  The Limited Use of Formal Mechanisms to Protect Preliminary Investments The interviewees were questioned as to how the parties ensured that the preliminary investments undertaken in the collaborative project would not be lost or

96  Internal Coordination used by the other party to blackmail the contractual partner to re-establish the relationship in unfair conditions. Overall, the interviewees seemed to attribute a limited importance to formal contractual mechanisms that could perform such a function, indicating that there was an unavoidable risk involved in such activity. I-5 and I-10 answered that the preliminary investments undertaken by their companies resemble a gamble, without many mechanisms of protection. I-18 stated that it sought to establish projects with common investments or infrastructure among partners. I-12 and I-17 said that investments were undertaken for a specific milestone of the project and were not recoverable. Once that phase of cooperation was over, however, there would be no further obligation to invest or cooperate. I-6 presented a more complex picture, claiming that her company possessed an internal committee of investment that would perform studies of technical viability for the contractual alliance, making a forecast of future profits. The investments had to be approved by the committee before being undertaken by the firm. I-6 recognised, though, that to a certain extent the alliance involved an inherent risk. The parties seek to draft the contract to undermine this risk as much as possible. Clauses for sharing of profits are drafted based on estimates of future profits. In certain situations, contracts may also establish sanction clauses for inadequate behaviour of the partner. Similarly, I-7 also claimed there were clauses establishing how the future profits would be shared among the parties as a form of recovering sunk investments. I-8 stated that the investments were secured in the creation of the equipment themselves that would arise from the partnership. I-14, I-15 and I-19 stated that the preliminary investments were consensually divided according to the established profit division in the contract: those with highest returns would invest more. There would be no mensuration of risks at the outset of the relationship, however, as those are too uncertain. I-17 stated that most often they simply expect returns by collecting royalties from the commercial exploration of its discoveries. On the existence of other mechanisms for securing preliminary investments, such as cross-shareholding or nomination of members to the boards of the partner companies, only I-6 confirmed that those mechanisms were frequently used. vii.  The Existence of Both National and International Collaborations When questioned about the nationality of the partners in those strategic alliances, seven of the interviewees said they had alliances both with national and international partners. I-6 stated that international alliances were common in cases where the company needed to license technology to be able to proceed in the production process. I-5, in contrast, stated that most of the alliances concluded by her company involved international partners. I-14 claimed to have many alliances with multinational companies, but most were based in Brazil. I-18 informed that most of its partners were Brazilian firms.

Evidence from Collaborative Networks  97 viii.  The Important Role of Governmental Support On the role of governmental support to foster collaborative alliances to produce innovation, the results were divergent. Some companies mentioned important governmental programmes to foster innovation that supported their activities, while others complained of the lack of support. I-6 claimed they are crucial181 and I-7 also emphasised the importance of government. They mentioned some specific projects where the government gave support to their company, particularly the governmental programme of export support. I-17 referred several programmes in the context of collaboration for innovation with large oil company Petrobras. Several subjects mentioned specific incentive programmes for SMEs while other interviewees claimed their companies had no governmental support (I-15, I-18, I-19). ix.  The Use of Escalated Dispute Resolution Mechanisms to Solve Conflicts Internally On the existence of conflict between the partners, there was unanimity that most of them would be solved internally through the steering committees or top manager renegotiations, with very few of them being actually litigated/ arbitrated. I-5 claimed that most of the conflicts stemmed from issues regarding the preliminary investments and changes in economic scenario. However, most of the conflicts are solved through agreement; rarely would any issues be litigated or arbitrated. In extreme cases, the parties would agree on the resolution of the contract according to clauses previously established in the contract. I-6 presented a similar scenario, in which, according to her, most conflicts had been solved in the context of the steering committees. The interviewees in general also agreed that the contract would contain specific clauses establishing the routes for the parties to leave the contract. Additionally, they stated that the applicable law to the contract would be, generally, one of a neutral forum. Some interviewees responded they had no direct experience in dealing with conflicts between the companies, not answering the question. I-14 answered that, in the company’s collaborations, the crucial difficulty is to establish the division of IP and tacit knowledge. She also pointed out, nonetheless, that disputes are rare, with only one litigation in which her company was involved. I-10, I-18 and I-19 also claimed they had faced no dispute resolution so far. Most of the parties agreed that issues would be submitted to arbitration rather than to state courts.

181 She specifically referred to a draft legal bill currently being analysed by the Congress that would improve the Brazilian Innovation Law, which she claims to contain many gaps. According to her, the main issues are the excess of bureaucracy and the difficulties of sending profits abroad.

98  Internal Coordination x.  Difficulties in Establishing Collaborations with SMEs Finally, when questioned whether their companies had concluded collaborative alliances with SMEs, the interviewees indicated that their companies had difficulties in establishing such relationships. I-10, especially, reported a few cases of failed attempts to negotiate collaborations with SMEs. The causes for such failure would relate to the fact that SMEs would have an unrealistic perspective of the value of their technology and know-how, about the feasibility of effectively developing a commercial product based on their technology and on general distrust. I-12, in turn, informed that it had a successful case of cooperation where some SMEs had, through a common association, established the collaborative relationship with her firm. 

Based on the interviews conducted in Brazil with lawyers and businesspeople involved in inter-firm contractual alliances to produce innovation, the following conclusions can be advanced. Such contractual collaborations are recurrent in the selected companies, among the most innovative in the country, but are seen as exceptional in the Brazilian market in general. They involve both alliances with one or with a plurality of other companies. The interviewees clearly had a perception that the contracts were important to guide the relationship and would often spend very long periods negotiating and drafting the agreements. All (except one) involved some form of governance board, such as steering committees. The existence of schedules of activities and the division of cooperation between the partners into different phases (milestones) is common. In those milestones, parties would be able to decide to move forward or not, with the decision requiring either unanimity or majority. Alternatively, these milestones would create moments triggering revision of the activities. Preliminary investments were sometimes risky, but this risk was occasionally undermined by connecting the level of investments of each party with the rate of expected future returns. Alliances with both national and international companies were common and most saw the state as having a role in fostering those relationships. Conflicts were mostly solved internally and very few cases actually had to be litigated and arbitrated. Most of the contracts referred their disputes to arbitration. Parties often mentioned the existence of carefully drafted termination provisions. There were few instances of cooperation with SMEs, with the parties indicating difficulties of overcoming the difference of perspective as to the feasibility of the project and as to the division of the expected profits. The empirical assessment in Brazil is significant, first, because there are no indications of previous empirical studies in the country analysing how projects that produce advanced innovation collaboratively are contractually structured. While other studies on contractual practices following a modular or relational

Inter-firm Innovation in England  99 model exist, this is not the case regarding co-creation. The importance of examining models to co-create innovation collaboratively to foster economic growth have been mentioned elsewhere.182 Second, the study presents a confirmation (in most points) on the existence of a number of governance mechanisms, as indicated by different theories on contracting for innovation. IV.  INTER-FIRM INNOVATION IN ENGLAND

This study did not purport to undertake empirical research to assess inter-firm relationships to innovate in England. Rather, secondary sources surveying the field are analysed below. Initially, legal studies about inter-firm innovation are analysed. Subsequently, management and business case studies regarding the English construction industry are examined. Such analysis provides relevant insights for the governance of collaborative innovation, since the projects also involve a significant amount of uncertainty and complexity. A.  Evidence from Legal Studies In England, a few studies have assessed the empirical field regarding inter-firm contractual relationships. Beale and Dugdale conducted a study confirming Macauley’s argument that, in long-term inter-firm relationships, parties tend to solve their conflicts relationally, without relying on contract planning to solve potential contingencies.183 In the 1990s, Deakin, Lane and Wilkinson undertook more extensive empirical research, comparing inter-firm practices in Britain, Italy and Germany, challenging the then predominant assumption that contract planning and incentive structures were rarely employed in inter-firm relationships.184 The results indicate the importance of institutional factors in developing trust between the parties and in creating an environment conducive to trust between them, through applications of the good faith principle, trade associations and standard-setting organisations.185 The empirical results demonstrated how, in each studied jurisdiction and sectors, these elements had a different importance and interactions for the contractual environment. For instance, while in Germany and Italy the concept of good faith has been more refined and connected with

182 See Introduction, section II. 183 H Beale and T Dugdale, ‘Contracts between Businessmen: Planning and the Use of Contractual Remedies’ (1975) 2 British Journal of Law and Society 45, 46. 184 S Deakin, C Lane and F Wilkinson, ‘Contract Law, Trust Relations, and Incentives for Co-Operation: A Comparative Study’ in S Deakin and J Michie (eds), Contracts, Co-operation and Competition (Oxford University Press 1997) 122–23. 185 ibid 111 ff.

100  Internal Coordination industry-level regulation to specify this general concept, in Britain good faith is less important and industry-level standards relatively rare.186 However, Deakin, Lane and Wilkinson’s study does not focus on ventures involving high uncertainty, such as those dealt with in this book. Under pervasive uncertainty, all the mentioned institutional factors may have to be adapted to deal with the (additional) need to constantly specify uncertainty, rather than only dealing with asset specificity and information asymmetry. Traditional forms of standard setting, trade associations and implication of terms may not be sufficient in a field of pure uncertainty. The narrative about a coordinated market economy model of contract law (such as the German or Japanese),187 employing high levels of trust in stable long-term relationships, also seems flawed to deal with relationships where a significant flexibility may be required to terminate the experimental project. There are a few empirical indications that the prescriptions of theories on contracting for innovation are relevant in England. For instance, Cullen et al have undertaken empirical research demonstrating that, in the aerospace industry, parties have established in their formal contracts a monitoring process and governance structure (eg risk–reward mechanisms and open-book working arrangements) to navigate the unpredictability of inter-firm relationships in this industry.188 Two senior partners at UK law firms were interviewed for this study. They are heads of technology transactions departments in their respective law firms in London and have wide experience dealing with collaborative inter-firm relationships to develop technology. Their experience derives from the involvement in software and internet-related projects, procurement, supply chains, crossrail tunnels, civil engineering, some advanced manufacturing and other specific technologies (for example, thermostatus technology). They agreed that, to deal with highly uncertain relationships to develop innovation collaboratively, governance mechanisms are employed. They mentioned most of the governance mechanisms previously referred to – steering committees, milestones, escalated dispute resolution mechanisms – and highlighted the importance of contract planning. They said that few disputes were solved by courts (claiming that the few disputes adjudicated would probably be arbitrated) and that most of them were solved internally by the firms involved. More empirical research would be necessary to provide a wider perspective on this issue. Nonetheless, there is an additional number of case studies on the 186 ibid 112–13. See description of the German productive system and the importance of good faith as opposed to Britain; G Teubner, ‘Legal Irritants: Good Faith in British Law or How Unifying Law Ends up in New Divergences’ (1998) 61 The Modern Law Review 11, 25–26. 187 PA Hall, ‘An Introduction to Varieties of Capitalism’ in D Soskice, PA Hall and D Soskice (eds), Varieties of Capitalism: The Institutional Foundations of Comparative Advantage (Oxford ­University Press 2001) 21. 188 PA Cullen and others, ‘A Critique of Contractual Relationships in the Aerospace Industry: Collaboration v Conflict’ (2005) 1 International Journal of Law in Context 397, 400–01.

Inter-firm Innovation in England  101 construction industry in England relevant to understanding how highly complex and collaborative projects are legally managed. B.  Collaborative Arrangements in Construction in the UK: Standard Agreements and Megaprojects One particular field where collaborative practices are emerging is the construction industry in the UK. Due to the technical complexity and intertwining relationships involved in a construction project, a number of standard-form agreements have been developed in the practice by different private and industry associations to facilitate a collaborative relationship.189 Moreover, a number of case studies regarding UK collaborative megaprojects reveal how contracts can be designed to facilitate a cooperative project, providing a contribution regarding the management of high uncertainty. The most discussed examples of standard-form collaborative agreements in the UK construction industry are the New Engineering Contract (NEC, with its latest version published in 2017, the NEC4) and the Association of Consultant Architects’ (ACA) Standard Form of Contract for Project Partnering (PPC 2000). The NEC involves a family of standard contracts, with core clauses and variable options regarding specific terms, providing the parties with the possibility to choose the one that fits best their business relationship. The main difference between the NEC and the PPC is that, while the former is a bilateral agreement, the latter is a multiparty agreement, reuniting, in a single agreement, ‘the Client, the Constructor (that is, the general contractor), the design team and any other consultants’.190 Nevertheless, there are important similarities to be found in both standard-form agreements that facilitate a collaborative relationship. The similarities start with the general approach and wording in both agreements explicitly favouring cooperation and partnering in detriment of an adversarial approach. The NEC3 (2005 edition), for instance, in its clause 10.1, states that ‘the employer, the contractor, the project manager and the supervisor shall act as stated in this contract and in a spirit of mutual trust and cooperation’. In both standard agreements, a number of mechanisms are designed to ensure that this goal is achieved. First, an early warning system, where the parties commit to notify each other about any potential matter that may affect the cost, completion, progress and quality of the project. In the case of the NEC, once a risk is identified the parties must meet in a ‘risk reduction meeting’ to discuss what steps will be taken

189 D Christie, ‘Capturing Collaboration in Construction Contracts in Their Commercial Context’ in J Lee and M Heidemann (eds), The future of commercial contract in scholarship and law reform – European and comparative perspectives (Springer 2018) 253–54. 190 E Baker, ‘Partnering Strategies: The Legal Dimension’ (2007) 23 Construction Law Journal 344, 350.

102  Internal Coordination to deal with the issue.191 The parties engage in a dialogue but no outcome is mandated by the contract; the parties themselves must find the best way forward in their relationship. In connection with the early warning system, a number of risk management provisions must be employed by the parties. For example, the NEC has a risk register, which allows the parties to describe potential risks involved in their relationship and determine which actions are expected from each party to avoid or mitigate this risk. Once a certain risk manifests itself, a notification to the counterparty must be made, as per the early warning system. Second, the agreements create pain/gain sharing provisions, which allow the parties to share the risks associated with the venture.192 This involves clauses that may establish, for instance, that, up to a certain value, the parties will share the additional costs beyond the initial target cost. It may also establish financial rewards for the achievement of key performance indicators (KPIs) – often associated with measures of time, cost, quality and safety. Such provisions create an incentive for the performance of a complex agreement. There are also clauses that are specific to the PPC 2000, reflecting its multiparty character. They are used to facilitate the management of supply chains. For example, clauses creating a procedure for the inclusion of a specialist in the core partnering team that oversees the construction. A further example are open-book management practices among the members of a supply chain, determining the disclosure of financial data, which ‘not only is … essential for the parties to have confidence that no advantage is obtained by concealment of information, it is also fundamental to the calculations for payment purposes’.193 Beyond these main provisions, other mechanisms can be included in such agreements to facilitate collaborative projects, such as common information systems, sometimes established through an electronic platform. Besides these collaborative standard-form agreements, different collaborative megaprojects in the UK have been framed to facilitate cooperation. The most notable case studies concern the construction of the Heathrow Terminal 5, the London 2012 Olympic Project, Crossrail, and the Thames Tideway Tunnel. The high complexity of these projects relates to their magnitude. The inherent complexity and unpredictability involving any endeavour – regarding technical challenges, changes in design and operational requirements, changes in costs, new regulations, disputes between the contractors – is magnified almost unforeseeably in a megaproject involving a highly significant number of actors and activities that have to be coordinated.194 For this reason, megaprojects often end up being delivered over time and above their predicted budget.195

191 Christie (n 188) 262. 192 Baker (n 189) 351. 193 ibid 354. 194 MDA Davies, DM Gann and CM Samuel, ‘Five Rules for Managing Large, Complex Projects’ (2017) 59 MIT Sloan Management Review 72, 73. 195 ibid 72–73.

Inter-firm Innovation in England  103 The conventional wisdom and mainstream practice in these large infrastructural projects is to avoid innovation and to stick to tested methods and practices, as this would be a way to undermine risks and uncertainties.196 Lowest-price bids and rigid management practices – even when there are changes in circumstances – are normally preferred. Nonetheless, some of the recent construction megaprojects in the UK have been adopting a different strategy, seeking to foster innovation, experimentation and learning. This ‘learning’ strategy was deployed specifically regarding the unpredictable activities in each of the projects, leaving the predictable tasks to be governed by fixed plans establishing schedules, deadlines and more rigid steps.197 The rationale behind this strategy is to discover innovations to cut costs, to create new solutions and to improve risk management.198 Despite the fact that these strategies challenge traditional project management, they have brought positive outcomes in these different cases.199 Two studies commissioned by the UK government during the 1990s (the Latham and Egan reports) on how to improve poor performance records in construction projects have influenced the deployment of such strategies.200 Both reports emphasised the need to promote innovative ideas and learning, drawing from successful practices in other industries. Before delving into these different learning strategies, it is worth providing an overview of the aforementioned megaprojects. The common thread among them is their magnitude, the high costs involved and their complexity, especially to coordinate performances. The construction of Heathrow Terminal 5 (2002–2008) had the goal of increasing the capacity of Heathrow airport from 67 to 95 million passengers a year. It cost £4.3 billion, involved more than 60,000 workers throughout the duration of the construction, and involved a long-term strategy to improve the capacities of British Airports Authority (BAA), owner of Heathrow airport, and its different suppliers.201 Crossrail is the largest civil engineering project underway in Europe: it involves the creation of a new east–west metro railway across London (a route of 118 km). Part of this route passes through central London and must cross ‘existing underground lines, sewers, utility tunnels, and building foundations 196 M Dodgson and others, ‘Innovation Strategy in New Transportation Systems: The Case of Crossrail’ (2015) 77 Transportation Research Part A 261. 197 See, eg, A Davies and I Mackenzie, ‘Project Complexity and Systems Integration: Constructing the London 2012 Olympics and Paralympics Games’ (2014) 32 International Journal of Project Management 773, 785. 198 A Davies and others, ‘Making Innovation Happen in a Megaproject: London’s Crossrail Suburban Railway System’ (2014) 45 Project Management Journal 25. 199 Davies, Gann and Samuel (n 193). 200 Davies and others (n 197) 25. 201 S Deakin and A Koukiadaki, ‘Governance Processes, Labour-Management Partnership and Employee Voice in the Construction of Heathrow Terminal 5’ (2009) 38 Industrial Law Journal 365, 372.

104  Internal Coordination of up to 40 metres, eventually connecting to ten new stations’.202 The project involves funding in the amount of £14.8 billion and involves several contractors working on the project, creating a scenario with complex coordination challenges. The construction works of the different structures needed to host the 2012 Olympic and Paralympic Games in London (2006–2011) had a final cost of £6.8 billion and comprised the development of more than 70 projects (including roads, bridges, tunnels, infrastructure) – especially the creation of an Olympic Park involving several highly complex and costly structures. 12,635 people were involved in this construction megaproject.203 Finally, the Thames Tideway Tunnel is an infrastructure project underway aiming to ‘reduce the flow of untreated sewage to the River Thames’ by creating a 25 km tunnel that intersects with the existing sewage network at 24 interception points.204 The project involves several contractors and has an estimated cost of £3.8 billion.205 There are three main common features that bring important insights to this study that can be identified consistently, if not in all, at least in most of these different projects. First, the creation of delivery partner organisations to coordinate the project or the contractual network. Second, the existence of risksharing contracts to structure the collaboration between the firms. Third, the existence of integrated project teams. i.  Delivery Organisations The first common feature observed in three out of the four projects is the fact that they involve the creation or partnering with an entity that coordinates their activities and ensures that the distinct performances can lead to a coherent outcome. As in a network of companies, often there is some entity responsible for organising and integrating the performances of different organisations. Traditionally, this network ‘coordinator’ is either the leading firm in the network or a special organisation hired or created for this purpose. In the case of these UK megaprojects, the creation of a special purpose organisation seems to be more common. In the Crossrail case, a temporary organisation was created (Crossrail Limited (CRL)) by the UK government itself to deliver this specific project.206

202 Davies and others (n 197) 29. 203 Davies and Mackenzie (n 196) 778. 204 M Gaunt, ‘BIM Model-Based Design Delivery: Tideway East, England, UK’ (2017) 170 ­Proceedings of the Institution of Civil Engineers – Smart Infrastructure and Construction 50. 205 ‘Thames Tideway Report 8% Rise in Costs but Project Still on Track for 2024’ (Infrastructure Intelligence, 7 April 2019) www.infrastructure-intelligence.com/article/apr-2019/thames-tidewayreport-8-rise-costs-project-still-track-2024. 206 T DeBarro and others, ‘Mantra to Method: Lessons from Managing Innovation on Crossrail, UK’ (2015) 168 Proceedings of the Institution of Civil Engineers – Civil Engineering 171, 173.

Inter-firm Innovation in England  105 As a temporary organisation, which is supposed to cease to exist once the project is completed, the purpose of innovating is not to maintain competitiveness in the market, but ‘to ensure the outcome is delivered safely, to schedule, to budget and that a quality outcome is delivered without complication or incident’.207 This special purpose organisation manages the programme and the integration of the performances of the different companies involved.208 CRL is accountable to two governmental project sponsors (the Department of Transport and Transport for London) and receives the support of two delivery partner organisations, which constitute an integrated programme team with the objective of ensuring the adequate performance of firms involved in the project. Once the project is concluded, this delivery organisation will be transformed into an operating railway.209 In the case of the 2012 Olympic Games, a public sector temporary organisation, the Olympic Delivery Authority (ODA), was created to oversee the project of design and construction of the Olympic park infrastructure and related venues.210 Once it was charged with this task, the ODA ‘faced the challenge of integrating a large-scale and complex system of systems in a densely-populated part of a major city’.211 Recognising the difficulties of undertaking all these tasks in-house and of using public procurement to hire talent, ODA decided to appoint a delivery partner, the joint venture organisation CLM, which was selected due to its ‘compatibility of working style’ and ‘capability to deal with problems’.212 The coordination of the project was organised as follows. ODA would be responsible for dealing with the ‘upward’ side of the project, establishing the goals of the programme and planning with CLM the delivery side, and negotiating and coordinating the conflicting interests of circa 750 stakeholders in the project (such as the Mayor of London and the International Olympic Committee).213 CLM was responsible for managing and coordinating the delivery and performance of the individual projects (and the respective firms involved – the ‘downward’ side of the project), informing ODA about their progress. For that purpose, it established ‘standardised processes, reporting procedures and documentation tools to coordinate the overall programme and interdependencies between systems’.214 The construction of the Thames Tideway Tunnel also involved the creation of a specially created company (Tideway) to deliver the project and later undertake responsibility for the maintenance of the tunnel. Thames Water is the privately owned licensed company responsible for sewerage infrastructure

207 ibid.

208 Davies 209 ibid.

210 Davies

and others (n 197) 30.

and Mackenzie (n 196) 778. 780. 212 ibid 781. 213 ibid 779, 781. 214 ibid 783. 211 ibid

106  Internal Coordination in London.215 Thames Water planned and designed the initial project. For its delivery, however, a procurement competition was organised, in collaboration with the UK government, which has an interest in the project. This competition was won by Tideway (Bazalgette Tunnel Limited – a consortium of investors), a specially created company with the purpose of overseeing the work and coordinating the delivery of the project.216 Subsequently, another procurement competition was organised to select three additional consortia to build three distinct sections of the tunnel.217 Bazalgette is responsible for the delivery of the project to time, cost, and quality, thus overseeing the work of the contractors.218 It has further contracted a systems integrator, the firm Amey, ‘responsible for providing process control, communication equipment and software systems for operation, maintenance and reporting across the Thames Tideway Tunnel system.’219 Unlike the previous examples, in the construction of Heathrow Terminal 5 BAA, the client organisation, remained as systems integrator of the project and even residually responsible for risks of the operation. It is important, however, to have in mind the possibilities and limitations of this approach, especially in situations where the client company has no previous experience with megaprojects: If the client organization assumes responsibility for systems integration, it must maintain the depth of in-house capabilities needed to lead the project, bear the risk, and work with teams to coordinate and control design and construction activities. Although this approach was used on T5, it was pioneered in the 1980s by large clients in offshore oil and gas projects such as BP, Shell, Mobil, Chevron, and Exxon. However, there are limits to client-led systems integration. Unlike BAA, BP, and Shell, many clients are involved in megaprojects only on a one-off basis and have no incentive to develop strong in-house capabilities. In such cases, the client may have to consider ways of sharing the risk and the responsibilities with external partners or consultants in a joint-venture, strategic partnership or Special Purpose Vehicle.220

ii.  Risk-sharing Contracts The contracts structuring cooperation in the creation of new or innovative ideas in these ventures employed a novel approach regarding risk sharing between clients and suppliers. The aim was to encourage the different collaborating companies to participate and engage in a complex project, while also being careful not to magnify the risks negligently.

215 A Korse, ‘Review of the Thames Tideway Tunnel’ (National Audit Office – Department for Environment, Food and Rural Affairs) Report by the Comptroller and Auditor General 15. 216 ibid. 217 ibid 28. 218 ibid. 219 Information available at www.tideway.london/about-us/the-organisation/#sub-nav. 220 A Davies, D Gann and T Douglas, ‘Innovation in Megaprojects: Systems Integration at London Heathrow Terminal 5’ (2009) 51 California Management Review 100, 111.

Inter-firm Innovation in England  107 In the case of the construction of Heathrow Terminal 5, the BAA elaborated a bespoke legally binding contract (the T5 Agreement), ruling over the relationships between BAA and more than 60 first-tier suppliers, but also serving as a model for the agreement between first-tier suppliers and subcontractors.221 The contract was based on the premise that BAA, the client, would be liable for the residual risks of the project.222 This was the result of recognition that the inevitable risks in a large, complex project cannot be passed on to the suppliers, but must remain – to a certain extent – with the client, lest the suppliers are discouraged from working on the project. The T5 Agreement established a sophisticated formula for sharing liabilities. BAA set ‘incentive funds’ to meet the liabilities of suppliers for contingencies or cost overruns, as well as contracted insurance for potential additional risks on a project-wide basis. Suppliers would be only liable for potential losses beyond the amounts established in the incentive funds. For this purpose, suppliers were separated into different project teams, liable on a no-fault basis for extra losses in certain areas. The suppliers’ payment was based on cost-plus contracts, receiving for the costs incurred in addition to a ring-fenced profit.223 In case of exceptional performance, suppliers would profit from bonuses, provided the incentive funds had not been depleted. This formula sought to provide incentives for the suppliers to join the project, without fearing liability for the inherent risks in a complex project, but at the same time being cautious not to increase these risks through lousy performance. In the Crossrail project CRL, the delivery organisation responsible for coordinating the project, selected contractors to the project through an approach called Optimised Contractor Involvement (OCI).224 This approach allowed the different suppliers procured for the endeavour to propose new and innovative ideas for the Crossrail project, sharing their risks and rewards with the client. The contractors were selected based on technical capabilities rather than cost considerations: Under OCI, the contractor is brought in after the target price has been established but early enough to have some input into the design and value engineering. To avoid encouraging suppliers to submit lowest-cost bids, Crossrail put increasing emphasis on the technical element to help select the best solution.225

More specifically, this contracting practice guarantees that innovations potentially generated and creating value, by the initiative of the suppliers, would have their value shared between the client and the contractor. This is a strategy based on the pain/gain share arrangement, as established in the New Engineering Contract, a standard agreement drafted by the UK Institution of Civil Engineers.226

221 Deakin 222 ibid. 223 ibid

and Koukiadaki (n 200) 373.

374. and others (n 197) 32. 225 Dodgson and others (n 195) 269. 226 Davies and others (n 197) 32. 224 Davies

108  Internal Coordination A similar strategy was employed in the construction of the most complex projects for the Olympic Games, where the clients established agreements with the contractors based on the third version of the New Engineering Contract (Option C).227 More specifically, a form of target cost contract (pain/gain) was established, setting also contingency funds to cover unpredictable circumstances that the contractors could face. In this case, a target cost is initially established. If the final costs are above the initial target (overspending), the contractor will share these costs with the employer; if the final costs are below the target, the contractor will share profits. There might be a variation of practices and circumstances where the target cost might be adjusted. Less complex projects incorporated a simpler version of the NEC, establishing a fixed price for the performance.228 The contracts contained a final programme that included ‘work breakdown structure, schedule, milestones and risk allocation’.229 The Thames Tideway Project followed the same pattern. The agreements concluded between Thames Water and the different contractors established a ‘target price’ and a risk/reward sharing mechanism: ‘If a contractor delivers its section below the target price, it is rewarded with fifty per cent of the underspend. Symmetrically, a contractor must absorb fifty per cent of any costs above the target price.’230 Through the sharing of the savings related to performance completed early or below the target, contractors are incentivised to seek ways to improve their methods and to actively pursue cost savings. In addition, as a form to incentivise the coordination of the performance of the different firms involved in the project (construction was organised in different ‘parcels’), a bonus fund of £1.6 billion was created, to be shared between the contractors if the project as a whole is completed early or below the established target price.231 More than simply establishing a risk-sharing structure, such agreements encourage the development of trust and a collaborative culture between the companies: since they will be sharing the risks and benefits resulting from the project, the incentive is to cooperate and to mutually adjust it as might be necessary.232 iii.  Integrated Project Teams Another commonly identifiable feature across some of these projects is the establishment of different mechanisms to ensure team working between the different companies involved.

227 Davies and Mackenzie (n 196) 784. 228 ibid. 229 ibid. 230 N Zhivov, ‘The Thames Tideway Tunnel: A Hybrid Approach to Infrastructure Delivery’ (­International Transport Forum/OECD 2018) Working Paper 17. 231 ibid 16. 232 Davies, Gann and Samuel (n 193) 75.

Inter-firm Innovation in England  109 In the case of Heathrow Terminal 5, the work was organised into different integrated project teams composed of the different suppliers, which were guided by principles of collaborative behaviour. Even before the beginning of the project, BAA had already developed a Continuous Improvement Project Process (CIPP) to ‘provide a set of standardized and repeatable time-sequenced tasks, milestones, and stage-gates to deliver cost-effective and profitable projects through the application of best practices across BAA’s capital projects’, which were later used in the T5 Project.233 These processes are outlined in the T5 Handbook, ‘including the lines of reporting, responsibilities, and accountabilities … to be used on T5’, enabling the different suppliers to work collaboratively and coordinate their performances.234 An educational programme was organised to diffuse this collaborative culture among many suppliers that insofar had no experience in conducting projects based on that logic.235 Besides, the framework contract governing the venture (the Major Projects Agreement (MPA)) created a compromise between the different parties to the project (including employees and the trade unions to which they were affiliated) to perform the teamwork in a collaborative way.236 In the case of Crossrail, different mechanisms were used to ensure integration and collaboration between the client and the different suppliers. This approach was used especially in complex aspects of the project, eg the planning for the creation of a ‘future digital railway’, where digital systems will be useful to operate future railway operations, for instance, 4G mobile technologies enabling communications in the stations and establishing networks of sensors in the stations to monitor the movement of passengers and the performance of the equipment.237 In this situation, the strategies involved the organisation of a workshop between the independent entities to plan collaboration; and the use of building information modelling (BIM), ‘a tool providing a digital representation of the transportation asset used through the life cycle from design and construction to handover, operation and maintenance’.238 In the case of the Olympic Games, the delivery organisations responsible for the project applied different strategies to ensure the integration of the individual projects, maintaining autonomy, while ensuring cooperation: Dealing with such reciprocal interdependencies could not be addressed by one ­organization on its own. It required the continuous interaction and penetration of all affected parties. The [delivery organizations] appointed representatives to work closely on site as part of co-located, integrated project teams with principal  contractors.



233 Davies,

Gann and Douglas (n 219) 115. 116. 235 ibid. 236 Deakin and Koukiadaki (n 200) 378. 237 Dodgson and others (n 195) 269–70. 238 ibid 272. 234 ibid

110  Internal Coordination The  pairing of an ODA executive (project sponsor) and CLM executive (project manager) applied across all the system projects (and bundles of smaller projects).239

Such mechanisms serve to facilitate coordination of the performances and the learning needed to undertake these complex and uncertain projects effectively. V. CONCLUSION

The objective of this chapter was to examine how the challenges of internal coordination in a contractual network to innovate are dealt with by its members. It has analysed different theories (particularly braiding, structural social capital and multivalent contracting theory) and their supporting evidence indicating that a variety of governance mechanisms are employed for that purpose. These mechanisms include the creation of inter-firm steering committees to resolve uncertainty and deal with contingencies in the contractual relationship, an information-sharing procedure, the division of the productive activity in different milestones and the creation of escalated dispute resolution mechanisms. Despite recognising the existence of these mechanisms to govern an innovative relationship, the different theories presented diverging explanations regarding different aspects of the contractual collaboration, such as basis of trust in these ventures and the discussion about the need to look beyond opportunism towards other factors (such as spillovers and entropy) to understand how these agreements are structured. Having in view examining the plausibility of these theories beyond the United States (where most of the empirical evidence had been collected so far), the chapter then presented the results of empirical research undertaken in Brazil and analysed secondary sources in England related to inter-firm collaboration. The analysis undertaken supported the description regarding the governance machinery employed for collaborative innovation outlined in the aforementioned theories. Indeed, contractual governance seems to be the main instrument (according to the empirical data so far published) to address problems of internal coordination between members in a collaborative network of contracts for innovation, as demonstrated by the few disputes arriving at courts and arbitral tribunals. Nonetheless, as elaborated in chapter three, the legal doctrine also has an important role, in most cases through ‘low-powered enforcement’. Particularly regarding the empirical research conducted in Brazil, the data presents confirmatory evidence to the theories on contracting for innovation on the existence of a number of complex governance mechanisms. At the same time, however, it indicates that consideration must be taken of the context of a developing country, which suggests the need to adapt the contractual landscape for innovation. Based on the interviews, the existence of purely contractual and

239 Davies

and Mackenzie (n 196) 784.

Conclusion  111 collaborative joint ventures for innovation co-creation in Brazil was confirmed. The parties did not point out a single formula on how to structure this kind of collaborative production, generally indicating the existence of a great degree of flexibility and variation on the possibilities of establishing those contracts. Moreover, this kind of collaborative contractual arrangement was contemplated as one type of arrangement among others that potentially may be chosen by firms in structuring their production process, such as equity joint ventures or partnerships or even production entirely conducted internally within a firm. The parties, when deciding on how to structure their productive activities, will take different reasons into consideration.240 In a preliminary analysis, both thickness of the market and level of uncertainty seem to be relevant when structuring collaborative ventures, as predicted by Gilson et al.241 In that sense, the interviews revealed that in the aerospace industry, due to the reduced number of participants, companies tend to give additional weight to relational elements, such as business trust and reputation. In contrast, in most other industries, the interviewees suggested that trust was more an outcome of the contract and that the agreement served as a guiding plan for them. All the companies were involved in ventures with a high degree of uncertainty, meaning that there were no traditional industry codes that would be relevant to directly solve issues of contractual unpredictability. However, there were codes of conduct relevant to different aspects of the relationship (such as the aerospace company manual of conduct for its suppliers or the environmental rules that may be applicable to different industries). Still, the parties themselves had to devise complex mechanisms of governance to solve their issues. This confirms a tendency to ‘proceduralise’ contracts.242 Such a phenomenon points towards the existence of an ‘organisational contract’ with different features from traditional discrete contracts and with many points of approximation to company law.243 Despite similarities in the contracting practice, there are some emerging differences in the contractual landscape, which seem closely related to the prevailing economic and social background of a developing economy such as Brazil. The first distinction, identified by several interviewees, refers to the customary participation of research institutes or universities in these projects. Although in developed countries collaboration with such entities is recurrent, in the case of Brazil most scientific workforces are in universities and research institutes,

240 Geis, ‘The Space Between Markets and Hierarchies’ (n 61) 107 ff, referring to transaction costs, financing costs and agency costs as core elements to be examined when establishing the organisational design of a business. 241 Gilson, Sabel and Scott, ‘Contract and Innovation’ (n 30) 173–74. 242 Grundmann, Möslein and Riesenhuber (n 5) 17. 243 Cafaggi, Grundmann and Vettori (n 1) 3.

112  Internal Coordination with a small proportion employed in the private sector.244 This contrasts with developed countries where it is not rare for innovative companies to have a relevant workforce of scientists and researchers.245 Consequently, in the Brazilian case, the need to ally with those institutions, especially in alliances involving only national partners, is even more important. The implication is that several of these collaborations may be subject to the specific administrative legislation/ regulation involving requisites for contracting with public entities, affecting many contracts for innovation. An example of that, in the Brazilian context, is the previous version of Article 9 of the Innovation Law (Law 10.973/2004). Art 9 formerly established that, in collaborative relationships involving a public Institute for Science and Technology (such as a public university or a public company involved in research activities), the public entity will necessarily retain the IP rights commensurate with the proportion of its investments. The result was that many collaborations were discouraged where a commercial firm (often carrying the full costs of developing and commercialising a certain product, based on the collaboratively created technology) would have no incentives to make the needed investments, as its rate of profits from the IP royalties would not be sufficient to cover the project costs. Moreover, the public entities, most often, would not have the financial resources and organisational abilities to develop and commercialise the product alone. As a result, experimentalism and innovation would be hindered. Article 9 was rightly revised in 2016, and now establishes that public ICTs shall be able to transfer to the private partner firm the entire IP rights in exchange for a financial or non-financial commensurate compensation. This is not to suggest that this is the best solution in all cases, but the point is that this possibility should not be ruled out by the legislation.246 A second difference relates to a greater need for public finance in developing economies. This is a consequence of the model of the corporate market and the related issue of access to finance in the capital markets. Emerging economies tend to have a less diffuse corporate market than developed countries, with the state or a few major shareholders dominating the main companies in the country, usually establishing controlling power through major shareholder agreements.247 Not unusually, these companies are owned by traditional families 244 67.5% of the researchers in Brazil are employed in higher learning institutions, while a meagre 26.2% are employed in companies – a level way below countries such as the US, Germany and Japan. Brazil – Ministry of Science, Technology and Innovation, Estratégia Nacional de Ciência, ­Tecnologia e Inovação 2012–2015 – Balanço das Atividades Estruturantes 2011 41–42 (2012). 245 Furthermore, the relationship between public universities and private companies still lags behind in relation to other countries, such as the UK, where this relationship is stronger, through science parks and spin-off companies in the university sector. The difference could be related to the fact that in the UK, this form of collaboration is more institutionalised, while, in Brazil, related efforts are still in an embryonic stage. 246 See Art 9, §3º of the Innovation Law (Law 10.973/2004). 247 See section 2.1 in M Pargendler, ‘Corporate Governance in Emerging Markets’ (2014) FGV Research Paper 17.

Conclusion  113 and do not (or at least not entirely) have their shares publicly available in the capital markets. Related to that, protective rules of shareholder minorities may not be as strong as to provide high liquidity for the public market of shares in emerging economies.248 This picture, essentially, reflects the Brazilian corporate market. The consequence of that is important: with a reduced and low-liquidity capital market less private equity is available, especially the venture capital that, in economies such as the UK and the US, is essential to fund innovative ventures.249 Without those funds available, how will finance be raised for innovation? Obviously, one option is to use a company’s profit to re-invest in innovative projects.250 However, for advanced, radical innovation, that will often not be sufficient. The state will have a central role in somehow supporting those ventures. Among the few Brazilian companies developing advanced innovation, some had benefited from state support. There are different models through which public finance can be raised and, again, those may have consequences in the contractual landscape for companies.251 An example of that is the financing of innovation projects through the Brazilian Association for Industrial Research and Innovation (‘Associação Brasileira de Pesquisa e Inovação Industrial’ – EMBRAPII), a non-profit private institution that receives funding from the government to coordinate activities among companies willing to solve collaboratively common issues of technology and innovation in their common field. For that purpose, they award certain Institutions of Science and Technology (ICTs – Instituições de Ciência e Tecnologia, such as public universities or private research institutions) the status of ‘EMBRAPII Units’. Such units will be able to select partner companies from a common industry to solve a technological problem collaboratively and to contract with them research and development agreements. That is the case of a group of cosmetic companies that allied with an EMBRAPII Unit, the IPT (Institute of Technological Research of São Paulo) to develop collaboratively a technique for the nanocoating of an active principle for cosmetic products.252 Having the status of an EMBRAPII Unit, the IPT was

248 ibid. 249 Regarding the need for an active stock market for venture capital to thrive, see B Black and RJ Gilson, ‘Does Venture Capital Require an Active Stock Market?’ (1999) 11 Journal of Applied Corporate Finance 36, 36. 250 Or to rely on cross-shareholding or bank-centred capital markets, as happens in countries such as Japan and Germany, where the bank has a significant role in monitoring large firms. This model, however, would be able to foster incremental innovation, but not radical innovation, as in areas such as software, biotechnology or semiconductors, with high level of uncertainty of the project. ibid 38–39. 251 For different possibilities of the role of the state as a venture capitalist, see RJ Gilson, ‘­Engineering a Venture Capital Market: Lessons from the American Experience’ (2003) 55 Stanford Law Review 1067, 1068 ff. 252 See press release at embrapii.org.br/projeto-de-inovacao-na-area-de-cosmeticos-entra-na-retafinal/.

114  Internal Coordination able to select freely the collaborating companies, without the intervention of the government or of EMBRAPII. For that project, IPT received from EMBRAPII, as non-recoverable funding, one-third of the costs of the collaborative project as an incentive for innovation. In exchange, EMBRAPII imposes a few clauses in the collaboration contracts between the partners.253 Finally, a third distinction relates to the fact that, often (in the research phase, but not in the development phase in supply chains), contractual collaborations to develop innovation in Brazil are pre-competitive ventures, that is, projects undertaken by several companies to solve a common technological industry problem. Once a solution is achieved, each company then moves on to produce their own product independently. That undermines the risks of coordination of the relationship among the parties as they will not be exposed to the risks of co-developing and jointly commercialising products; rather, each will have its own separate product, although they may have used a common technology to develop it separately. There will be no need, in this case, to establish clauses to share profits or mechanisms to solve uncertainties in the development process. Likewise, the division of the foreground IP will be more straightforward. However, the undermining of the coordination of the firms comes at a high cost: less possibilities in the development of innovation. Regarding inter-firm collaboration in England, the analysis of secondary sources reinforces the role of governance mechanisms in coordinating complex projects. In particular, the case studies on construction megaprojects present relevant insights. Such projects involve high uncertainty due to the magnitude of the tasks and difficulties of coordinating the performances of different parties in the venture. The coordination of a project involves often the establishment of delivery units, of risk sharing contracts and mechanisms to facilitate the joint work between the partners. In conclusion, private governance mechanisms are usually employed by partners in collaborative contracts for innovation and present a suitable framework to deal with several of the internal challenges posed by these kinds of relationship. Nonetheless, such governance mechanisms also have limitations and some disputes may arise between partners despite the sophisticated contractual structure established. The next chapter discusses the role of the legal doctrine in relation to the internal coordination between members of an innovative contractual network. 253 One of them establishes a mandatory nested option in favour of the Institute of Science in ­Technology involved in the project. It determines that, if any of the partners receives the exclusive licence to commercialise the foreground IP resulting from the collaborative venture, that exclusive licence shall be revocable if, after 48 months from the IP filing before the Brazilian IP Registry, the entitled company(ies) fail(s) to license and/or commercially explore such IP rights. See Annex 2 of Model of EMBRAPII Partnering Agreement, Clause 5 (copy with the author). The rationale for such a clause is to encourage the application of developed technologies in the country’s productive sector. This clause, obviously, alters the contractual design and the balance of incentives in the contract.

3 Managing the Internal Coordination of the Network: The Role of the Legal Doctrine and the Duty of Loyalty to the Network

H

ighly uncertain projects to innovate are usually managed through contractual governance mechanisms, allowing for the parties to jointly specify their obligations as their collaboration evolves.1 After all, for the parties to advance their innovation project amid high uncertainty, voluntary cooperation is necessary since a high degree of joint learning, joint problem solving and freedom to experiment will be vital for the innovative project to evolve. That freedom would be curtailed if a court were to dictate terms for the parties’ relationship. Instead, their cooperation can be facilitated through the combination of formal contracts (including governance mechanisms) with informal incentives (trust, reputational and business considerations), creating an environment conducive to collaboration. This is how the innovative project can advance according to the evidence presented,2 and courts or arbitral tribunals should not try to force this collaboration in most circumstances. Furthermore, most conflicts in collaborative contractual networks for innovation are solved internally, in one of the levels of the escalated dispute resolution process often established by the parties. This is largely acknowledged in empirical studies and the interviews conducted in this study provide supporting evidence.3 Ultimately, if cases are to be adjudicated, most are submitted to arbitration and few go to state courts.4 Few cases have been arbitrated/litigated, although the confidential nature of arbitral proceedings may hide a number of relevant disputes.

1 Ch 2, section II.B. 2 Ch 2, section II.B. 3 Gillian Hadfield and Iva Bozovic, ‘Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation’ (2016) 5 Wisconsin Law Review 981. M Jennejohn, ‘Contract Adjudication in a Collaborative Economy’ (2010) 5 Virginia Law & Business Review 173, 222 ff.; see ch 2, section III, on the interviews conducted by the author. 4 Jennejohn (n 3) 197 ff.

116  Managing the Internal Coordination What role, then, is left to the legal doctrine and to the law of contract in this scenario? This chapter deals with a scenario where the legal doctrine would have significance: once the parties have a conflict and their collaboration breaks down (and cannot be solved through the internal escalated dispute resolution mechanisms), there may be a need to determine whether a violation of the contract has happened and how it should be remedied. This chapter seeks to deal with this theme and further elaborate the concept of a duty of loyalty to the network as an interpretative guideline to identify contractual violations. The rationale of such duty of loyalty, however, does not involve forcing the continuation of the relationship. According to braiding theory, once a violation to the contract to innovate is identified, the sanction for it should not be forcing the continuation of the relationship or imposing expectation damages, but simply awarding reliance damages that can cover the investments lost due to the lack of commitment of one of the parties to the project. This is what Gilson et al propose should be the ‘low-powered enforcement’ required in contracts to innovate.5 They claim that once ‘red-faced’ violations are identified, reliance damages should be awarded for the aggrieved party. In contrast, Jennejohn presents a distinct opinion, rejecting the idea that expectation damages should be discarded outright. In support of this position, he claims that cases presented by braiding theory as examples of ‘low-powered enforcement’, when closely analysed, had in fact enforced expectation damages.6 For him, there is a ‘variety of doctrines implicated’ in such types of dispute (such as contract law and patent law) and the main question is how to balance the application of these doctrines.7 While acknowledging that different doctrines may be applicable in varied circumstances, this book follows the viewpoint that, as a default rule, lowpowered enforcement would be the most adequate approach to govern contracts for innovation, particularly regarding the most uncertain aspects of these agreements. Even if available, expectation damages would be too speculative to be quantified. Similarly, specific performance would be inadequate for a relationship where voluntariness is important to allow for inventiveness and creativity to flourish. The expectation interest could still remain as an exceptional possibility in situations where the contractual collaboration has already been concluded or generated an output, such as an intellectual property right. In that case, obviously, it may be possible for a party to claim the contractual rights (or to raise other potentially relevant doctrines) to be enforced over the materialised result of the collaboration. The initial uncertainty is then overcome by the generation of the output. Similarly, as further explored, contracts for innovation also contain a number of definite obligations (such as duties to share clearly specified 5 See ch 3, section I.A. 6 M Jennejohn, ‘The Private Order of Innovation Networks’ (2016) 68 Stanford Law Review 281, 358–59. 7 ibid.

Managing the Internal Coordination  117 kinds of information or machines for a process to be undertaken). In relation to those specific obligations, expectation damages also remain a possibility. The core challenge, however, regards the uncertain duties of cooperation contained in these agreements. In relation to those, it seems that the best approach is to provide reliance damages as remedy. However, even if one accepts that, as a default rule, reliance damages are to be awarded for violations of agreements to innovate, still it is not always easy to determine whether a ‘red-faced’ violation of a contract to innovate has occurred. The parties’ obligations are to be specified jointly and the duties of cooperation are often established broadly. Therefore, if a controversy arises, there may be a need to interpret the practical meaning of these duties. Even if the controversy does not reach an adjudicatory body, being instead settled by the parties themselves (as is often the case),8 the understanding of their rights under the applicable legal system will influence the leverage each one will have in negotiating a settlement. That is particularly true in a context where the contract serves as a guiding plan for the parties’ business relationship, as in the field of innovation. Legal rules and doctrine establish the incentive structure, which is the strategic leverage that each party will have in the (continuous) (re-)negotiations to shape the obligations of network members (in addition to the existing contractual structure established by the parties).9 It is questionable whether courts could have any role in contracts for innovation when the parties’ relationship is ongoing, ie it has not broken down.10 If there are governance mechanisms established to solve contingencies, courts should as a rule respect parties’ allocation of risk and not intervene until the process laid out has been concluded, respecting party autonomy. In extreme cases, they may review whether a transparent and non-abusive participatory procedure for the parties to make their own decisions has been established without imposing the relationship’s continuation.11 There is still a need to further

8 See n [3], above. 9 ‘The legal analysis of market transactions holds particular interest, of course, for practising lawyers who may be brought in to advise businesses on how to best organise their transactions.’ H Collins, Contract Law (4th edn, Cambridge University Press 2008) 2. 10 This differentiation between contracts with ongoing cooperation or with a finished phase of cooperation is similar to that of Gilson et al, where they claim that long-term contracts (with ongoing uncertainty) and discrete contracts for innovation (where uncertainty ceases after a certain stage, raising then the issue of opportunism) generate different kinds of deals. RJ Gilson, CF Sabel and RE Scott, ‘Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration’ (2009) 109 Columbia Law Review 431, 473–74. 11 A possibility to ensure the transparency of governance mechanisms, especially for the benefit of SMEs, would be to establish, in certain industries or sectors, regulatory rules to create a contextualising regime, including procedures for cooperation, information sharing and dispute resolution, creating a default regime from which the parties could opt out. Through this contextualising regime, courts would have reliable information to make decisions if a conflict arises and adjudication is necessary. Absent such regulatory background or a contextualising regime (established by the parties themselves or through regulation), no reliable information will generally be available regarding such highly complex collaborations. In such cases, I do not think that courts should (or would be

118  Managing the Internal Coordination understand the variety of governance mechanisms and their applicability in different circumstances before this issue can be analysed deeply. It seems that, where the governance procedures establish an extravagant unilateral power for one of the parties in the relationship, there may be a justification for an (exceptional) intervention to terminate the relationship, but not to force cooperation to innovate, which is unlikely to be successful unless the parties trust each other and are voluntarily willing to collaborate. This chapter considers the broad general legal doctrine prescriptions relevant to collaborative contracts for innovation in the US, Europe and Brazil. It also considers whether the notion of ‘low-powered enforcement’ could be adopted by the current English and Brazilian law or whether any adjustment would be necessary. Even if one accepts that the issue of damages seems more settled regarding contracts for innovation (reliance damages should be awarded as a default rule), the meaning of the substantial duties inserted in these agreements is little explored. The chapter then discusses a duty of loyalty to the network or collaborative project, seeking to refine this notion, increasingly proposed as a suitable interpretative guide for these relationships. It concludes by considering whether this duty of loyalty to the network/collaborative project could be adopted by English and Brazilian law and how this adoption could be undertaken. I.  THE LEGAL DOCTRINE REGARDING CONTRACTUAL NETWORKS: A COMPARATIVE PERSPECTIVE

Considering the inherent uncertainty of contracts for innovation (even about core elements, such as the contractual performance), perhaps the first legal issue to be faced by adjudicators is whether the agreement to innovate is ­enforceable.12 Even if considered enforceable, it will be incomplete, filled with gaps or vague clauses, and, thus, there will be a need to determine whether terms can be implied when governance procedures fail in this task. In collaborative contractual networks, classical contract law issues call for a different balance between freedom of contract and communitarianism, especially considering parties’ inability to allocate risks beforehand due to their relationship’s inherent uncertainty. At the same time, courts seeking to imply terms of cooperation for an experimental relationship would likely provide an

able to) impose the continuation of these relationships or impose expectation damages, but at the most reimburse reliance damages for clear contractual violations. The imposition of the continuation of experimental relationships would likely destroy the trust and flexibility necessary to develop innovation. 12 See above, Introduction, section III.B.

The Legal Doctrine  119 inadequate framework for innovation to thrive.13 Experimentalism requires trust and flexibility between the partners and freedom to walk away from an unpromising relationship, something hard to attain when courts dictate the parties’ obligations. Moreover, in ventures established to permanently innovate, there is a continuous uncertainty about the terms of the parties’ productive relationship that must be regularly solved by the parties themselves, who alone can assess the best way to move forward. Even their decisions will be temporary and require continuous modification. This constant adjustment allows for permanent learning through problem-solving activities.14 Without undergoing the problem-solving/learning activity, innovation is unlikely. Courts imposing terms would undermine a party’s capacity to learn and innovate. Finally, the difficulties of fact finding by courts ex post would become an insurmountable obstacle in many situations, considering the interdependency between the parties and the experimental character of the relationship, where it is difficult to distinguish an act of cooperation from one of defection.15 Few studies specifically analysed the role of contract law for collaborative contracts for innovation in the US, Europe and Brazil, but general studies on contractual networks provide important insights and, sometimes, adequate solutions to the problems encountered. A crucial issue is whether the notion of ‘low-powered enforcement’ should prevail in contracts to innovate and how could it be adopted under English and Brazilian law. A.  US Braiding Theory – ‘Low-powered Enforcement’ and Critique Braiding theory has been previously examined and this section focuses specifically on its perspective on the court’s role in contractual interpretation. Braiding theory rejects both textualism and contextualism due to the continuous and pervasive uncertainty in experimental innovation.16 Rejecting textualism, it argues that there is an inherent impossibility to contractually allocate risks in a constantly changing project. In economic terms, there is pure uncertainty,17 ie the impossibility of estimating probabilistically the occurrence of a certain outcome. Rejecting contextualism, it claims that courts cannot apprehend the ‘logic’ of an experimental relationship.18 Ex ante, the parties 13 RJ Gilson, C Sabel and RE Scott, ‘Contract and Innovation: The Limited Role of Generalist Courts in the Evolution of Novel Contractual Terms’ (2012) 88 NYU Law Review 170, 174, 175. 14 SJ Spear, Chasing the Rabbit: How Market Leaders Outdistance the Competition and How Great Companies Can Catch Up and Win (1st edn, McGraw-Hill Education 2008) 193 ff. 15 Gilson, Sabel and Scott, ‘Contracting for Innovation’ (n 10) 479. 16 RJ Gilson, CF Sabel and RE Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (2010) 110 Columbia Law Review 1377, 1382, 1385 (claiming that persistent uncertainty can coexist both in technological and non-technological fields). 17 F Knight, Risk, Uncertainty and Profit (Martino Fine Books 1921). 18 Gilson, Sabel and Scott, ‘Contract and Innovation’ (n 13) 174–75.

120  Managing the Internal Coordination themselves could not establish their substantive obligations, but rather set out to discover them iteratively, as cooperation continues. Ex post (in an ongoing project), courts may not be able to apprehend this logic because the project is constantly changing, and only the parties immersed in the cooperation, provided they regularly exchange information, can make an informed decision on their relationship’s continuation. Braiding theory claims that contracts for innovation combine (mutually reinforcing) formal and informal elements to incentivise the inter-firm ­relationship19 and proposes a form of contract law that does not strongly intervene in the parties’ relationship by forcing them to move forward or imposing terms. It claims the opposite: the decision to continue cooperating should be the parties’ prerogative. A court’s role is simply to enforce the few formal contractual obligations. The question is, how does braiding propose to enforce formal contractual terms, especially general duties of cooperation? Besides them, few other substantial obligations are contained in most of these agreements, at least regarding the innovative activity. For braiding, implying any terms beyond those would be inadequate. First, because it would crowd out the trust between the parties and second, because of the inadequacy of external advice on how to conduct experimentation. Regarding these formal obligations, braiding theory suggests ‘low-powered enforcement’20 and the violation of contractually established duties should be remedied with reliance interest, seeking to put the aggrieved party in the initial position. Gilson et al peruse US decisions with different approaches on the amount of damages awarded in similar situations, indicating that this is a moving area of the law.21 The authors strongly oppose granting expectation damages, claiming that courts should not establish a level of recovery that forces the parties to continue their cooperation in experimental relationships, but rather allow the parties room for discretion.22 It should simply sanction ‘red-faced violations’ of these clauses through reliance damages. While the issue of damages is clearly established in braiding theory, the question of interpretation of duties of cooperation has been little explored. What Gilson et al claim to be ‘red-faced violations’ are not always clearly identifiable in practice. The most significant legal development in the US, in this regard, is the acceptance by several state/district courts of a duty to negotiate in good faith preliminary agreements where the parties have ‘contemplated further negotiations’, although there is still uncertainty regarding the extent of this obligation’s

19 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 16) 1384 ff. 20 ibid 1415 ff. 21 ibid 1444–45. 22 ibid 1443–44.

The Legal Doctrine  121 enforceability.23 Gilson et al rightly see this rule as a potential tool to facilitate braiding in contracts for innovation. Such duty of negotiating in good faith has been interpreted as not allowing courts to decide on the outcome of the collaboration, but rather sanctioning solely the ‘cheating on the parties’ mutual commitment to iterative collaboration’.24 Jennejohn has a sceptical perspective regarding braiding theory’s call for a minimalist court intervention.25 Rather than pleading for a minimalist or maximalist contract law, he defends a balancing between different doctrines potentially applicable to each particular case (such as contract law and patent law). The author points out two main objections to low-powered enforcement. First, he highlights that Eli Lilly & Co v Emisphere Technologies, Inc (2006),26 the case that braiding theory presents as an example of low-powered enforcement, has been misread. In his view, the court granted to the claimant certain patents at issue in the dispute, indicating that its expectation interest had been met. Furthermore, the court rejected enforcing the contract referee mechanism established in the agreement, stating that the claimant had waived it – a circumstance indicating that the court had lost the opportunity to follow a lowpowered approach. Second, Jennejohn restates his argument that contracts for innovation do not braid informal and informal mechanisms to avoid opportunism but rather takes into consideration a number of factors, especially spillovers and entropy. As a result, the courts do not need to maintain the ‘braiding’ established in the contract, but are able to act according to the different factors at play in each case. Both these objections are relevant to examine the contract doctrine applicable to contracts for innovation, but it does seem that they could be accommodated with braiding theory’s doctrinal approach provided two distinctions are made. First, it is necessary to make a distinction between vague and uncertain obligations contained in contracts for innovation and those more precise clauses in these agreements. Second, it is necessary to distinguish between cooperation that has already generated some output or that has been already concluded and collaborations that are ongoing and have not yet produced results. It seems that Jennejohn’s objections are relevant for situations involving either more defined contractual terms and/or collaborations that have already generated an output (such as patents). In such cases, it does seem that either expectation damages or specific performance could be granted by adjudicators, since it is more feasible then to quantify or request specific performance from one party, as the situation allows more certainty for the court. This would not be the case when the parties’

23 ibid 1424, 1427 ff. See also A Schwartz and R Scott, ‘Precontractual Liability and Preliminary Agreements’ (2007) 120 Harvard Law Review 661, 664. 24 Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 16) 1427. 25 Jennejohn (n 6) 354. 26 Eli Lilly & Co v Emisphere Technologies, Inc, 408 F Supp 2d 668 (SD Ind 2006).

122  Managing the Internal Coordination collaboration is ongoing and/or has not generated any output and the parties’ relationship is governed by vague contractual legal obligations and governance mechanisms. In such cases, there would be simply too much uncertainty to quantify expectation damages, even if they were available. Similarly, specific performance would likely curtail the creativity and inventiveness that is usually required for the development of an innovative output. For these reasons, it seems that, regarding particularly the highly uncertain and vague aspects of a relationship to co-create innovation, low-powered enforcement would be more adequate. That does not bar, of course, that a different approach may be followed for other aspects of the relationship and that different doctrines overlapping may provide different factors to be taken into consideration. Summarising, this book follows the approach that, in general, the main role for courts should be to enforce mutual duties of cooperation and preliminary investments agreed between the parties through reliance damages, as a form to prevent defection in the initial phase of cooperation. Courts should not generally engage in determining whether the parties should continue cooperating or in which terms. That would crowd out trust and cooperation among themselves and destroy chances of real experimentation. That prescription, however, should be relativised in relation to aspects of the contractual collaboration that involve more certainty, such as a generated output or more definite contractual terms. B.  European Private Law In Europe, early discussions regarding contractual networks used different denominations.27 These early denominations were considered to fall under a general category of ‘linked contracts’.28 Based on these types of contract, further discussions on complex forms of contractual connections emerged, considering the logic of simultaneous cooperation and competition between the parties and the pervasive uncertainty of relationships to innovate. The first studies acknowledging the specificity of such ventures date from the early 1990s. The early studies on the topic deal with franchising, exploring how the dependence of the franchisees upon the franchisor required recasting contractual principles and interpretation.29 They were then focused on a form of hierarchical network. To regulate hierarchical relationships, private law’s main purpose would be the protection of the weakest link in the network against the network leader. However, subsequently, authors such as Teubner recognise

27 ie, Contratti collegati in Italy, groups of contracts (groupes des contrats) in France, connected contracts (Verbundeneverträge) in Germany. 28 See ch 1, section I.B.ii. 29 eg, E Schanze, ‘Symbiotic Contracts: Exploring Long-Term Agency Structures between Contract and Corporation’ in C Joerges (ed), Franchising and the Law: Theoretical and Comparative Approaches in Europe and the United States (Bloomsbury Publishing 1991).

The Legal Doctrine  123 the existence of heterarchical networks, truly collaborative ventures where the parties are all vulnerable in relation to each other due to the spirit of discovery and the project’s uncertainty.30 In this sense, the legal problems involving hierarchical networks often require different responses to those required by heterarchical networks. In the latter case, the typical issue is not asymmetry and/ or the protection of the weakest party, but rather true coordination, monitoring and transparency between the parties. Two main topics have been growingly discussed regarding contractual networks. First, the interpretation of bilateral contracts inserted in a multilateral network, especially the intensification of contractual duties.31 Second, thirdparty network liability. Despite several discussions, in most jurisdictions direct contractual actions against a non-contractual partner are only exceptionally possible,32 and tort claims for pure economic loss have a very limited applicability.33 The mainstream prescription is that claims should be pursued further down the contractual chain, even though there may be exceptions; normally very narrow to constitute a general rule. In practice, most disputes involving contractual networks have been decided on an ad hoc basis, proposing solutions tailored to each case but lacking solid support in contractual theory. Despite different contributions, uncertainty remains on how courts should interpret cooperation duties and bilateral contracts embedded in networks. C.  Brazilian Law The current Brazilian Civil Code was enacted in 2002, but its project traces back to the 1960s.34 It contains no specific provisions on networks of contracts and only few articles on long-term contracts.35 Absent specific rules on contractual networks, Brazilian law resorted to its tradition of directly referencing foreign legal doctrines that could be locally relevant (bartolismo).36 Most recently, Brazilian authors developed studies on the topic of linked contracts. 30 G Teubner, ‘Beyond Contract and Organization? The External Liability of Franchising Systems in German Law’ in C Joerges (ed), Franchising and the Law: Theoretical and Comparative Approaches in Europe and the United States (Nomos 1991) 105. 31 F Cafaggi, ‘Il Contratto Di Rete Nelle Prassi: Verso Il Consolidamento’ in F Cafaggi, P Iamiceli and G Mosco (eds), Il Contratto di Rete per la Crescita delle Imprese (Giuffrè 2012) 74–84. 32 eg, S Grundmann, ‘Contractual Networks in German Private Law’ in F Cafaggi (ed), Contractual Networks, Inter-firm Cooperation and Economic Growth (Edward Elgar 2011) 160–61. 33 H Collins, ‘Introduction to Networks as Connected Contracts’, Networks as Connected Contracts (Hart Publishing 2011) 51. 34 M Reale, Projeto Do Novo Código Civil (Saraiva 1998) 26. 35 Arts 317, 473 and 478 to 480 of the Brazilian Civil Code. 36 Brazilian jurists referenced the French theories of groups of contracts (groupes de contrats), Italian theories of connected contracts (contratti collegati) and Argentinian seminal works by Lorenzetti and Iturraspe on contractual networks. J Martins-Costa, A Boa-Fé No Direito Privado: Critérios Para a Sua Aplicação (Marcial Pons 2015) 241 ff.

124  Managing the Internal Coordination Although these are valuable to understand cases involving long-term and linked contracts, most of them fail to address the specificities deriving from networks for innovation since they do not involve pervasive uncertainty or challenges to articulate competition and cooperation. In most cases, they are forms of linked contracts.37 The pioneering work in Brazilian law is Leonardo’s monograph on contractual networks in the real estate market.38 Nevertheless, this study does not relate closely to the issues presently discussed: under Brazilian law, individuals acquiring real estate from companies are considered to be consumers, governed by the Brazilian Consumer Code.39 Still, the paradigmatic case discussed by Leonardo is in the real estate context40 and has relevance to the present topic regarding the flexibility of the notion of privity of contract.41 The linked contracts mentioned, however, operate in a relatively stable scenario, which contrasts with the everchanging scenario of innovation. Another important contribution is Konder’s book on connected contracts, again referring mainly to linked contracts.42 Similarly, Marino’s book on connected contracts also focuses on linked contracts.43 Notably, he distinguishes the concept of connected contracts from the notion of networks of contracts, demonstrating that the relevance of his contribution is limited for the purposes of the present study. Finally, Fernandes has analysed the status of the principle of contractual privity in linked contracts under Brazilian law,44 arguing that it has been considerably relaxed. Macedo’s book, introducing Macneil’s concept of relational contracts in Brazilian law,45 recognises that flexible specialisation creates the need to adapt contract law to different forms of production, typically organised through networks of contracts.46 He claims that the concept of relational contract, applying the principle of good faith, could provide incentives to develop trust relationships to boost cooperative production.47 He acknowledges, however, 37 Ch 1, section B.ii. 38 R Leonardo and A Tomasetti Junior, Redes Contratuais No Mercado Habitacional (Revista dos Tribunais 2003). 39 ibid 78. 40 R Leonardo, ‘A Teoria Das Redes Contratuais e a Função Social Dos Contratos: Reflexões a Partir de Uma Recente Decisão Do Superior Tribunal de Justiça’ (2005) 832 Revista dos Tribunais 100. 41 The construction company and the financial institution are jointly liable for an economic operation to facilitate to consumers the acquisition of housing units, even if the financial institution did not contract directly with the consumer. Superior Court of Justice, Special Appeal 316.640, Third Chamber, Justice Nancy Andrighi, judged on 18 May 2004. 42 C Konder, Contratos Conexos – Grupos de Contratos, Redes Contratuais e Contratos Coligados (Renovar 2006). 43 F Marino, Contratos Coligados No Direito Brasileiro (Saraiva 2009). 44 M Fernandes, Contratos: Eficácia e Relatividade Nas Coligações Contratuais (Saraiva 2014). 45 R Macedo, Contratos Relacionais e Defesa Do Consumidor (2nd edn, Revista dos Tribunais 2006). 46 ibid 145. 47 ibid 187–88.

The Legal Doctrine  125 that this approach depends on empirical studies on specific industries analysing the meaning of good faith in practice.48 His perspective, however, does not discuss how relational contracts could be applied in the realm of contractual networks. More recently, De Nardi49 published a book analysing the evolution of the concept of contract, considering how the phenomenon of contractual networks altered the classical concept of contract. His concept of contractual networks, however, refers mostly to linked contracts. Rizzardo Filho’s book on contractual networks is much closer to the topic of this work. He deals with networks between companies that seek to achieve a common goal by cooperating in a common project, analysing how these kinds of venture have become prominent in the new economy.50 He analyses such networks from the perspective of autopoietic theory, claiming that the particularities of networks of companies ‘irritate’ the legal system and require a legal adaptation to the peculiarities of these kinds of business.51 He emphasises the importance of coordination and governance mechanisms in these relationships.52 He lists six kinds of typical contracts in Brazilian law that are used as a basis to form contractual networks (ie, franchising and agency), apart from other atypical agreements. His book focuses on analysing Brazilian judicial decisions regarding franchising, identifying their shortcomings in understanding the economic and business rationale of contractual networks.53 Many aspects of his work are relevant for this book. For instance, he claims that a franchiser that does not deliver to the franchisees a report containing information about the functioning of the network is undertaking a significant violation – more than acknowledged by Brazilian courts.54 For him, such information is crucial for the proper functioning of the system created by the network. Similarly, he claims that the franchiser, as leader and coordinator of the network, is seriously undermining the franchise if he fails to duly standardise information about the know-how, methodology and manuals and to provide such materials to the franchisees.55 The crucial difference between his work and this book is that the networks he examines involve neither pervasive uncertainty nor actual co-creation of some output. There is, indeed, a need for coordination between the performance of the parties in the franchising, but what he seems to describe in most cases is

48 ibid 187–88. 49 M De Nardi, Redes de Contratos: Em Perspectiva de Interpretação Sistêmica (Verbo Jurídico 2015). 50 A Rizzardo Filho, Redes Empresariais e Organização Contratual Na Nova Economia (Tirant Lo Blanch 2018) 23 ff. 51 ibid 184. 52 ibid 88. 53 See ch 4 in Rizzardo Filho (n 50). 54 ibid 127 ff. 55 ibid 156 ff.

126  Managing the Internal Coordination a situation where the franchiser dominates the relationship, makes the crucial decisions and provides the franchisees with the required technology and knowhow.56 The role of the franchisees is not significant in contributing to generate innovation in the network. The role of the law, rather than aligning incentives toward common learning, focuses on the protection of franchisees against the dominant power of the franchisors. While this theme is pertinent, it does not constitute the core issue in the context of innovation networks – the specification of uncertainty and joint learning. His focus is on networks involving an average level of uncertainty. Additionally, Toledo Da Silva’s book, focusing specifically on practices in the construction industry, examines collaborative alliance contracts performed between firms in Brazil, Australia and New Zealand.57 He proposes that, in construction alliance agreements, the main function of the contract is not to establish punitive sanctions for the potential violation of the agreement, but rather to create incentives to cooperation. Based on the studies of Gilson, Sabel and Scott, he endorses the claim that low-powered enforcement should be adopted in the context of these agreements to avoid the crowding-out effect and further argues that these contracts combine formal and informal incentives. Through surveys conducted with professionals working on Brazilian, Australian and New Zealand companies performing such kinds of alliance agreement, he found evidence to support his findings and to describe the different governance strategies employed in the construction industry.58 He provides suggestions on how the legal doctrine should be reshaped to deal with these agreements, claiming that the principle of good faith in this context should acquire a more procedural perspective, similar to a notion of due process.59 Many of his theoretical and doctrinal suggestions seem applicable to collaborative contracting, although there is no focus on the context of high uncertainty. Some suggestions, however, are specific to the construction industry. In summary, in Brazilian doctrine, the concept and role of contractual networks is little explored in contexts of innovation and pervasive uncertainty. D.  The Possibility of Low-Powered Enforcement under English and Brazilian Law In analysing the enforceability of contracts to innovate in general, it is possible to identify three categories of clause in these agreements, each with different degrees of enforceability.

56 eg, ibid 147–48. 57 LT da Silva, Contrato de Aliança: Projetos Colaborativos Em Infraestrutura e Construção (Almedina 2017). 58 See ibid, ch 2. 59 See ibid, ch 4.

The Legal Doctrine  127 The first category refers to aspirational clauses contained in these contracts. For instance, terms describing the objectives of the parties’ collaboration or broad descriptions of the expected innovative output (which cannot be described in detail at the relationship’s outset), often contained in Memoranda of Understanding (in which they set out the terms of their initial interactions60) or in the agreement’s initial descriptive clauses. These clauses are set to establish the goals guiding the parties’ performance but they are too vague and abstract to be enforceable per se. The high degree of uncertainty regarding the content of the obligation prevents enforceability. The second category refers to precise and clearly enforceable clauses established in agreements to innovate – for example, clauses establishing escalated dispute resolution mechanisms and sometimes precise provisions on profitsharing, termination, liquidated damages and intellectual property, among others. If the agreement establishes that some decision should be undertaken by a steering committee in the contractual network, defining voting rules, these should be enforceable. These terms are sufficiently precise as to allow for enforcement. While the first category of clauses is clearly unenforceable and the second is clearly enforceable, the third category lies in an intermediate point on the spectrum of enforceability. The third category concerns express terms that are vague and difficult to be interpreted in practice, such as clauses containing duties to cooperate earnestly or to make best endeavours towards a certain goal. In civil law systems, such as French law, they could be classified as ‘obligations of means’ instead of ‘obligations of result’, as they impose ‘a duty to engage in the promised activity but not to bring the contemplated result’.61 In the context of innovation contracts, for instance, broad duties often determine that the parties must cooperate to exchange information to perform the collaborative project, but cannot establish precisely ex ante what information should be shared between the parties to move the project forward and what information should be legitimately withheld. This is a borderline category, where it is difficult to determine whether and how this duty to cooperate and share information will be enforceable in practice. This third category is the focus of this section. The law needs to determine whether these express clauses, lacking precision, can be enforced by courts.

60 For a description of the setting of different phases in strategic alliances, see ch 2, section II.B.iii, and GW Dent, ‘Lawyers and Trust in Business Alliances’ (2002) 58 The Business Lawyer 45.; DG  Smith, ‘The Exit Structure of Strategic Alliances Symposium: Uncorporation: A New Age’ [2005] University of Illinois Law Review 303.; Gilson, Sabel and Scott, ‘Contract and Innovation’ (n 13) 189–90. 61 The typical examples are the obligations of different professionals (eg, doctors or lawyers), who have an obligation to conduct their activities according to certain standards, but cannot be obliged to guarantee that the expected result will be attained. GH Treitel, Remedies for Breach of Contract: A Comparative Account (Oxford University Press 1988) 9.

128  Managing the Internal Coordination In practice, the parties may design their agreement to indicate whether certain terms are enforceable or not. First, they could expressly indicate in the agreement itself whether the agreement or certain terms are enforceable or simply represent an unenforceable understanding. Second, the parties may divide their collaboration into two different stages: one involving an initial, tentative agreement with few or no enforceable clauses and a subsequent establishing a more formalised and enforceable agreement, after the initial stages of cooperation demonstrate to be promising. An example of this two-stage form of cooperation was presented elsewhere, with the analysis of how Memoranda of Understanding may precede the signature of Joint Development Agreements.62 i.  English Law This section argues that, despite the uncertainty and incompleteness in express but vague contract terms (the third category referred to above), such as duties to cooperate in the contract to innovate, these would be, in many cases, capable of enforcement by English courts through contractual construction which seeks to provide more certainty to these obligations’ content. In a few situations they could be too aspirational and considered unable to create legal relations. Most likely, if enforced, these terms would allow for reliance damages, as prescribed by braiding theory. As further explained, expectation damages would be too speculative to be quantified in the context of innovation. English law has undergone a process of evolution regarding the enforceability of duties of good faith and cooperation. Presently, good faith is a moving area of English contract law,63 but several cases point to a trend towards recognising the enforceability of a duty of good faith in the context of relational contracts, especially when such duties have been expressly inserted by the parties in their agreement.64 As long as there is an objective criterion allowing for uncertainty to be resolved, courts tend to be in favour of enforcing such clauses.65 The traditional view under English law is that contracts lacking the certainty necessary to adjudicate a dispute will be unenforceable.66 The reason for that is that such contracts do not provide the necessary guidelines for a dispute to be adjudicated. The general rule established under Walford v Miles (1992)67 is that agreements to negotiate in good faith are invalid as they lack certainty or predictability and would not provide a sufficient guideline to lead to a reasonable solution. 62 See ch 2, section II.B.iii. 63 N Andrews, Contract Law (Cambridge University Press 2015) 589 ff (on the ‘good faith debate’). 64 LE Trakman and K Sharma, ‘The Binding Force of Agreements to Negotiate in Good Faith’ (2014) 73 The Cambridge Law Journal 598, 628. 65 Andrews (n 63) 90 ff. 66 ibid 88–89. 67 Walford v Miles [1992] 2 AC 128. This approach has been also followed in recent cases, eg Barbudev v Eurocom Cable Management Bulgaria EOOD [2012] EWCA Civ 548.

The Legal Doctrine  129 Even though good faith is not recognised as a general principle under English law,68 ‘English courts can achieve similar results on the basis of the interpretation of particular contracts’.69 In the context of performance, duties of cooperation can be implied into the contract through a process of contractual construction, to ‘supplement the express terms with further implied obligations which support co-operation’.70 Thus, through contractual construction, English courts are able to give some certainty to the content of broad duties of cooperation. Several cases have recognised the possibility of enforcing a duty to negotiate in good faith that can be given a sufficiently certain content in the circumstances, illustrating how this process occurs in practice. In Petromec Inc v Petroleo Brasileiro (2006),71 it was stated in dicta that a clause to negotiate in good faith would be enforceable, distinguishing the case from Walford v Miles (1992) based on two grounds: first, the fact that the parties had expressly included a clause to negotiate in good faith in their contract; and second, the fact that the contract was part of a framework including other several contracts, supposedly making it possible to objectively evaluate, according to the dealings among the parties, what would be good faith in casu. In MRI Trading v Erdenet Mining Corp LLC (2013),72 an agreement that failed to specify particular charges and the shipping schedule was considered sufficiently certain to be enforceable. The Court of Appeal reasoned that the fact that the core issues in the agreement had been agreed and that the issue at stake involved merely a secondary, ancillary agreement, indicated the need to consider the contract enforceable. This was reinforced by the fact that the parties had undertaken substantial performance of the agreement, that the contracts were part of a wider set of agreements already performed (demonstrating the partners’ willingness to be legally bound) and established a machinery for settling disputes. In this situation, the court considered that there was reasonable background allowing implication of terms into the contract. There are other examples where English courts have found negotiating agreements to be sufficiently certain and thus enforceable. In Pitt v PHH Asset Management Ltd (1994),73 a contract containing a lock-out agreement to

68 J Cartwright, Contract Law (Hart Publishing 2013) 63. 69 Collins, Contract Law (n 9) 333. For some, this reflects a greater recognition in English law of the special characters of relational contracts; see D Campbell, ‘Good Faith and the Ubiquity of the “Relational” Contract’ (2014) 77 The Modern Law Review 475, 475–76. 70 Collins, Contract Law (n 9) 333. Collins provides one example of such implied terms of cooperation in the context of an incomplete contract, a requirements contract where the buyer must buy all products produced by the other party. In this situation, this duty must be exercised in good faith, in honesty, within the reasonable expectation of what would be sold to the buyer under the circumstances. ibid 334. 71 Petromec Inc v Petroleo Brasileiro [2006] 1 Lloyd’s Rep 121. 72 MRI Trading AG v Erdenet Mining Corp LLC [2013] EWCA Civ 156; [2013] 1 CLC 423; [2013] 1 Lloyd’s Rep 76. 73 Pitt v PHH Asset Management Ltd [1994] 1 WLR 327.

130  Managing the Internal Coordination negotiate for a specified period of time was deemed valid. Similarly, an obligation to make the best or reasonable efforts in obtaining a permission are also deemed sufficiently valid, as well as an obligation to pursue mediation, as contractually determined.74 Most notably, [t]he notion of good faith is not uncertain if it is linked to (1) a performance obligation, as distinct from (2) a negotiation obligation … it will impose a positive duty to take action consistent with the achievement of the contract’s main purpose; and it will impose a negative duty to refrain from conduct which will stultify that purpose.75

More recent cases have taken an even more expansive view on good faith (both involving ongoing contractual relationships with strong relational aspects). In Yam Seng Pte Ltd v International Trade Corporation Ltd (2013),76 the High Court implied a duty of good faith in a distribution contract, stating that such duty could be implied in fact, but not in law, when there was clear indication that it was necessary to imply such duty to give business efficacy to the contract. The judge claimed that good faith, in this case, represented two things: honesty in performance of the contract and fidelity to the parties’ bargain (promoting values explicit and implicit in the agreement).77 In Al Nehayan v Kent (2018),78 the High Court implied a duty of good faith into an oral joint venture, concluded considering both the fact that the parties to the project had a personal relationship of trust and the ‘relational’ nature of the agreement, requiring, for example, that several decisions on their collaborative venture should be taken between the participants. Leggatt J identified two instances where the defendant’s behaviour violated the appropriate standard of conduct expected in these relational environments: First, it would be inconsistent with that standard for one party to agree or enter into negotiations to sell his interest or part of his interest in the companies which they jointly owned to a third party covertly and without informing the other beneficial owner. Second, while the parties to the joint venture were generally free to pursue their own interests and did not owe an obligation of loyalty to the other, it would be contrary to the obligation to act in good faith for either party to use his position as a shareholder of the companies to obtain a financial benefit for himself at the expense of the other.79

Clearly, there is no attempt to determine precisely what the content is of the duty of good faith, but rather to ‘require a party to refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable 74 Andrews (n 63) 32, 102. For other cases where uncertainty was no obstacle to the enforcement of the agreement, ibid, 90 ff. 75 ibid 34. 76 Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111. 77 H Pugh, ‘An Implied Term of Good Faith: A Watershed or a Damp Squib?’ (2013) 28 Butterworths Journal of International Banking and Financial Law 347. 78 Al Nehayan v Kent [2018] EWHC 333 (Comm). 79 ibid, para 152.

The Legal Doctrine  131 and honest people’.80 In other words, instead of attempting the difficult project of determining what positive actions are required from parties under good faith, this approach simply identifies what things are contrary to good faith under given circumstances. As the cases cited above have demonstrated, there are a number of elements that can be considered in seeking to make these duties of cooperation more concrete, especially past conduct and past performance under the agreement. In the case of contracts to innovate, most circumstances seem to indicate that duties of good faith or express terms of cooperation, even though abstract, would be in many cases enforceable. Even though the continuation of the project should not be imposed because of the need for voluntary participation and trust between the parties for innovation to be successful, courts could still enforce violations to the agreement to innovate by interpreting what these duties mean in each case. Chapter four proposes how violations of duties of cooperation in innovation contracts should be assessed. There are sufficient elements to consider these terms enforceable under English law. First, innovation is often structured through a contractual framework, as examined in chapter two, involving different kinds of governance mechanisms, established through either bilateral connected contracts, multiparty agreements or a combination of both. The existence of a wider set of contextualising agreements and mechanisms contributes to provide more certainty to the agreement, pointing towards the enforceability of duties of cooperation (see MRI Trading and Petromec). Second, these agreements anchor projects involving significant relational elements: the parties have a strong working relationship and mechanisms institutionalising cooperation and trust. These institutional and relational elements contribute to specify these cooperation duties. Third, once a potential violation of duties of cooperation has to be assessed in these agreements, the contract is on the course of performance. This existent performance and behaviour of the parties provides a guideline to examine, based on the reality of their relationship, whether a violation has occurred. In summary, duties of cooperation, in many cases, can be interpreted to determine whether a lack of earnest cooperation generated a contractual violation. Regarding the form of enforcement of these clauses, reliance damages would most likely be awarded for these violations under English law. English law does not contemplate claims for the specific performance of obligations to supply personal services or to maintain personal relationships for which the existence of trust is paramount for the success of the relationship.81 Conceptually, obligations of means, unlike obligations of result, are not

80 ibid. 81 H Beale (ed), Chitty on Contracts, Vol 1, General principles (32nd edn, Sweet & Maxwell 2015) 27–027 and 27–025.

132  Managing the Internal Coordination subject to specific enforcement. Specific performance is a very narrow remedy in English law, mostly applicable in situations where damages would be clearly an inadequate remedy.82 There are three main kinds of agreement where specific performance is the primary remedy to be obtained: agreements for transfer of land, for transfer of shares in private companies and to enforce contractual obligations to disclose information or materials for inspection.83 This result is compatible with braiding theory’s rejection of specific performance. In collaborative relationships, especially innovative ones, involving high uncertainty, the success of the endeavour is dependent on a relationship of mutual trust between the parties. Without that trust, the achievement of collaborative innovation is improbable, and will hardly be achieved through a court imposing upon the parties the continuation of the relationship. Furthermore, expectation damages would likely not be awarded because they would be too speculative to quantify in the current context.84 The only way to remedy the broken-down relationship would be, in most cases, to collect the reliance damages for the lost investments. ii.  Brazilian Law Under Brazilian law, duties of cooperation in contracts to innovate, despite their uncertainty, could be considered enforceable in cases where it is possible, through contractual interpretation, to ascribe to them a practical content. Most likely, reliance damages would be granted for the violation of these duties under the protection of reliance, a principle deriving from the conjunction of the objective good faith principle with abuse of rights provision (Art 422 in conjunction with Art 187 Brazilian Civil Code).85 There would be no need for any legal reform to adjust Brazilian law to ‘low-powered enforcement’, only the need to clarify doctrinally the specificities of these kinds of relationship. Likewise, under Brazilian law, abstract duties of cooperation or good faith would raise the issue whether they are enforceable under Art 104(II), Brazilian Civil Code, which states that the ‘validity of a legal transaction depends … on its subject matter being … determined or determinable’. Regarding preliminary agreements or memoranda of understanding, Pontes de Miranda considers that ‘without agreement on all points raised or on all points needed for the conclusion of a legal transaction, no legal transaction has been concluded’.86 That does not mean, however, that these documents might not be used for evidentiary purposes, making possible for contractual interpretation to give practical meaning to abstract cooperation duties.

82 Andrews (n 63) 525. 83 ibid. 84 ibid 492, 497. 85 Ch 3, section II.B.i and ii. 86 F Pontes de Miranda, Tratado de Direito Privado, Tomo XXXVIII (Revista dos Tribunais 2012) 187.

The Legal Doctrine  133 Indeed, it is questionable to what extent the gaps left in a contract to innovate could not be read into the agreement by a court. In Brazilian law, it is considered that one of the functions of the principle of good faith is to read into the agreement accessory obligations, not explicitly established by the parties, but necessary to attain the successful obligation of the relevant performance.87 This possibility could be also envisaged through an ‘integrative contractual interpretation’, which considers not only the express contractual terms, but the objective of the transaction undertaken by the parties.88 Once again, the same obstacles subsist to imply terms to this relationship in Brazilian law: there is too much uncertainty and no previous guidance to determine how a project to innovate should continue. Thus, it would be very unlikely that a court would fill its gaps and enforce implied terms. If the contract contains other obligations that are specified and unrelated to the collaboration to innovate, those will remain enforceable, but the duty to cooperate to generate innovation cannot be used to force the continuation of the relationship. Nonetheless, it is possible that the violation of a duty to cooperate to innovate in an incomplete contract would amount to a violation to the principle of objective good faith. Good faith extends, according to the legal doctrine, to the pre-contractual phase of negotiations, especially for unjustified breach of negotiations, for the violation of cooperation duties or duties to exchange information.89 It must be also emphasised that the baseline principle in Brazilian law is that preliminary negotiations create an intermediate environment between a contractual relationship and a relationship where no ‘social contact’ exists between the parties, being potentially subject to tort law.90 In this intermediate sphere, there is a certain amount of vulnerability, trust and fidelity that should be taken into consideration. According to the legal doctrine, violations of duties of cooperation in this intermediate sphere should be compensated.91 The Brazilian case law has recognised this duty to compensate potential breaches in the pre-contractual phase, based on an interpretation of the principle of objective good faith (Art 422 Civil Code), with the provision on abuse of rights (Art 187) and with the provision requiring that violations of obligations in general should be compensated (Art 389). This form of enforcement has been applied to situations where one contractual partner has unjustifiably cancelled negotiations after providing objective indications that a certain business deal would be concluded; for providing incorrect information in the pre-contractual negotiations, or maliciously seeking to give a false impression 87 O Gomes, Contratos (26th edn, Forense 2008) 44–45. 88 Pontes de Miranda (n 86) 162 ff. 89 Gomes (n 87) 45. 90 J Martins-Costa, ‘Um Aspecto Da Obrigação de Indenizar: Notas Para Uma Sistematização Dos Deveres Pré-Negociais de Proteção No Direito Civil Brasileiro’ (2012) 867 Revista dos Tribunais 11, 11, 13–14. 91 ibid 14–15.

134  Managing the Internal Coordination to its contractual partner about a certain aspect of the negotiation or by failing to maintain secrecy about confidential information, for instance.92 The same principle of protection of reliance in preliminary negotiations could be extended to contracts for innovation, where the parties use the contract as a ‘guiding plan’, but not as an enforceable instrument of the final performance planned under the agreement. If there is a violation of the duties inserted in the agreement (see chapter four), reliance damages should be collected.93 This principle allows for ‘low-powered enforcement’ in Brazilian law without the need for legal reform. It is necessary, however, to clarify the nature of contracts to innovate as legal instruments that, despite often not creating an enforceable obligation for cooperation to be sought until a final innovative output is produced, creates the possibility of a compensation for violation of cooperation duties through reliance damages. E.  The Legal Concept of Relational Contract in English Law As mentioned before, vague clauses in incomplete contractual agreements to innovate may be enforceable under English law, particularly if these agreements contain express good faith terms and are considered to be ‘relational contracts’. Despite this reference, the category of relational contracts is often considered to be too vague and abstract to embody a fully fledged legal concept. This section examines the recent theorising and case law about relational contracts in the UK, especially the claim that there is a rising, albeit infant, legal concept of relational contract in English law. This discussion is relevant to examine the proposition that contracts to innovate could be subject to a different form of contractual interpretation, particularly because they could be classified under the category of relational contracts. Initially, it is necessary to make a distinction between the claim that the spirit of English contract law has become more contextualist (and even ‘relational’) from the idea that there is a specific legal concept of ‘relational contract’, to which certain consequences and a particular form of interpretation should be attached. While the generalist idea of a ‘relational’ contract law could facilitate a contextualist interpretation of contracts for innovation, it would not provide particular doctrinal guidelines as to what kinds of agreement would qualify as relational contracts and what legal consequences would ensue.

92 ibid 29 ff. 93 Brazilian legislation and legal doctrine do not commonly present the distinction between positive and negative interest regarding the valuation of damages. Nonetheless, in practice, the violation of a pre-contractual duty will be likely recovered through reliance damages. See RC Steiner, ‘Interesse positivo e Interesse negativo: a reparação de danos no direito privado brasileiro’ (PhD Thesis, Universidade de São Paulo 2016) 325–26; see www.teses.usp.br/teses/disponiveis/2/2131/ tde-20082016-121314/.

The Legal Doctrine  135 From the point of view of comparative contract law, there is a recurrent narrative that there has been a transition from a classical and formalistic version of contract law to a more social and contextualist version. In common law jurisdictions, Atiyah has written about the ‘Rise and fall of freedom of contract’94 and Gilmore about the ‘Death of contract’.95 In the civil law world, the legalhistorical account of Wieacker refers to the rise of solidarity in the market economy96 and Zimmerman and Whittaker claim that the prevalence of the principle of freedom of contract seems to be giving way to a growing role for the notion of reliance and reasonable expectations of the contractual parties.97 This is not a linear narrative, however. Textualism and contextualism and other ‘ideologies’ in contract law seem to be in a constant tug-of-war, with ebbs and flows.98 In this context, Jamin contends that there has been a hypertrophy of the principle of good faith99 and Feinman warns about the ‘conservative campaign to roll back the common law’.100 Besides, Duncan Kennedy defends that, after a period of rise of the social, we are now in the Third Globalization of Law, where elements of both classical and social law coexist in an unsynthesised manner in different scenarios.101 In different jurisdictions, textualism and contextualism are in a constant battle. The English context presents a particularly nuanced history, where, nonetheless, the notion of contextualism in contract law seems to be on the rise. It is common to hear the narrative that English law does not have a general principle of good faith (in contrast with many other jurisdictions)102 and that the paradigm of English contract law is based on the model of a one-time ‘snapshot’ discrete contract, ‘moving from no contract to completed contract’,103 not modelled to consider the relational elements existing in a long-term contractual relationship, all of this potentially indicating a more formalist contract law. After all, the notion of good faith (as well as concepts such as ‘best efforts’) is considered, in relational contract theory, to be a concept closer to a relational

94 PS Atiyah, The Rise and Fall of Freedom of Contract (Oxford University Press 1985). 95 G Gilmore, Death of Contract (RKL Collins ed, 2nd edn, Ohio State University Press 1995). 96 F Wieacker, A History of Private Law in Europe: With Particular Reference to Germany (T Weir trans, 1st edn, Clarendon Press 1996) 434 ff. 97 R Zimmerman and S Whittaker, Good Faith in European Contract Law (Cambridge University Press 2000) 700. 98 R Brownsword, Contract Law: Themes for the Twenty-First Century (2nd edn, Oxford University Press 2006) 165. 99 C Jamin, ‘Quelle nouvelle crise du contrat?’ in C Jamin and D Mazeaud (eds), La nouvelle crise du contrat (Dalloz 2003) 14. 100 JM Feinman, Un-Making Law: The Conservative Campaign to Roll Back the Common Law (Beacon Press 2005). 101 D Kennedy, ‘Three Globalizations of Law and Legal Thought: 1850–2000’ in D Trubek and A Santos (eds), The New Law and Economic Development: A Critical Appraisal (Cambridge University Press 2006) 63. 102 E McKendrick, Contract Law (11th edn, Palgrave 2015) 217–18. 103 S Mouzas and M Furmstom, ‘From Contract to Umbrella Agreement’ (2008) 67 The Cambridge Law Journal 37, 37.

136  Managing the Internal Coordination approach of contracts, as it distances itself from the premise of discrete contractual models, which are promise-based.104 Yet, from the mid-twentieth century, and especially from the early 1990s, with Lord Hoffmann’s decisions at the Supreme Court – particularly Investors Compensation Scheme Ltd v West Bromwich Building Society (1997),105 English contract law has seen a marked turn towards contextualism.106 This development is acknowledged not only by scholars who (to different degrees) defend a more contextualist interpretation of contract law such as Brownsword,107 Campbell,108 Collins109 and Wightman,110 but also – at least to a certain extent – by authors who defend a more neo-classical or neo-formalist position. According to Morgan, The English law remains broadly formalist … This is nowhere truer than the law of contract … However, this desirable trait has arguably declined from the midtwentieth century. As we will describe below, the English courts have loosened clear-cut common law doctrines in favour of those requiring considerable discretion in application in areas as diverse as formation, interpretation and even duress. Statutory incursions have been worse and not limited to consumer contracts (which fall outside our present concern with commercial law). Treitel’s inaugural lecture expressed concern about growing statutory discretion in the heartlands of contract. Brownsword’s examination of the current ‘themes’ of contract law finds fairness and reasonableness as pervasive values. Ibbetson’s historical account examines the rise of ‘legal regulation and contractual fairness’ conducing that at the end of the twentieth century: ‘No longer could it be said without considerable qualification that contract law was based on the assumption that effect should be given to the agreement of the parties.’ Such comments show an urgent need for a restatement of English law, championing the classical values of formal certainty and minimal intervention that have made it such a global success. The creep of contextualism, discretion and regulation threatens that reputation.111

104 I Macneil, ‘Relational Contract: What We Do and Do Not Know’ (1985) 1985 Wisconsin Law Review 483, 498. 105 Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] UKHL 28. 106 For a genealogy of the rise of contextualism in English contract law, including the relevant case law, see J Wightman, ‘Contract in a Pre-Realist World: Professor Macaulay, Lord Hoffmann and the Rise of Context in the English Law of Contract’ in WC Whitford, J Kidwell and J Braucher (eds), Revisiting the Contracts Scholarship of Stewart Macaulay: On the Empirical and the Lyrical (Hart Publishing 2013) 383 ff. He particularly claims that there are two strands in contract law where the development of contextualism is notable: in the construction of the express terms of an agreement; and in the consideration of the commercial setting as a criterion to limit the amount of damages due in a certain dispute. 107 Brownsword (n 98) 148. 108 D Campbell and H Collins, ‘Discovering the Implicit Dimensions of Contracts’ in D Campbell, H Collins and J Wightman (eds), Implicit Dimensions of Contract: Discrete, Relational, and Network Contracts (Hart Publishing 2013). 109 ibid. 110 Wightman (n 106) 383 ff. 111 J Morgan, Contract Law Minimalism: A Formalist Restatement of Commercial Contract Law (Cambridge University Press 2013) 218–19.

The Legal Doctrine  137 For Wightman, Lord Hoffmann’s decisions would advance a particular form of ‘extended’ objective approach in contract law.112 A first objective and ‘contextualist’ approach would have been advanced by English commercial lawyers that pressed courts for the need to take into consideration the context by looking into the commercial practices and understandings when making decisions. Wightman submits that Lord Hoffmann’s decisions represent a turn to an extended objective approach to contracts, where context is not only to be considered but can even become the prime consideration in deciding certain cases, bringing English contract law closer to the notion of a relational contract law.113 The defenders of neo-formalism do not deny the existence of relational contracts as a socio-legal category. They do challenge, however, the position that the legal rules and legal interpretation should be adapted to facilitate co-operation in such situations.114 Their main concern is that courts lack the expertise to provide adequate responses to certain complex commercial challenges and to understand the parties’ contractual intent – undermining the economic efficiency of contract law.115 The contextualist approach would enhance uncertainty, cost and difficulties. It would be preferable to have the parties themselves allocate risks through the agreement and to have clear and safe formal default contract law rules, to be interpreted literally by courts that ‘decline the invitation to complete the contract’.116 Such an approach would generate predictability over the potential outcomes of contractual conflicts that may arise among them. Legal predictability is, for neo-formalism, the principal concern, and the solution is to prevent courts’ indiscretions by barring invasive ‘contextualist’ forms of interpretation. Contractual contextualism evokes Macaulay’s stand that there is a difference between the real deal and the paper deal and advances that the law cannot ignore this gap.117 The formal contract law rules are not only unknown to many businesspeople but sometimes even seen as inadequate to deal with contractual contingencies. More than that, contextualism claims that the understanding of a contract depends fundamentally on grasping the context, the ‘implicit understandings’ that can provide particular meanings for relationships in different sectors of the economy and amid distinct contracting communities.118 Contextualism purports not to be a form of welfarism, but a serious attempt to 112 Wightman (n 106) 378–79. 113 ibid 395 ff. 114 Morgan (n 111) 69–70. 115 RE Scott, ‘The Case for Formalism in Relational Contract’ (2000) 94 Northwestern University Law Review 847, 875–76. 116 ibid 859–60. 117 S Macaulay, ‘The Real Deal and the Paper Deal: Empirical Pictures of Relationships, Complexity and the Urge for Transparent Simple Rules’ in H Collins, D Campbell and J Wightman (eds), Implicit Dimensions of Contract: Discrete, Relational and Network Contracts (Hart Publishing 2003). 118 H Collins, ‘Introduction: The Research Agenda of Implicit Dimensions of Contracts’ in H Collins, D Campbell and J Wightman (eds), Implicit Dimensions of Contract: Discrete, Relational and Network Contracts (Hart Publishing 2003) 8–9.

138  Managing the Internal Coordination understand what was agreed in reality by the parties. In that sense, Brownsword defends that, in interpreting the concept of reasonableness in contract law, there are two potential perspectives: a static and a dynamic market-individualist ideology approach.119 The former seeks to ‘constitute’ the market by establishing a set of formal and predictable default rules that can provide the parties with stability in their commercial relationships – even if that may mean that the formal rules are not in accordance with commercial reality. The latter seeks to apprehend what is actually happening in the commercial practice and what are the legitimate expectations of businesspeople and to make a judgment based on that.120 This dynamic market-individualist perspective, which for Brownsword is on the rise in English contract law,121 would be coherent with a relational and contextualist perspective of contract law. The broader claim that English contract law is acquiring an increasingly contextualist or relational approach, is connected but distinct from the idea that there is a legal concept of ‘relational contract’ to which particular consequences are attached. In the writings of Macneil, there is no clearly defined concept of ‘relational contract’, but as aforementioned, the description of a spectrum ranging from contracts with discrete to more relational elements.122 But relational elements are to be found in all contractual relationships, even in those closer to the discrete pole. Apart from that, one of the common criticisms against relational contract law is its lack of clear directives or a legal doctrine to govern those relationships, apart from a general advice to take the relational context into account. In English law, particularly, the discussion about a legal concept of relational contract is not a novelty. In the past, McKendrick affirmed that ‘English law would not be justified in taking the step of recognising the existence of a formal category of relational contracts’,123 an approach that was followed in Baird Textile Holdings Ltd v Marks & Spencer plc (2001).124 Later, Campbell diverged from this position, stating ‘that this step should be taken is so obvious that the failure to do so is the principal cause of discontent in the current teaching of contract’.125 For him, the concept of relational contract would be crucial to understand even settled doctrinal issues in English contract law. For instance, he claims that the decision to consider enforceable an additional payment to the subcontractor in Williams v Roffey Bros & Nicholls (Contractors) Ltd (1989)126 only makes sense if this is considered to be a distinct ‘relational agreement’

119 Brownsword (n 98) 137. 120 ibid 138 ff. 121 ibid 165. 122 See ch 1, section I.B.i. 123 E McKendrick, ‘The Regulation of Long-Term Contracts in English Law’ in J Beatson and D Friedman (eds), Good faith and fault in Contract Law (Clarendon Press 1997) 323. 124 Baird Textile Holdings Ltd v Marks & Spencer plc [2001] EWCA Civ 274. 125 Campbell (n 69) 478. 126 Williams v Roffey Bros & Nicholls (Contractors) Ltd [1989] EWCA Civ 5.

The Legal Doctrine  139 (under Macneil’s perspective), based on mutual trust and confidence, where the parties should try to adjust performance as their relationship unfolds.127 More recently Hugh Collins has argued that there is a growingly discernible – although still incipient – legal concept of relational contract being developed in English law for commercial cases, with definite legal consequences.128 Collins bases his assertion on three English contract law cases in which the High Court has expressly mentioned the concept of ‘relational contract’. Collins’ argument is reinforced by at least two additional, more recent judgments: the aforementioned case Al Nehayan v Kent and Bates v Post Office Ltd (No 3) [2019].129 In the words of Collins, The trilogy of cases suggests that the idea of a relational contract is a legal concept in the sense that the judges have in mind a descriptive paradigm of a relational contract, and, having identified the existence of a relational contract, they are prepared for that reason to imply contractual obligations such as duties of fair dealing, good faith, and mutual trust and confidence.130

Yam Seng has already been mentioned and the specifics of the case are further discussed in chapter four, section I.C. A crucial statement in this case, where an implied duty of good faith was found by the court due to the relational nature of the agreement, is that relational contracts, as they are sometimes called, may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and involve expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements.131

Bristol Groundschool Ltd v Intelligent Data Capture Ltd (2014)132 is the second case mentioned by Collins. It deals with a particular form of joint venture between the claimant, who developed and commercialised training material for pilots, and the defendant, who digitalised this material and added functionalities. After the parties’ commercial relationship started to become unsustainable, the claimant secretly accessed the defendant’s database to download digital files and, later, contacted another supplier with this material to continue developing the digital version of its products. The judge in the case held that this conduct breached an implied duty of good faith in performance typical of this ‘relational’ agreement. Spearman QC considered that this was a relational contract having in view the ‘long-term relationship, to which the parties had both made

127 Campbell (n 69) 478 ff. 128 H Collins, ‘Is a Relational Contract a Legal Concept?’ in S Degeling, J Edelman and J ­Goudkamp (eds), Contract in commercial law (Thomson Reuters 2016). 129 Bates v Post Office Ltd (No 3) [2019] EWHC 606 (QB). 130 Collins, ‘Is a Relational Contract a Legal Concept?’ (n 128) 43. 131 Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111, para [142]. 132 Bristol Groundschool Ltd v Intelligent Data Capture Ltd [2014] EWHC 2145 (Ch).

140  Managing the Internal Coordination financial commitments and in the evidence of the parties during the trial it was acknowledged that they needed to act towards each other in a trustworthy and honest way’.133 The third case is D&G Case Ltd v Essex Police Authority (2013),134 involving a franchise contract through which the police authority granted an exclusive licence to a private contractor to dispose of cars apprehended by the police. Instead of destroying the apprehended cars according to the instructions of the police, it was discovered that the defendant was using parts of these cars for its own commercial purposes, concealing that by transferring the chassis and damaged parts of the vehicle to another one. In the analysis of the case, Dove J considered this agreement to be a ‘relational contract par excellence’. Based on that analysis, the court implied a term in this long-term agreement for the parties to act ‘with honesty and integrity in operating the contract’. The defendant was found to be in breach of the agreement not only for disregarding the instructions of the claimant, but also for pursuing a behaviour that is ‘inconsistent with the maintenance of the long-term relationship’. Besides the three cases mentioned by Collins, two additional ones deserve to be mentioned. One of them is Al Nehayan v Kent (2018), previously described. Legatt J implied a duty of good faith in this agreement because it constituted a relational contract – a joint venture and long-term co-investment agreement among the parties in a luxury hotel business and, later, in an online business service. Legatt J referred that relational contracts involve a particular form of trust and confidence ‘that the other party will act with integrity and in a spirit of cooperation’.135 Besides mentioning the three decisions referred to by Collins on which the High Court has mentioned a legal concept of relational contract, this decision also refers to decisions where no duty of good faith was implied because the relevant agreements in the envisaged cases were not considered to be relational contracts: There are other cases in which the implication of a duty of good faith has been rejected on the ground that the contract in question was not a relational contract. For example, in National Private Air Transport Services Co v Windrose Aviation Co [2016] EWHC 2144 (Comm), at paras 133–136, Blair J found (unsurprisingly) that an aircraft lease was not a relational contract and that no duty to act in good faith was to be implied into an obligation to redeliver the aircraft. But the judge also rejected an attempt to cast general doubt on the approach suggested in the Yam Seng case. Furthermore, in Globe Motors v TRW Lucas Varity Electric Steering Ltd [2016] EWCA Civ 396, [2016] 1 CLC 712 at para 67, Beatson LJ in the Court of Appeal endorsed the view that, in certain categories of long-term contract of the



133 Collins,

‘Is a Relational Contract a Legal Concept?’ (n 128) 41. Case Ltd v Essex Police Authority [2013] EWCA Civ 514. 135 ibid, para [167]. 134 D&G

The Legal Doctrine  141 kind mentioned in the Yam Seng case, courts may be more willing to imply a duty of good faith – which he characterised essentially as a duty to cooperate.136

The second additional case to be mentioned, reflecting a crystallisation of the legal concept of relational contracts in English law, is Bates v Post Office Ltd (No 3) (2019). This judgment constitutes one of a series of decisions in an ongoing group litigation involving the Post Office, as defendant, and 550 claimants, most of them subpostmasters of the Post Office. The subpostmasters operated branches of the Post Office in different parts of the UK, performing a varied range of services. They were required by the Post Office at the time to use a version of a computerised system called Horizon to perform the accounting both in the branches and between the branches and the Post Office itself. The claimants alleged that Horizon contained a number of software coding errors, bugs, defects that generated distortions in the accounting undertaken by the branches with the Post Office. The Post Office, as defendant, claimed that the subpostmasters were responsible for these distortions, either due to mistake or to dishonesty. In most cases, the claimants were asked to and had to pay the supposedly additional amounts to the Post Office, even though they did not recognise that their accounting was flawed. This ongoing dispute involves a series of judgments due to the high number of litigants and to the complexities of the case (particularly the technical aspects of the Horizon system). The specific decision dealt with in this book involves a number of substantial common issues relevant to the dispute, among them the issue of whether the contracts between the Post Office and the claimants should be considered relational contracts to which a duty of good faith should be implied. After analysing a considerable list of English judicial precedents either applying or referring to the concept of relational contract, Fraser J came to the conclusion that ‘the concept of relational contracts is an established one in English law’.137 In his words, there is a specie of contracts, which are most usefully termed ‘relational contracts’, in which there is implied an obligation of good faith (which is also termed ‘fair dealing’ in some of the cases). This means that the parties must refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people. An implied duty of good faith does not mean solely that the parties must be honest.138

Fraser J identifies a number of indicative and non-exhaustive criteria that would suggest the existence of relational contract under English law, such as the commitment to collaboration, the impossibility of exhaustively e­ stablishing

136 ibid,

para [170]. v Post Office Ltd (No 3) [2019] EWHC 606 (QB), para 705. 138 ibid, para 711. 137 Bates

142  Managing the Internal Coordination the objectives of the cooperation in the contract, and ‘high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty’.139 In any case, ‘[t]he circumstances of the relationship, defined by the terms of the agreement, set in its commercial context, is what decides whether a contract is relational or not’.140 Under the circumstances, Fraser J found that that the contracts of the Post Office with claimants could be considered relational contracts, requiring the implication of a duty of good faith and, as a consequence, many of the particular terms raised by the claimants. According to Collins, the legal concept of relational contract emerging out of these cases involves three features.141 First, a long-term contract in which the parties are unable to specify their obligations, resulting in an indeterminacy of the performance obligations. Second, a commitment to the continuous and cooperative adaptation of the parties’ obligations to the business relationship, materialised in a number of indeterminate clauses of cooperation and good faith. Third, these obligations are not to be understood as deriving from a duty of honesty or reciprocity, but from ‘general concepts of co-operation and loyalty or commitment to the project’.142 Contracts for innovation fit the general features that Collins ascribes to the emerging concept of relational contract in English law. However, they do not necessarily involve long-term agreements, even though they have a significant level of indeterminacy. As relational contracts, they involve duties of cooperation to attain the objective of the deal. The main consequence of classifying a contract as relational, according to Collins, is to follow a contextualist approach in the interpretation of relational contracts, to ‘search the context for additional obligations that the parties recognize implicitly in their dealings but have not included in the contract’.143 He rightly rebukes the formalist argument in this particular context, according to which courts have no knowledge and expertise to imply terms into agreements and that it would be better to let the parties design their agreement to address any potential issues.144 In the context of relational contracts, there is inherent uncertainty preventing the parties from doing so, thus the parties themselves often include in the agreement clauses of good faith or clauses mentioning that the parties should perform the contract with a cooperative spirit and trustworthy behaviour. Based on that, duties are normally implied to allow the aggrieved party to justify a repudiatory breach. In the context of contracts for innovation, these observations seem to be even more relevant. The kind of pervasive uncertainty present in contracts for

139 ibid,

para 725–26. para 721. 141 Collins, ‘Is a Relational Contract a Legal Concept?’ (n 128) 52 ff. 142 ibid 55. 143 ibid 56. 144 ibid 56–57. 140 ibid,

Duties of the Members of the Network  143 innovation is even higher than the average level of risk present in many relational contracts. Furthermore, these duties, as argued before, have the sole objective of determining whether a violation of the agreement has occurred and whether reliance damages should be awarded for that potential violation. They should not give rise to implied duties to force the parties to continue cooperating. Therefore, the legal concept of relational contract that seems to be gradually emerging in English law – although still in embryonic form – could present a promising framework under which contracts for innovation could be interpreted and have duties of cooperation enhanced. The continued development of the legal concept of ‘relational contract’ in English law would be welcome from this point of view. Nonetheless, it still seems that a more particular categorisation of agreements to innovate – as particular forms of relational agreement – would be beneficial, for the reasons advanced in chapter one. One of them would be the development of a duty of loyalty to the collaborative project or to the network as a particular interpretative guideline applicable to these agreements. II.  DUTIES OF THE MEMBERS OF THE NETWORK: THE PROPOSAL OF A DUTY OF LOYALTY OR SINCERE COOPERATION TOWARDS THE NETWORK

Initially, it is important to clarify that, in a contractual network involving multiple parties, the ‘nodes’ of the network (as opposed to the centre of the network, which may be, for instance, the leading company or a steering committee making decisions for the overall network) owe two kinds of duty.145 First, as developed below, there is a duty of loyalty of the members towards the overall network, where the parties have to take into consideration the overall purpose of the network in each of the different contractual relationships to which they engage within the network. The different ‘nodes’ of the network must behave in accordance with the purpose of business to which they have subscribed and, in certain situations, that may signify the intensification of duties of cooperation. Second, the different members of the network (or ‘nodes’) have bilateral relationships among them that may not necessarily affect the network purpose. In those situations, in many jurisdictions – particularly in civil law countries – the  parties will owe to each other traditional good faith duties, less intense than loyalty duties towards the network. In other jurisdictions, the relationship among the network nodes will be more adversarial, or at least present a more nuanced application of the good faith principle. Regardless of their commitment to the overall network, the parties continue to owe the traditional duties among each other that may be required under the relevant jurisdiction.



145 G

Teubner, Networks as Connected Contracts (Hart Publishing 2011) 185.

144  Managing the Internal Coordination A.  The Proposal and the Justification of a Duty of Loyalty or Sincere Cooperation towards the Network This section discusses the concept of a duty of loyalty or sincere cooperation to the contractual network/collaborative project as a potential contractual interpretative guideline in these relationships. This guideline could serve to shed light on whether a violation to the abstract and vague duties established in a contract to innovate occurred. It is not about implying terms, but rather interpreting these abstract duties in light of the specificities of contracts to innovate. This study does not propose to rethink the basic principles of contract law for that purpose, but rather to rethink how the current legal framework and its principles should be applied contextually to deal with networks to innovate. Such a duty of loyalty to the network/collaborative project could serve as an interpretative guideline for this context but should be further refined and differentiated from other legal constructs. Teubner advanced this concept, where duties of cooperation and good faith are potentially intensified146 in some circumstances but not in all. The nature of collaborative relationships to innovate presents a need to balance the parties’ allegiance to the purpose of their common project with the freedom to pursue their individual interests. Justifications for this principle could resort to different values under different normative theories: efficiency, fairness, good faith and private autonomy.147 Perhaps a better approach would be to consider that a duty of loyalty to the network should be based on the need to give legal effectiveness to the parties’ evolving expectations in this specific kind of business arrangement (but not necessarily to the formal words in their agreement, which is inherently incomplete). The parties have concluded a form of business agreement where a constant tension prevails between individual and collective aims; whether one or the other should prevail should depend on the maximisation of the interests of the network, to be analysed contextually. Contextualism is often connected with the pursuit of distributive goals, but it also ‘contributes to the constructions of markets and a vibrant economy’,148 especially amid high uncertainty. In this case, what is required is a form of ‘institutional contextualism’, which employs governance mechanisms (or some contextualising regime) to be effective, collecting through them information necessary

146 ibid 184–86; also considering the importance of a duty of loyalty in the contractual network, see E Weitzenboeck, A Legal Framework for Emerging Business Models – Dynamic Networks as Collaborative Contracts (Edward Elgar 2012) 318 ff; F Cafaggi, ‘Organizational Loyalties and Models of Firms: Governance Design and Standard of Duties’ (2005) 6 Theoretical Inquiries in Law 463, 518 ff (focusing on loyalty inside networks of small and medium companies); Collins, ‘Introduction to Networks as Connected Contracts’ (n 33) 14–15, 43 ff. 147 A Schwartz and R Scott, ‘Contract Theory and the Limits of Contract Law’ (2003) 113 Yale Law Journal 541, 176. 148 H Collins, Regulating Contracts (Oxford University Press 2002) 176.

Duties of the Members of the Network  145 to understand the evolving expectations of the parties under unpredictable circumstances.149 If the parties could know in advance, they would specify which cooperation duties should be intensified in which circumstances. They are, however, unable to do so due to the highly uncertain nature of the relationship: which specific information should be exchanged in an innovative project? How should one allocate responsibility for tasks not foreseeable in the initial plan? While the parties cannot initially allocate these tasks, risks and benefits, it is their intention to create a collaborative project, where each should receive and be liable according to its merits and actions. They establish this ‘collaborative’ aim in the contract (perhaps in its recitals). The difficulty is to contractually specify what these duties mean before the collaboration starts, for they will only be specified as the collaboration evolves. Teubner explains the need to identify the specific situations where a duty of loyalty applies: The legal formula is thus as follows: to distinguish situations in which an intensified duty of loyalty to the network exists, from situations in which only the contractual duty of good faith will apply, even though each obligation must be modified with reference to the other. The legal task is one of distinguishing between contractual good faith and the duty of loyalty to the network. At the same time, however, care must be taken to ensure that this duty is not simply equated with the duty of loyalty within corporation law, but that, for its part, it is given a de-centralised bias. Such differences clearly educe from the repeatedly discussion between a network and a collective: the pervasive combination of autonomy and association.150

The author proposes that ‘sectors must be distinguished in the network’151 where either the collective or the individual logic prevails. He warns, however, that this does not mean the full ‘contractualisation’ or ‘collectivisation’ of certain sectors; in each, the opposite logic should still be regarded as a secondary objective, which constrains and modifies the dominating tendency. The duty of loyalty, therefore, creates an intensified level of commitment towards the project to which the parties have adhered, but should not be applied indiscriminately, barring the parties from remaining competitors in the market. This notion of loyalty is a guideline that will reflect in the intensification of different duties of cooperation and good faith. That is why Teubner refers to a ‘non-exhaustive’ list of loyalty duties in contractual networks, ie intensified duties of information, confidentiality, risk sharing and profit sharing, among others.152 It is not possible, therefore, to establish ex ante a list of potential

149 See ch 2, n [137] and accompanying text. 150 G Teubner, ‘Coincidentia Oppositorum: Hybrid Networks beyond Contract and Organization’ in G Teubner and M Amstutz (eds), Networks: Legal Issues of Multilateral Co-operation, Vol 3 (Hart Publishing 2011) 24–25. 151 Teubner, Networks as Connected Contracts (n 145) 185. 152 ibid 186 ff.

146  Managing the Internal Coordination duties that will derive from a contractual network to innovate; a contextual analysis is necessary. How should one conceptualise this duty of loyalty under the existing private law theory? A relevant background to discuss this subject, subsequently examined in more depth, would be that of the Principles of European Contract Law (PECL). Article 1:201 PECL establishes: ‘Each party must act in accordance with good faith and fair dealing’. Article 1:202 PECL states: ‘Each party owes to the other a duty to cooperate in order to give full effect to the contract.’ It is relevant whether a duty of loyalty to the network can be anchored either on good faith and fair dealing (1:201 PECL) or on a duty to cooperate (1:202 PECL). Generally, it is possible to identify two opposing meanings conveyed in these principles, one negative and the other positive. The concept of good faith, under the PECL, is seen as negative, ie the absence of malice or bad faith. The concept of a duty to cooperate or fair dealing, however, is often associated with some positive objective behaviour required of the contractual partner. The commentary to the PECL mentions examples: the duty to allow the other party to perform its obligations under the agreement,153 informing the other parties about potential risks to persons or property involved in the performance or performing collateral duties in the contract. All these ideas convey a notion of loyalty. The distinctiveness of a duty of loyalty to the network, however, is that the analysis of whether this duty exists in each case will depend on whether each action contributes to advancing the interests of the collaborative project. Sometimes, this may mean advancing the interests of an individual party, ie when this party can perform a service for the network for a better price, even if that means undermining other partners’ participation; sometimes, it may mean advancing the collective interests, by requesting an individual to disclose information/know-how required for the project to several network members. The difficult question is to determine when the duty of loyalty to the network applies and when it does not apply to each case. Chapter four discusses how this principle could apply in different scenarios. It argues that, for each conflictual situation, the concept of a duty of loyalty could serve as an interpretative guideline to determine whether the collective interests of the network or the individual interests of a certain member should prevail. The best way to undertake this task would be to balance different criteria (mostly collected from low-level analogies with similar cases),154 to determine

153 O Lando and H Beale, Principles of European Contract Law, Parts I and II (Combined and Revised), Prepared by the Commission of European Contract Law (Kluwer Law International, 2000) 113 ff (especially the commentaries to Arts 1:201 and 1:202); eg by applying for necessary building licences or exercising its option to nominate a vessel to deliver the goods. 154 Defending a form of legal interpretation resorting to low-level analogies as opposed to an idealising, rationalising perspective of the law; RM Unger, What Should Legal Analysis Become? (Verso 1996) 134.

Duties of the Members of the Network  147 the outcome to a certain dispute. The different sections of chapter four propose how this form of interpretation would play out. Below, this duty of loyalty is differentiated from other general comparative private law principles that could potentially serve as guidelines to co-creation projects. B.  Other Distinct Concepts in Comparative Private Law i.  Objective Good Faith in Comparative Private Law The concept of objective good faith in comparative private law represents a potential interpretative guideline for the partners’ obligations in a co-creation project. In the civil law context, good faith can be either subjective or objective.155 In collaborative projects, the difficulty is not to regulate subjective malicious behaviour. Different legal systems have legal concepts to address these cases, such as misrepresentation and fraud. Furthermore, it may be difficult to establish subjective good faith in the fluid context of innovation, where parties have set out to experiment whether a certain behaviour is an expression of innovation seeking or an evasion of contractual duties.156 The potentially useful concept to analyse whether the contractual partner acted according to a reasonable objective standard of behaviour, therefore, would be objective good faith. This concept, initially developed in German law, influenced other legal systems.157 Since the entry into force of the BGB (the German Civil Code (1900)), the difficulty of concretisation of the general clause of good faith in §242 has been subject to controversy.158 According to Wieacker, objective good faith has three functions.159 First, as an interpretative guide to legal relations. Second, as a source of secondary duties to the main contractual obligations,160 supposedly analogous to the common law process of implying terms into a contract. Third, as a limitation to the

155 Subjective good faith prevails when a party has no intent to act against the law. Objective good faith represents a standard to analyse a situation – uninfluenced by an individual’s state of mind. The party acting under the standard expected of the ‘reasonable man’ will be acting in objective good faith. Martijn W Hesselink, ‘The Concept of Good Faith’ in M Hartkamp and others (eds), Towards a European Civil Code (4th edn, Kluwer Law International 2011) 619. 156 The so-called ‘observability problem’: Gilson, Sabel and Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (n 16) 1392. 157 Zimmerman and Whittaker (n 97) 49. 158 ibid 19–20. German legal doctrine worked around this criticism and refined the concept, identifying its different functions and developing methodologies for interpreting general clauses. Basil S Markesinis, Hannes Unberath and Angus C Johnston, The German Law of Contract: A Comparative Treatise (2nd edn, Hart Publishing 2006) 118 ff. 159 Franz Wieacker, Zur Rechtstheoretischen Präzisierung Des § 242 BGB (Mohr Siebeck 1956). 160 eg duties to inform about the risks of a product under Brazilian Consumer Law. C Marques, Contratos No Código de Defesa Do Consumidor (8th edn, Revista dos Tribunais 2016) 220 ff, 873 ff.

148  Managing the Internal Coordination exercise of subjective rights, establishing that there are inadmissible forms of exerting legal rights,161 for instance, venire contra factum proprium (the civilian equivalent to the common law concept of estoppel). To deal with the uncertainty in the concept of objective good faith, German doctrine developed the technique of providing similar legal solutions to ‘groups of cases’ (Fallgruppen) with similar fact patterns.162 Thus, legal interpretation could be harmonised, clarifying how to apply an abstract concept. Notwithstanding this methodology, good faith remains an open concept, to be concretised by the courts in casu.163 Over time, groups of cases where good faith will apply are delineated, but the open nature of the concept allows judges’ discretion to create new ‘groups of cases’. This section focuses on the first potential function of objective good faith as an interpretative guideline. This function translates into the need to interpret legal obligations in the context of the wider set of legal obligations contained both in the contract and in the network.164 It further translates into the need to observe the practical circumstances arising in the performance of legal obligations. Objective good faith, although connected to the idea of objective interpretation of contracts, should not be restricted to this narrow concept. The concept of objective good faith has modified the form of envisioning the law of obligations in the twentieth century across different jurisdictions. Karl Larenz,165 Couto e Silva166 and other eminent legal scholars167 pointed out the transition from a formalistic, static perspective on the law of obligations to a dynamic perspective.168 In the emerging dynamic perspective of legal obligations, they constantly evolve over time, requiring the legal interpreter to consider the context. According to Couto e Silva, the legal obligation becomes a ‘process towards the fulfilment of the creditor’s interest’,169 with the legal interpreter having a role in filling gaps by an integrative interpretation that takes into consideration the general aim of the parties’ relationship and the surrounding context, resembling the notion of relational contracts in the common law.170 Duties of loyalty are mentioned in different jurisdictions as derivations of the good faith principle.171 It is important to analyse their meaning and how they 161 Zimmerman and Whittaker (n 97) 430. 162 Hesselink (n 155) 623 ff. 163 ibid. 164 Martins-Costa, A Boa-Fé No Direito Privado: Critérios Para a Sua Aplicação (n 36) 430. 165 K Larenz, Lehrbuch Des Schuldrechts, vol Allgemeiner Teil, 1 (14th edn, 1987) 26–29. 166 CC Silva, A obrigação como processo (FGV 2006) 17 ff. 167 In German Law, MüKoBGB/Schubert, 7 Aufl 2016, BGB § 242 Rn 17–23. 168 The former envisions obligations from the perspective of the elements that compose it (eg the parties, the obligations formally expressed) and considers them to be contained within the contract, shunning references to the context. This would ensure the respect to the parties’ bargain and allocation of risks. 169 Silva (n 166) 167. 170 J Martins-Costa, Comentários Ao Novo Código Civil: Do Direito Das Obrigações – Adimplemento e Extinção Das Obrigações, Vol V, Tomo I (2nd edn, Forense 2005) 32. 171 Gomes (n 87) 43.

Duties of the Members of the Network  149 could be useful in interpreting collaborative contracts. Picod distinguishes two forms of loyalty in the contractual performance:172 the loyalty of the contractual party and contractual loyalty in general. The breach of loyalty of the contractual partner is assessed by examining whether the partner acted maliciously, remitting to subjective good faith. The second kind, contractual loyalty, has a positive content,173 the obligation to perform the contract in a way that renders it effective (effet utile).174 This would amount to an obligation to cooperate with the contractual partner and to provide relevant information necessary for the effective contractual performance.175 For Picod, that means that the ‘debtor must perform the contract by giving it its maximum effectiveness’ and ‘the most complete’ performance and the ‘creditor must facilitate the performance of the obligations of the debtor offering him all the needed assistance’.176 It is a notion of loyalty tied to the concept of an exchange contract, not to a joint, collaborative relationship. The duty of cooperation is the sum of individual aims:177 each party must facilitate the other’s due performance of their obligations, but it has nothing to do with co-creation and resolving uncertainty together. There is, therefore, an important limitation in interpreting legal obligations based on objective good faith. The traditional concept of legal obligation is composed of a creditor and a debtor, where the debtor receives the payment (usually money) and, in exchange, must fulfil the main performance of the contract in favour of the creditor’s interests.178 The model of fulfilment of the contract is steered towards the effective fulfilment of the creditor’s interests. This is the model of an exchange contract, where the parties are in a position where they do not actually co-create something, but normally will exchange something for money. Indeed, they may mutually cooperate towards the fulfilment of their contractual obligations, such as by facilitating payment, providing relevant information or reviewing the price conditions in certain cases. However, the model of exchange contract does not foresee co-creation by the partners, where instead of exchange the relationship basis is a common project. As argued by Hamelin,179 there are specifics of alliance contracts in relation to exchange contracts; but one should also notice how the traditional conceptualisation of good faith is inappropriate to deal with these agreements. The difficulties of coordination in a co-creation project are much more significant than in exchange, where problems may be solved through damages 172 Y Picod, Le devoir de loyauté dans l’exécution du contrat (Librairie générale de droit et de jurisprudence 1989) 21–22. 173 ibid 22. 174 ibid 97–99. 175 ibid 111 ff. 176 ibid 104. It is uncertain to what extent this obligation means performing well what has been agreed by the parties or whether it goes beyond, encompassing the duty to make the best efforts to make the project succeed. 177 R Demogue, Traité Des Obligations – Il Effet Des Obligations – Part VI (Arthur Rousseau 1931) 3(9). 178 Silva (n 166) 20. 179 J Hamelin, Le contrat-alliance (Economica 2012), see n [70] in ch 1 and accompanying text.

150  Managing the Internal Coordination or by seeking a substitute performance. Instead, co-creation involves a partial ‘communion’ of interests, with joint efforts, investments, time and expectations. In summary, the concept of objective good faith, seeking to create an interpretive guide to legal obligations based on the ‘reasonable person’ or the commercial standard, could potentially serve to adjudicate disputes involving collaborative legal relationships. The limitations are twofold. First, there is no clear guideline to determine what is ‘reasonable’ or ‘standard’ in uncharted territory, where the parties are seeking to create something novel. Second, this concept is connected to a model of exchange contract, not one where parties are co-creating, where the level of uncertainty and the need for coordination is heightened, creating issues that common duties of good faith would not solve. Therefore, the narrative of cooperation between a creditor that should facilitate the performance of the debtor and a debtor that should do its best to provide the adequate performance to the creditor does not translate the needs of these collaborative projects. There is a need for a different narrative. ii.  Abuse of Rights The modern concept of abuse of rights originated in France and Italy, with the purpose of maintaining the Roman basis of civil law, avoiding the reference to a good faith concept.180 It sought to inaugurate a legal reasoning pervaded by social solidarity, in response to the formalistic classical contract law.181 Different jurisdictions developed distinct versions of abuse of rights, ranging from a subjectivist perspective, where the existence of an abuse is analysed based on the party’s intention, to an objectivist perspective, where the configuration of an abuse is to be analysed based on the party’s conduct.182 Although it found diffusion around the civil law world, the concept of abuse of rights soon entered a phase of decadence, for it had not been scientifically systematised and lacked concretisation.183 The result was a conceptual emptiness, creating an ‘intermediate ordinating figure’ to be applied in conjunction with other concepts.184 In France, the concept was remitted to the notion of responsabilité civile, and in German law, to good faith.185 According to ­Vogenauer, the continued application of the concept of abuse of rights by the European Court of Justice (ECJ) is creating an emerging principle of EU law, with definite requirements, but still ‘embryonic’ and with no universal ­recognition.186 180 A Menezes Cordeiro, Da Boa-Fé No Direito Civil, Vol 2 (Almedina 1984) 700. 181 A Di Robilant, ‘Abuse of Rights: The Continental Drug and the Common Law’ (2010) 61 Hastings Law Journal 687, 687, 690. 182 ibid 691–92. 183 Menezes Cordeiro (n 180) 700. 184 ibid 706. 185 ibid 704–05. 186 R Feria de la and Vogenauer, S (eds), ‘The Prohibition of Abuse of Law: An Emerging General Principle of EU Law’, Prohibition of Abuse of Law: A New General Principle of EU Law? (Hart Publishing 2011) 571.

Duties of the Members of the Network  151 The concept of abuse of rights is established in Article 187 of the Brazilian Civil Code,187 determining that those exerting a right beyond its socio-economic purpose will be committing an illegal act. This concept has an objectivist perspective and normally will be applied in conjunction with other general private law clauses, such as good faith.188 The concept of abuse of rights, therefore, seems too abstract to provide a basis for the legal interpretation of collaborative relationships. The notion of socio-economic purpose of the collaborative contractual network could provide a guidance if further refined. Without this refinement, however, abuse of rights becomes hardly ascertainable under high uncertainty. iii.  Restraint of Trade Restraint of trade developed in the common law and responds to the need to protect parties against unjustifiable restrictions for the exercise of their economic activities in the market.189 The doctrine’s rationale is that, for the benefit of society, parties should be able to perform their trade or to employ their knowledge/ expertise freely. To prevent such activities would create a violation of public policy to be sanctioned. However, every limitation should be analysed case by case, to assess whether there is reasonable justification for the restraint of trade. The doctrine of restraint of trade is further analysed in chapter four, section II.C. At this point, however, it is relevant to examine whether this concept could serve as a suitable general guideline to interpret collaborative relationships. First, restraint of trade could be useful when the contractual network design creates a situation where a company is unjustifiably prevented from exerting its activities. The concept could be a starting point to a further development of the principle for collaborative relationships, delineating criteria of reasonableness and public policy to determine to what extent competition or cooperation should prevail in each case. The main problem with the approach, besides its indeterminacy, is that loyalty in collaborative relationships is not simply about negative duties, the duty not to prevent the activities of the other party.190 It is also about interpreting what positive duties derive from the parties’ clauses establishing duties to cooperate, disclosure of relevant information, warning about certain events – in other words, making the collaborative project work by adequately performing the contractual duties. A doctrine such as restraint of trade that establishes only a negative duty not to contain the other 187 Brazilian Civil Code – Art 187. The rightsholder who exerts a right clearly beyond the scope of its economic and social purpose, good faith or good morals will be committing an illegal act (free translation). 188 For instance, the principle of venire contra factum proprium, the general prohibition for contradicting one’s own previous behaviour, if certain requirements are met, is a derivation of the principle of objective good faith in conjunction with abuse of rights. A Schreiber, A Proibição Do Comportamento Contraditório (2nd edn, Atlas 2007) 119. 189 Beale (n 81) 16–87 ff. 190 This resembles the civilian principle of abuse of rights, punishing certain excessively bad behaviour.

152  Managing the Internal Coordination partners’ behaviour has only partially dealt with these challenges and reveals an insufficient and less comprehensive guideline than the notion of loyalty to the common aim of the project. Second, the logic behind restraint of trade clauses (non-compete clauses) of ‘separation’ between areas where different behaviours are allowed is alien to the logic of companies that decide to establish behaviours to compete and cooperate simultaneously. Consider a contract of employment as a background example, where a former business collaborator, engaged in cooperation with a certain firm or group of firms, should pay a ‘price’ for leaving the working team: not to work in the same field or geographical zone for a certain time. However, in networks of collaborative contracts, this logic of ‘separation’ between the working place, the working hours or the fields of projects where parties may act, has never existed. The parties are engaged in experimental projects, where few deliverables are identifiable at the outset. They may not be able to establish with precision the times of employment or collaboration, or the geographical zones where the party should not continue working. These companies may from the beginning be willing to create projects with competing companies in the same area. Thus, restraint of trade is not suitable as a general guideline for collaborative relationships. iv.  Fiduciary Logic Contracts for innovation also do not fit fiduciary categories of contracts,191 where the counterparty’s interest must be given preference over the party owing the duty. Overall, English law seems to present a picture where there is a dichotomy between contracts of utmost good faith, where stronger duties of cooperation should prevail, and ordinary commercial contracts, where they are basically in an adversarial relationship.192 Neither fits the purpose of agreements where competition and cooperation coexist under high uncertainty. The specific limitations of partnerships to these kinds of relationships have been discussed elsewhere.193 v.  Corporate Law Insights for Contracts for Innovation The similarities between collaborative contractual networks to innovate and corporate-like structures are evident.194 Independent companies in a collaborative project have a close working relationship that resembles a single organisation, 191 Relationships of trust, where one must act in the interest of the other party, see ch 4, section I.C.i, ‘General Approach on Disclosure of Information’. 192 Criticising this dichotomy, see Leggatt J, Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111, para 142. 193 Teubner, Networks as Connected Contracts (n 145) 120. 194 The contractarian theory of corporate law envisions the corporation as a ‘network of contracts’, where the different shareholders have legal agreements with each other, oriented towards creating an organisation with a common purpose; Pontes de Miranda (n 86) 65.

Duties of the Members of the Network  153 yet maintain independence, structuring their project through an ‘organisational contract’.195 This section first explores the potential connections between ‘organisational contracts’ and corporate law. Second, it examines the meaning of the duty of managers and directors to act ‘in the best interests of the company’, analysing whether the logic behind this notion could apply to contracts for innovation (particularly those delegating decisions to certain bodies). Despite the fact that this logic is inadequate, it can provide relevant insights. a.  Connections between Corporate Law and Organisational Contracts One foundational feature of organisational contracts is their relation to company law.196 The organisational contract represents a separate pole of contract law, opposed to exchange contracts, where the parties envision a common goal, even if no new legal entity is created.197 Similar issues arise both in corporate law and in organisational contracts. Two main contributions from company law provide important considerations.198 First, the principal agent theory.199 In contractual networks, it is common to delegate to an appointed management body200 or to a party the power to make decisions, requiring the overall network interest to be considered. This is similar to the duty of the manager and of the controlling shareholder to act in the best interest of the company. Both in networks of contracts and in corporate contexts, there may be difficulties in ascertaining whose interest is the principal. If networks of contracts do not delegate decision-making power to one of the parties, the parties may establish a procedure to reach decisions once a conflict arises. The choice between an appointed delegated body and a procedure to reach a decision is normally taken balancing transaction and monitoring costs.201 The second relevant contribution is the termination regime.202 In corporate law, in general, parties will not be able to exit the company, except through a winding-up procedure, unless they sell their shares to another party. This exit normally does not allow a party to recuperate the assets invested in the

195 S Grundmann, F Cafaggi and G Vettori, The Organizational Contract (Ashgate 2013). 196 F Cafaggi, S Grundmann and G Vettori, ‘The Contractual Basis of Long-Term Organization – the Overall Architecture’ in S Grundmann, F Cafaggi and G Vettori (eds), The Organizational Contract (Ashgate 2013) 5–6. 197 ibid 6. 198 ibid 28 ff. 199 ibid 32. MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305, 305. 200 The delegation might be formal or de facto. Cafaggi, Grundmann and Vettori (n 196) 32. 201 If a delegated body is chosen, transaction costs of renegotiation will be low, but there might be high costs to monitor the agent for moral hazard, whereas a procedure might involve low monitoring costs between the parties, but high transaction costs to reach a compromise; ibid 34–35. 202 ibid 33; Cafaggi (n 31) 82–84.

154  Managing the Internal Coordination company, lest it might destabilise it. Regarding networks of contracts, the exit of a party is less destabilising because there is not necessarily limited liability of parties. Thus, rules of termination often allow parties to exit the long-term relationship after a certain period, sometimes granting them the right to take their investments back. Specifically, in contracts for innovation, however, exit may be allowed after certain contractual milestones, or carefully drafted clauses may balance commitment to cooperate with freedom to disembark from the project. In summary, similar issues arise in the context of contractual networks and corporate law, but different solutions may be required.203 In any case, company law may provide relevant insights for contractual networks. b.  ‘The Best Interest of the Company’ It is questionable whether the notion of ‘best interest of the company’ could provide a suitable interpretative guideline for contractual relationships to innovate. This notion is significant in examining the behaviour of parties or delegated bodies responsible for making decisions in contractual networks. It will be less relevant when a decision-making procedure is established, ex ante determining how to specify uncertainty. Most jurisdictions recognise that directors and controlling shareholders, in exerting their powers in a corporation, are constrained by general fiduciary principles.204 The prevailing narrative is that shareholder’s interests must be given primacy,205 having in view profit maximisation for the company. By focusing on the controlling shareholders’ interests, the general interest of shareholders would be best protected.206 According to Hansmann and Kraakman, this view of shareholder primacy is dominant in corporate governance studies.207 A more nuanced view is perceptible in certain jurisdictions.208 Even if one accepts the primacy of shareholders’ interests, there are still controversial issues regarding this duty’s content. There is a widely accepted

203 Cafaggi, Grundmann and Vettori (n 196) 37–38. 204 L Enriques, H Hansmann and R Kraakman, ‘The Basic Governance Structure: The Interests of Shareholders as a Class’ in R Kraakman and J Amour (eds), The anatomy of corporate law (Oxford University Press 2009) 78–79. 205 H Hansmann and R Kraakman, ‘The End of History for Corporate Law’ (2000) 89 Georgetown Law Journal 439, 439 (pointing to the convergence towards the shareholder interest primacy model); P Ireland, ‘Shareholder Primacy and the Distribution of Wealth’ (2005) 68 The Modern Law Review 49, 49–51 (acknowledging, critically, the growing influence of the shareholder interest primacy across different jurisdictions). 206 Hansmann and Kraakman (n 205) 441–42. 207 ibid 468. 208 eg Canada, where recent Supreme Court decisions have affirmed that directors must instead act in the corporation’s best interests, with consideration given to other stakeholders’ interests. I Lee, ‘Peoples Department Stores v Wise and the “Best Interests of the Corporation”’ (2005) 41 (212) Canadian Business Law Journal 22.

Duties of the Members of the Network  155 distinction between duties of care and duties of loyalty.209 Duties of care refer to the need to act diligently in making decisions for a company, making responsible and informed decisions, serving the purposes of maximising the profit of the corporation. Duties of loyalty require a director to disclose or avoid conflicts of interest, especially in transactions with related parties. There seems to be a certain level of convergence in the application of these principles across jurisdictions.210 In most European jurisdictions, similar fiduciary concepts prevail.211 In most cases, there is not a clear guideline establishing the meaning of the concept. Regardless of these duties being codified in the national jurisdiction or developed on the case law ‘the analysis suggests that the law in most legal systems is elastic enough to allow the courts to derive solutions to novel conflicts that are not addressed’.212 How do these concepts provide analogies to contracts for innovation? A similar problem pervades both legal models: to create a balance between the interests of shareholders/independent companies and the collective interest of the company/network. If the questions are similar, it is questionable whether similar answers could be provided. First, the concept of acting in the corporation’s best interests seems to unilaterally favour the collective interests of the shareholders over the individual interest of any of them. This means that a majority decision will steer the activities of the corporation in a certain direction. This logic seems inappropriate in network of contracts, where the independence of the companies should allow freedom to undertake parallel activities. Even if there may be limitations on the activities they may undertake (eg practical constraints imposed by IP licences) still, in most cases, a firm retains a significant level of independence to control its activities. Second, corporate law provides several mechanisms for the protection of minority shareholders against detrimental decisions of the majority.213 There is an attempt to balance the majority interests with the protection of the minority of shareholders. The question, then, is to what extent this kind of balance could be used in a collaborative network for innovation. Certain governance features of collaborative contracts, especially those establishing voting procedures, may recall (to a certain extent) available mechanisms for minorities to question the decisions of the board of directors. In several collaborative projects, however, the decision to continue the project after a 209 M Ventoruzzo and P Conac, Comparative Corporate Law (West Academic 2015) 295. 210 K Hopt, ‘Common Principles of Corporate Governance in Europe?’ in J McCahery and others (eds), Corporate Governance Regimes: Convergence and Diversity (Oxford University Press 2002) 175–77. English case law presents a similar development, see Boardman v Phipps [1967] 2 AC 46. 211 Analysing the 28 EU jurisdictions on the issue, see ‘Study on Directors’ Duties and Liability Prepared for the EU Commission DG Markt’ (2013) ec.europa.eu/internal_market/company/docs/ board/2013-study-analysis_en.pdf. 212 ibid viii. 213 eg, exit rights, tag-along and drag-along rules, rights to challenge the board of directors’ decisions. Discussing some shareholders’ rights to protect minorities, see R Porta and others, ‘Law and Finance’ (1998) 106 Journal of Political Economy 1113, 1126.

156  Managing the Internal Coordination certain stage (or ‘milestone’) is often subject to the parties’ acquiescence. The basic framework in a collaborative project must be one that creates an incentive for the parties to continue their collaboration, providing a flexible background, allowing for specification of the duties amid uncertainty, but without always subjecting the minority to the majority. In high-trust relationships, if there is no continuous willingness to work together (arguably broken by imposed decisions), the collaborative process hardly leads to innovation. Differently from corporate law, where the ‘compensation’ for minority shareholders works out to balance the relationship and prevent expropriation,214 in collaborative relationships to innovate the balance of interests must be achieved by creating a framework incentivising continuous collaboration. According to Teubner, the corporate logic of giving preference to the corporation collective interests does not translate the needs of contractual networks where parties simultaneously cooperate and compete. In these projects, the collective logic would prevent competition between the parties, blocking experimentalism. In conclusion, the analogy with the concept of best interests of the company is not adequate to translate the level of constant tension between the collective and the individual interests in a network. C.  A Duty of Loyalty to the Common Objective of the Collaborative Project There are two potential sources of inspiration for a duty of loyalty to the collaborative project involving simultaneous competition and cooperation. First, in the ambit of EU law, the member states’ duty of loyalty towards the European Union. Second, the constitutional principle of loyalty (fidelity) to the federation (Bundestreue) in German law. In both cases, the federations/member states retain significant independence, while their collaboration is essential for the collective body’s success. Duties of loyalty have been present in different EU treaties.215 The baseline concept is referred to as the principle of ‘sincere cooperation’,216 enshrined in Article 4(3) Treaty on the European Union (TEU).217

214 R Porta and others, ‘Investor Protection and Corporate Governance’ (2000) 58 Journal of Financial Economics 3, 4 ff. 215 G de Baere and T Roes, ‘EU Loyalty as Good Faith’ (2015) 64 International & Comparative Law Quarterly 829, 830–34. 216 ibid 830. 217 Treaty on the European Union – Art 4(3). Pursuant to the principle of sincere cooperation, the Union and the Member States shall, in full mutual respect, assist each other in carrying out tasks which flow from the Treaties. The Member States shall take any appropriate measure, general or particular, to ensure fulfilment of the obligations arising out of the Treaties or resulting from the acts of the institutions of the Union. The Member States shall facilitate the achievement of the Union’s tasks and refrain from any measure which could jeopardise the attainment of the Union’s objectives.

Duties of the Members of the Network  157 The fact that EU treaties establish different (and mixed) competences for the member states and for the Union and its institutions, give the impression that most potential conflicts between them are solved by these rules. However, there may be situations where the way one member or the union exerts these competencies may undermine the purposes or the fulfilment of the Union’s obligations. This is the reason why a principle of sincere cooperation has an important function: in exerting their legitimate functions, the members must guarantee that the Union’s objectives are effectively reached. This notion of loyalty/sincere cooperation led to different obligations formulated by the ECJ. De Baere and Roes identify three main lines of argument based on loyalty, with similarities to the good faith concept in international law. First, pacta sunt servanda:218 the parties who willingly conclude an agreement are not only bound by it but should perform it in good faith.219 That would involve, according to the ECJ, national courts applying EU rules within their jurisdiction, giving full effect to these provisions (principle of effectiveness).220 Furthermore, the courts should not rely on internal norms to refuse giving effect to EU provisions. Second, the member states should not take actions that could compromise precepts of a European directive during its period of transposition.221 Third, duties of cooperation, often translated into duties to provide information in specific situations, especially when that may be necessary to ensure the ‘fulfilment of the obligations arising out of the treaties’.222 An example involves the possibility that a member state, finding unforeseen difficulties in implementing EU law, may submit such issues to the Commission, proposing potential amendments to certain provisions, with loyalty requiring ‘genuine cooperation’ between the parties.223 This concept of sincere cooperation in EU law creates an interpretative guideline to identify behaviours that should be required in this context of independence articulated with collaboration.224 This concept is useful in interpreting both bilateral and multilateral relationships.225

218 Baere and Roes (n 215) 839. 219 Racke v Hauptzollamt Mainz, C-162/96, EU:C:1998:293. 220 Baere and Roes (n 215) 842. 221 ibid 845–46. 222 ibid 850. 223 Another example where a Member State will be violating a duty of cooperation is when the EU Commission receives authorisation to negotiate an international treaty on certain matters with other states and the Member State concludes, in the interim, an international agreement on the same subject. Regarding mixed agreements (signed by both the Union and some or all the Member States), the duties of cooperation are existent, especially when the parties have joint competences to fulfil certain commitments. In such situations, one member should not initiate dispute resolution proceedings without first consulting and informing the Union, if the subject matter of the controversy is in a field interconnected with the competence of the Union. ibid 851–52. 224 EU Member States might compete, for instance, in sales of armaments or in the exploration of the Antarctic continent. 225 “Network-like” relationships often involve a chain leader, and the relevant analogy will be with the vertical duty of loyalty between the Union and its members. For the bilateral collaborative

158  Managing the Internal Coordination The second potential analogy for a suitable duty of loyalty is the constitutional notion of fidelity to the federation (Bundestreue) under German law, one of the bases for the concept of loyalty in EU law.226 This principle requires the federation member states (Länder) to respect each other’s interests and the federation interest and requires the federation to respect the Länder’s ­interests.227 This involves not only refraining from impairing each other’s interests, but also positively assisting each other in certain circumstances. Accordingly, the German Constitutional Court applied the notion of loyalty similarly to the ECJ.228 For instance, while both the German states (Länder) and the Federation (Bund) have the competence to conclude international agreements, the Länder have a serious obligation of loyalty towards the Bund in this field, for the latter holds a ‘presumption’ of external capacity.229 Regarding shared competences, there is a presumption of the Bund’s competence under German law, invalidating contrary decisions by the provinces.230 This is not an ‘expression of superiority’ of the Federation, but of ‘the spirit of federal minded fidelity of an ally’.231 It is in this spirit that the different duties of federal fidelity developed in German law, contributing to the attainment of the interests of the different federation members.232 Despite the similarities, there are differences between the principle of federal fidelity and the duty of loyalty in EU law, such as the fact that the Union delegates to the national states the implementation of its decision – which finds no correspondence in the federation context.233 For Klammert, the importance of loyalty in EU law is much wider than in federal law, for it admits the acknowledgment of implied competences, while federal fidelity deals mostly with defining how already established competences should be exercised.234 In that sense, the extent of the analogy would be limited.

relationships, the relevant analogy will be that of horizontal loyalty, due by the Member States of the European Union in relation to each other, see M Klamert, The Principle of Loyalty in EU Law (Oxford University Press 2014) 22. 226 Along with the principle of solidarity and the notion of a duty of cooperation. ibid 31–32. 227 D Currie, The Constitution of the Federal Republic of Germany (The University of Chicago Press 1994) 77. 228 ibid 55–58. On the genealogy of the principle of fidelity in German Law, ibid 77–78. 229 Baere and Roes (n 215) 856. 230 Klamert (n 225) 55–56. 231 See also the case where the Constitutional Court acknowledged that the distribution of federal funds for public housing required unanimous approval by all the Länder, but also that the approval should not be withheld arbitrarily, without objective justification; ibid. See also Currie (n 227) 78–79. 232 See the case where some Länder sought to arrange for referenda to consult their population about the decision of the Federal Government to authorise the stationing of nuclear weapons in Germany, considered by the Constitutional Court as encroaching upon the federation’s authority. Currie (n 227) 79. 233 Klamert (n 225) 60. 234 ibid 61.

Conclusion  159 According to De Baere and Roes, the concept of loyalty in EU law could derive from the notion of good faith in international law.235 Accordingly, the concept of a duty of loyalty in collaborative networks of contracts for innovation could derive, in civil law systems, from a general notion of (objective) good faith. While these analogies are relevant, the possibility of exit in these realms seems more difficult than in experimental private relationships to innovate, where loose frameworks often provide the parties with greater freedom to walk away. III.  CONCLUSION: FINDING A DUTY OF LOYALTY TO THE NETWORK/ COLLABORATIVE PROJECT UNDER ENGLISH AND BRAZILIAN LAW

The concept of duty of loyalty to the collaborative network of contracts represents a conceptualisation different from the notion of loyalty common in private law studies (meaning duties for the parties, in an exchange contract, to facilitate each other’s contractual performance). A tailored concept of loyalty to the collaborative network must be developed. The best sources of inspiration would be the notion of a duty of loyalty in EU law and, to a lesser extent, of federal fidelity in its German version. In these cases, the parties retain their independence but contribute to the fulfilment of a collective objective. Under this interpretative guideline, the individual and the collective interests are in constant tension in networks to innovate; whether one or the other should prevail in each context should hinge upon which advances the interests of the network project. Both Brazilian and English law could adapt this notion as applicable to a trans-typical category of contracts236 involving high uncertainty and simultaneous competition and cooperation. Under English law, this duty of loyalty could be derived from the general principles of contractual interpretation provided in Investors Compensation. The case elaborated five principles of interpretation,237 foremost among them the notion that a contract should be construed as having in view what a reasonable person with knowledge of the background reasonably available to the parties at the time of their transaction would have understood their words to mean. The background includes the context of the transaction or its ‘factual matrix’ (such as its landscape and location in the relevant ‘market’) but excludes any prior negotiations.238 In assessing this contextual background, courts should be

235 Baere

and Roes (n 215) 874. ch 1, Conclusion. (n 63) 359. 238 ibid 359–60. 236 See

237 Andrews

160  Managing the Internal Coordination guided by objectivity and commercial common sense.239 Under this principle, a reasonable person’s understanding on the interpretation of the contract, considering the non-conclusive drafting of the agreement, should turn mostly on the nature of the specific production mode in which the parties have moulded their relationship, that would be the ‘landscape’ of the transaction. This is not a simple exchange relationship, but one where the parties are strongly collaborating towards a final output that neither of them knew beforehand what would be. The collaboration between the parties involved a level of complexity that required mechanisms establishing communications and interactions between the parties. This duty of loyalty should not be understood as a tool for dictating terms for the continuation of the parties’ relationship in collaborative contracts to innovate, for that would discourage experimentalism between the parties, but as a guideline for contractual interpretation. Since Attorney General of Belize v Belize (2009),240 there has been a discussion under English law whether the criteria for implication of terms would be the same as that for interpretation of contracts. Lord Hoffmann’s words in Belize about the process of implication of terms led to that impression, when he claimed that ‘[t]here is only one question: is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean?’. This view was later rejected at the Court of Appeals in Mediterranean Salvage and Towage Ltd v Seamar Trading and Commerce Inc: The Reborn (2009).241 It was not until late 2015, notwithstanding, that the UK Supreme Court, in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd (2015),242 clearly established that interpretation of contracts and implication of terms are subject to different tests, confirming the prescription of many doctrinal writings on the matter.243 The doctrinal distinction is the following.244 Interpretation of contracts occurs where the contract is vague or ambiguous and the court’s role is primarily in interpreting, based on the existing contract and in the surrounding ‘factual matrix’, what is the meaning to be ascribed to the agreement. Implication of terms, on the other side, would relate to the process of creating clauses where the parties have not, in fact, allocated risks in their contract or predicted a certain set of factors that

239 ibid 362. 240 Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10. 241 Mediterranean Salvage and Towage Ltd v Seamar Trading and Commerce Inc: The Reborn [2009] EWCA Civ 531 (claiming the test of reasonableness alone was not sufficient: the implied terms still had to pass a test of necessity). 242 Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd [2015] UKSC 72. 243 J O’Sullivan, ‘Silence Is Golden: Implied Terms in the Supreme Court’ (2016) 75 The Cambridge Law Journal 199, 199. 244 ibid 201–02. See H Collins, ‘Implied terms: the foundation in good faith and fair dealing’, 67 Current Legal Problems 297, 309–13 (2014).

Conclusion  161 later materialised. In this case, the process would go beyond a mere interpretation of the agreement to encompass a more active (albeit limited) judicial role in designing rules adequate to the case. It is important to highlight, therefore, that the duty of loyalty to the network in English law should be understood as a tool for contractual interpretation allowed by the nature of innovation contracts and the commercial sense that guides these agreements. For instance, these contracts typically contain express but broad clauses requiring exchange of information between the parties; there is no need to imply such a term, simply to interpret it. In the context of Brazilian law (or in most civil law countries), this logic could be derived from a general principle of objective good faith (Article 422 Civil Code), applied in the context of contractual performance. As previously argued, one of the functions of this principle is to serve as an interpretative guideline for different kinds of transaction. What is necessary is to articulate doctrinally a trans-typical category of collaborative contractual networks to innovate245 to which this logic of a duty of loyalty in relation to the collaborative project applies, as a concretisation of the general objective good faith principle. In summary, both legal systems under analysis could adopt a concept of duty of loyalty to the network under their current configuration without the need for legal reform. This guideline could serve to interpret contractual clauses to identify criteria to determine whether to intensify cooperation duties or not. This notion of a duty of loyalty, however, remains abstract. It is necessary to consider how it should be applied in practice to determine whether duties of cooperation should be intensified or not in the context of collaborative relationships. Chapter four turns to this task, considering recurrent forms of conflict in collaborations to innovate and how they would likely be applied in different contexts, to determine the extent of the following duties: to share information in the network; not to discriminate against network members; to share profits; and possibilities of termination in the network.



245 Cafaggi

(n 31) and n [93] in ch 1 and accompanying text.

4 Legal Interpretation in Contracts to Innovate: Potential Matters of Dispute

T

he main legal obligations contained in contracts for innovation have been discussed previously.1 While they include some clearly specified obligations for the initial steps of cooperation (particularly deliverables established in schedules of activities), they often lack substantial obligations imposing cooperation until a final output is produced. Instead, they usually contain abstract duties of cooperation and procedures for the constant specification of uncertainty.2 This chapter analyses four recurrent sources of conflict in the practice of contractual networks to innovate. According to the literature and the interviews conducted, these potential sources of conflict involve duties to share information, duties of non-discrimination between network members, duties to share profits and termination provisions. Each section of the chapter follows a similar procedure. It starts analysing the specific issues generated by the relevant duty or clause for contractual networks for innovation, often mentioning pertinent case law. It then examines how these issues would likely be solved both under English and Brazilian law, evidencing the possibilities and limitations of current legal approaches. Then, suitable criteria for legal interpretation of these issues are proposed, based on the guidelines of loyalty to the collaborative project. These criteria are developed through low-level analogies with cases with similar patterns, avoiding an idealised formula for these highly varied relationships. The section considers whether, under current Brazilian and English law, the suggestions provided would require a legal reform or if they simply require some sophisticated form of contractual interpretation to be adopted in each legal system. Finally, reference is made to the potential governance mechanisms that could be specifically employed to deal with the issue under examination in the section. If successful, this specific governance mechanism could avoid the need to evaluate a dispute and the doctrinal examination of the duty’s meaning. This governance would braid the formal governance inserted in these agreements to generate informal incentives (trust, relational considerations) that could either prevent conflicts,

1 Ch

2 See

2, section II.B.iii. ch 3, section I.D.

Duty to Share Information  163 facilitate their internal resolution or provide information for adjudicators to solve them more easily. In this sense, this book follows an approach that considers in conjunction both legal doctrine and governance. It is important to emphasise, once more, that the violation to any of the duties analysed in this chapter, if verified, in most cases should not give rise to the right to request specific performance or expectation damages, but simply to request reliance damages, in accordance with ‘low-powered enforcement’. I.  DUTY TO SHARE INFORMATION

First, the difficulties in concretising a duty to share information in collaborative relationships are explored, referring to case law. Second, this issue is analysed under both English and Brazilian law. Third, criteria are proposed to potentially determine how to interpret broadly drafted clauses with duties to provide information in both legal systems. In conclusion, different forms of governance mechanisms that could be braided to prevent such difficulties are discussed, interweaving formal and informal incentives. A.  Prelude: Constant Exchange of Information and Heightened Duties of Cooperation in Collaborative Networks The need to exchange information in collaborative relationships to innovate generates legal issues. In most cases, the collaborators involved in experimental projects insert in their agreement broad clauses establishing obligations to mutually share information about their productive process and discoveries. This exchange paves the way for further innovation and contributes to prevent disruptions and risks in their closely interrelated performance. Consider the following real example. A collaborative research, development and licence agreement between a research laboratory and a pharmaceutical company for the development of compound eye-care applications, establishing the duty for each party to ‘make available and disclose to one another all results of the work conducted pursuant to the Research Plan … prior to and in preparation for JRC [Joint Research Committee] meetings, in the form and format to be designated by the JRC’.3 The logic of collaboration projects requires the parties to be constantly exchanging information if they want to co-create. At the same time, they should 3 Clause 3.3, Collaborative Research, Development and License Agreement – ACADIA Pharmaceuticals Inc, Allergan Inc and Allergan Sales LLC, available at contracts.onecle.com/acadiapharmaceuticals/allergan-collab-2003-03-27.shtml.

164  Legal Interpretation in Contracts be able to avoid the abuse of this exchanged information by their partners and withhold from them information developed in the context of unrelated projects. In practice, it is not always easy to distinguish each situation; therefore, the general issue is the extent and intensity in which a broad duty to share information in the context of collaborative contracts should be interpreted.4 In principle, disclosure duties in contractual networks can be of two types: duties to warn (about something relevant to the network) and duties to care (for instance, about the threat of a disruption in the network).5 Additionally, innovative activities require exchange of information needed to co-create an output. These disclosure duties refer to information emerging in the course of the performance of the collaborative project (potentially in the hands of any or several of the parties), not the information available previously to signing off the contract.6 The latter would involve ‘due diligence’ information about the financial situation of the companies, about contracts with other competitors or about the firm’s technological capabilities, which is not specific to contracts for innovation, even if it may be present in them. Theoretically, such matters would be dealt with in the common law by the rules on misrepresentation and/ or mistake.7 However, for the specific innovative activities undertaken by the parties, this kind of preliminary information seems less relevant, as the contractual obligations themselves are inherently incomplete, thus, there seems to be fewer instances where a mistake or misrepresentation could occur.8 B.  Case Law The cases below illustrate disputes over the extent of a duty to provide information in the context of innovation.9

4 M Wellenhofer, ‘Third Party Effects in Bilateral Contracts within the Network’ in M Amstutz and G Teubner (eds), Networks – Legal Issues of Multilateral Co-operation (Hart Publishing 2009) 123 (for whom disclosure duties in contractual networks do not present any remarkable distinction that could not be solved by ordinary contractual interpretation, presenting a diverging position from the one advanced in this book); B Massimo, ‘Good Faith Related Duties of Disclosure and a View on Franchising’ in S Grundmann, F Cafaggi and G Vettori (eds), The Organizational Contract (Ashgate 2013) 181 ff. 5 S Grundmann, ‘Contractual Networks in German Private Law’ in F Cafaggi (ed), Contractual Networks, Inter-firm Cooperation and Economic Growth (Edward Elgar 2011) 151–52. 6 ibid. 7 On the limitations of a disclosure duty under English common law, see section I.C below. 8 Exceptions could relate to situations where one of the contractual partners misrepresents, for instance, the capabilities to undertake a specific form of advanced research or the possessed expertise in a certain field. Even in those instances, nevertheless, matters seem not to be very settled, as one of the parties might have initially earnestly considered to have those capabilities/expertise, only to later discover that it had not, as the experimentation project went further along. 9 Other relevant cases are In the matter of the Arbitration between Pharmacia & Upjohn Co v Elan Pharmaceuticals, 781 N YS 2d 95 (2004); and Static Control Components v Mitsubishi Kagaku Imaging Corp, 2007 WL 586710 (MD NC).

Duty to Share Information  165 In Federal Trade Commission v Intel Corp (1999),10 Intel supplied several companies with microprocessor components, sharing through an electronic platform (ATI system) information regarding their design and specifications. Such detailed early information was crucial for the supplied firms to adjust their technology and build microcomputers based on the specifications. Intel, in this case, was being jointly sued by three complainants who alleged that Intel was coercing them to transfer to Intel commercially valuable microprocessor-related technology, in intellectual property related disputes. For that purpose, Intel was withholding from the supplied companies access to the ATI system, alleging those companies would use the technology for unfair competition purposes. Intel’s violations, therefore, would be unjustified appropriation of the partner companies’ technology and withholding the ATI system access to subject them to accept such behaviour.11 A settlement was reached with the US Federal Trade Commission. The settlement defined that, while Intel should not withhold access to the ATI system to prevail in intellectual property disputes (therefore, establishing a positive duty to share certain microprocessor-related information through the ATI system), it could do so for the purposes of preventing competitors from obtaining inadequate information for their own purposes and potentially forcing Intel to enter into a relationship with them. In Eli Lilly & Co v Emisphere Technologies, Inc (2006),12 two companies were closely collaborating towards the development of ‘new chemical carrier compounds’. Both parties shared protected information to undertake the common project. Later, it was found that Lilly was using a molecular carrier provided by Emisphere in its own secret research projects, indicating an abuse of the information exchange regime. The court held that there was an implied covenant that the parties would use the shared information in the context of the licence agreement, therefore prohibiting the continuation of Lilly’s secret project. The court, Gilson et al claim, has rightly refused to decide whether the parties should continue their cooperation or not or in what terms; it simply sanctioned the specific violation of the cooperation duties in the case.13 Both cases illustrate the main issue of this chapter: difficulties in defining the extent and limits of a duty to share information in collaborative relationships to innovate.

10 In the Matter of Intel Corporation (1999), Administrative Complaint, available at www.ftc.gov/ enforcement/cases-proceedings/951-0028/intel-corporation-matter-1999. Proceedings discussed in RJ Gilson, CF Sabel and RE Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (2010) 110 Columbia Law Review 1377, 1418 ff. 11 ibid 1420. 12 Ely Lilly & Co v Emisphere Technologies, Inc, 408 F Supp 2d 668 (SD Ind 2006). Discussed in ibid 1416. 13 Presenting a diverging view of this case, see Jennejohn’s position in ch 3, section I.A.

166  Legal Interpretation in Contracts C.  English Law From a doctrinal viewpoint, the issue is how a general clause to disclose information in a collaborative contract for innovation may be interpreted under English law. Normally such contracts contain disclosure clauses drafted too broadly to solve potential conflicts, since the experimental and innovative character of the relationship prevents the parties from defining ex ante the specific information they must disclose. First, the general approach of English law regarding disclosure duties is analysed, identifying the dichotomy between contracts of utmost good faith and ordinary commercial contracts, but also the argument that in the category of ‘relational contracts’ intensified duties of disclosure prevail. This argument, it should be noted, is controversial since there are authors defending that a ‘relational’ category of contracts does not exist in itself, but rather there are simply contracts that need to be interpreted according to their contextual specificities.14 Second, it examines whether collaborative contracts for innovation fit these legal categories where positive duties of disclosure are required. While they do not clearly fit these categories, relevant analogies can be drawn from this comparison. i.  The General Approach on Disclosure of Information Under English law, absent an explicit contractual commitment, there is no general obligation to disclose information relevant to the counterparty.15 The parties decide which information to disclose but, once they do, they will be liable for providing false information to their counterparty.16 For that purpose, rules on misrepresentation and mistake apply. Exceptionally, in special relationships, English law envisages a positive duty for the parties to provide information to each other.17 Nonetheless, no general test can be applied to identify these situations.18 Cartwright indicates the following categories of contract where particular duties of disclosure

14 MA Eisenberg, ‘Why There Is No Law of Relational Contracts’ (1999) 94 Northwestern University Law Review 805. Defending the relevance of the notion of relational contracts, see Hugh Collins, ‘Is a Relational Contract a Legal Concept?’, Contract in commercial law (Thomson Reuters 2016) 56 ff. 15 N Andrews, Contract Law (Cambridge University Press 2015) 251–52; J Cartwright, Contract Law (Hart Publishing 2013) 783; according to McKendrick, three main reasons justify this position. First, since information has financial value, disclosure should not be imposed without compensation. Second, the presumption of the contractual relationship as an adversarial relationship. Third, the difficulties in delimiting the content of this duty, generating legal uncertainty. E McKendrick, Contract Law (11th edn, Palgrave 2015) 213. 16 McKendrick (n 15) 213. 17 ibid 214–17. 18 J Cartwright, Misrepresentation, Mistake and Non-Disclosure (3rd edn, Sweet & Maxwell 2012) 788.

Duty to Share Information  167 prevail:  contracts uberrimae fidei, insurance contracts, partnership contracts, surety contracts, compromises, releases and family arrangements and contracts for the sale of land.19 Contracts of utmost good faith (uberrimae fidei) are those where information material for a relationship is held by only one of the parties, which has the legal obligation to disclose it to the counterparties.20 A contract of insurance is considered a contract uberrimae fidei, having in view the need for the insured party, who knows the specific conditions of the insured persons/ goods, to pass on information to the insurer. A duty to disclose information is also present in specific relationships considered fiduciary, under certain circumstances.21 The content of such duty would vary according to the nature of the parties’ ­relationship.22 Overall, English law presents a dichotomy between contracts of utmost good faith and related contractual categories (where positive duties of disclosure prevail) and ordinary commercial contracts (where parties are not obliged to disclose any information). Leggatt J criticises this dichotomy as too simplistic in Yam Seng Pte Ltd v International Trade Corporation Ltd (2013):23 English law has traditionally drawn a sharp distinction between certain relationships – such as partnership, trusteeship and other fiduciary relationships – on the one hand, in which the parties owe onerous obligations of disclosure to each other, and other contractual relationships in which no duty of disclosure is supposed to operate. Arguably at least, that dichotomy is too simplistic. While it seems unlikely that any duty to disclose information in performance of the contract would be implied where the contract involves a simple exchange, many contracts do not fit this model and involve a longer-term relationship between the parties which they make a substantial commitment. Such ‘relational’ contracts, as they are sometimes called, may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and involve expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements.

The Yam Seng decision renewed24 the claim that in so-called ‘relational contracts’, or contracts having stronger relational elements,25 more intensive duties of cooperation apply. As previously mentioned, there is a growing literature and case

19 ibid 789–821. 20 A recurrent critique to the concept of uberrimae fidei is that it is overly general since, for each contractual category, the extent of the duty to disclose and the remedies will vary. H Beale (ed), Chitty on Contracts, Vol 1 – General principles (32nd edn, Sweet & Maxwell 2015) 7–155. 21 A Burrows, A Restatement of the English Law of Contract (Oxford University Press 2016) 213–15 (discussing the duty of disclosure on fiduciary relationships of facts that were ‘material’ and ‘induced’ the contract). 22 Cartwright (n 18) 821–22. 23 Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111, para 142. 24 E McKendrick, ‘The Regulation of Long-Term Contracts in English Law’ in J Beatson and D Friedman (eds), Good faith and fault in Contract Law (Clarendon Press 1997) 305–06. 25 D Campbell, ‘Good Faith and the Ubiquity of the “Relational” Contract’ (2014) 77 The Modern Law Review 475, 477 ff.

168  Legal Interpretation in Contracts law in English law arguing that there is an infant legal concept of relational contract.26 Although the definition of relational contracts is far from set,27 they would involve long-term contracts, or contracts involving a high level of cooperation between the parties, such as distributorship, partnerships or franchise contracts. Some authors claimed that such obligations could be implied from a growingly accepted doctrine of good faith in English law, particularly when the contractual partners expressly include such clauses in their agreement.28 For some authors, however, Yam Seng remains a controversial case.29 ii.  The Possibility of Finding a Duty to Disclose Information in Collaborative Relationships Mingling Competition and Cooperation Considering the general English approach, it is analysed whether there is a positive duty to disclose information in collaborative relationships to innovate. First, the collaborative contracts envisaged cannot be classified as utmost good faith contracts or related categories. Furthermore, ‘the category of contracts accepted as being uberrimae fidei cannot be extended, and so is not based on a general principle which can be applied by analogy in new cases’, although courts have not always been consistent in applying this reasoning.30 In addition, the basis of uberrimae fidei points to the fact that one of the contractual parties has more material information than the other and that should be disclosed.31 This is not the case in collaborative relationships to innovate, where neither of the parties has ex ante the information necessary to the project, but develops it experimentally along their collaboration. Second, it should be analysed whether these relationships could be considered ‘relational contracts’ where more intensive duties of good faith are (arguably) required. Regarding a duty implied in fact to provide information in ‘relational contracts’, Yam Seng is the emblematic case. In the context of a long-term distribution agreement, the supplier company provided false information to its counterparty regarding the prices that other distributors would charge in the domestic retail market. Subsequently it provided misleading information on the negotiations entailed to make these other distributors increase their price

26 See ch 3, section I.E. 27 H Collins, ‘Implied Terms: The Foundation in Good Faith and Fair Dealing’ (2014) 67 Current Legal Problems 297, 301. 28 LE Trakman and K Sharma, ‘The Binding Force of Agreements to Negotiate in Good Faith’ (2014) 73 The Cambridge Law Journal 598, 615 ff. 29 Referring to a ‘lukewarm reception’ of the case, ‘with the courts tending to express that the context and type of contract are all important and that one must not undermine the express terms of the contract’; J Beatson, AS Burrows and J Cartwright, Anson’s Law of Contract (30th edn, Oxford University Press 2016) 166. 30 Cartwright (n 18) 791–92 and at fn 8 on p 791. 31 ibid.

Duty to Share Information  169 to make Yam Seng’s distributed products in the Singapore duty-free shops more competitive. Leggatt J ruled, on the facts of the case, that the distributorship (‘relational’) contract had specificities that allowed a term implied in fact indicating that parties should not provide false information to each other.32 The court has not, however, implied a positive duty to provide information, but simply stated that there was a duty not to provide false information.33 Leggatt J suggested that this duty was a manifestation of the principle of good faith in English law, requiring from the parties honesty in performance and fidelity to their transaction. Nevertheless, in contracts between parties that cooperate and compete concomitantly there will be times when information should be legitimately withheld. As clarified in FTC v Intel, some information should be transmitted, while some should be kept by Intel, preventing abuse of competition. The general category of relational contracts developed in Yam Seng, where all duties of good faith are intensified, therefore, seems inept to the purposes of the collaborative relationships upon which this study focus. Furthermore, it is questionable to what extent the facts and the contractual relationships described in Yam Seng resemble collaborative relationships to innovate. The similarities reside in the need for the cooperation of all the parties for the overall success of the endeavour. The difference is that, in Yam Seng, the parties do not have a deep level of collaboration.34 Alternatively, these contracts could be considered a sub-category within relational contracts where a positive duty to provide information to the counterparty exists. In that regard, Collins claimed for the recognition of heightened ‘good faith’ duties for quasi-integration contracts involving productive activities of companies that simultaneously compete and cooperate.35 In my view, it is not the duration of contracts that provides the key variable in the spectrum of good faith obligations, but rather the incentive structure of the contract, which itself is determined by how the contract fits into relations of production … Contracts that lie well towards the organizational end of the spectrum may be described as contracts that constitute an arrangement for quasi-integration of production, hybrids, or, more snappily, networks. By quasi-integration is meant the idea that though no single legal entity binds the parties together but rather the arrangement is formed by two or more separate organizations that retain their antagonistic interests,

32 Yam Seng, para 156: ‘[I]t was clearly implied that ITC would not knowingly provide false information on which Yam Seng was likely to rely. Such conduct would plainly infringe the core expectation of honesty discussed earlier.’ 33 Especially the need not to undercut duty free prices, considering contextual features of the case, namely, the lack of specification of detailed obligations in the agreement, the reference to a ‘duty free retail price’ and an ‘industry assumption that retail prices in domestic markets will be higher than the corresponding duty free retail prices’; ibid, paras 157–64. 34 eg, teams of the companies working directly together, modifying the product, joint committees for making decisions. 35 Collins, ‘Implied Terms’ (n 27) 326–27.

170  Legal Interpretation in Contracts the agreement seeks to achieve many features of organizations for the purpose of establishing efficient relations of production.

The concept of productive networks of companies simultaneously competing and cooperating could provide a better guidance for interpretation of these transactions. Although polemic, a few decisions,36 such as Ross River Ltd v Cambridge City Football Club Ltd (2007), seem to support the possibility of exceptionally recognising a duty of disclosure in relationships ‘having in them elements of joint enterprise’:37 In relationships falling short of partnership, but having in them elements of joint enterprise or joint venture, there is no hard and fast rule as to the existence or otherwise either of a duty of good faith, a fiduciary duty or a duty of disclosure. Each case will turn on its own facts, but if the relationship is regulated by a contract, then the terms of that contract will be of primary importance, and wider duties will not lightly be implied, in particular in commercial contracts negotiated at arms’ length between parties with comparable bargaining power.

Based on this rationale, duties to disclose relevant information in the context of contracts for innovation could be recognised. iii.  Further Difficulties: No Positive Duty of Disclosure in the Course of Performance Even if one accepts this notion of productive networks or relational contracts as applying to cases such as FTC v Intel, two kinds of difficulty persist. The first is technical: most cases allow for a positive duty for disclosure of information only in contract formation. The main difficulty, for the cases discussed throughout this book, regards disclosure of information produced in the course of contractual performance. The analogy with most cases, therefore, remains of limited value. The second difficulty is to identify criteria to determine whether these duties to share information should be intensified or not.38 Regarding the first difficulty, there are two exceptions where the duty to provide information was implied/interpreted in the context of contractual performance. First, in partnership law cases, considering fiduciary relationships where the parties are required to take into consideration the interests of their contractual partners in their actions. Even if those contracts for innovation

36 A duty of disclosure was found to exist in Banwaitt v Dewji [2013] EWHC 879 (QB), see para [72]. See also ING Bank NV v Ros Roca SA [2011] EWCA Civ 353; the case is mentioned by Andrews, who claims, however, that the distinction made in the case between ‘commerce in raw’ and transactions with ‘strong elements of collaboration’ was not made clear-cut and could disturb the law. Andrews (n 15) 252. 37 Ross River Ltd v Cambridge City Football Club Ltd [2007] EWHC 2115 (Ch), [2008] 1 All ER 1004 at [197] (Briggs J). 38 Section I.E below.

Duty to Share Information  171 are not fiduciary, partnerships provide the closest existing analogy regarding disclosure of information:39 If a partner comes into possession of information in the course of carrying on the partnership business or otherwise as a result of his connection with the firm and uses it to secure some personal benefit from the transaction which is within the scope of the partnership business, he will be accountable therefor. However, no such duty will in general arise if the transaction does not involve competition with the partnership business and falls outside its scope.

Aas v Benham (1891)40 provides a useful analogy. Benham was the partner in a shipbroking partnership company involved in negotiations with governments and shipbuilders. During parallel work in which he was employed by a third firm, he learned information about opportunities to reconstruct shipbuilding companies, which he used to produce a prospectus for the company, rendering him profits. His partners in the broking firm claimed he was liable to account for such actions and profits to them. The court held, however, that he was not liable, as the advice on reconstruction of companies was not within the scope of the partnership. The case indicates that, in activities outside the scope of the partnership, parties can retain valuable information from a partnership of which they are members. Even though the analogy is useful, one must have in mind the fact that, in contracts for innovation, parties may be competitors within the scope of the same kind of activity, while partners in specific projects. A company producing chemical components may ally with a research laboratory to produce a specific microorganism, while competing with the laboratory regarding other chemical components. The possibility to distinguish clearly the scope of the relationship, therefore, becomes less obvious than in partnerships. The second exception was Yam Seng itself, where the judge implied a duty to act in good faith during contractual performance, the prohibition to provide false information to the counterparty in the context of a ‘relational’ contract. Once again, this analogy has limited value, for Yam Seng implied a negative duty but not the positive duty to provide relevant information. In practice, this duty could comprise, for instance, as in FTC v Intel, the duty to provide early information about the design and technical specificities of microprocessors to supplied companies; or, as in Eli Lilly, the duty to provide information on chemical carrier compounds to be used in the collaborative project (but not beyond this scope). The conclusion to chapter three stated that English law could accept the potential intensification of a contractual clause establishing a duty to share information based on the notion of a duty of loyalty to the collaborative project/network. This interpretative guideline could derive from the principles

39 RA

40 Aas

Banks, Lindley & Banks on Partnership (Sweet & Maxwell 2010) 569. v Benham [1891] 2 Ch 244.

172  Legal Interpretation in Contracts of contractual interpretation in English contract law, as previously argued, and be applicable to a trans-typical category of contractual network to innovate or to Collins’ notion of productive networks.41 D.  Duty to Provide Information under Brazilian Law In the Brazilian law of obligations, there are two main regimes regarding the duty to provide information to a contractual counterparty: first, the general regime established by the Brazilian Civil Code and, second, the Brazilian Consumer Code regime. Further statutory rules may apply to specific kinds of relationships or types of contracts. Under the regime created by the Consumer Code, the duty to provide information is more intense than in the Civil Code,42 establishing rules applicable to relationships between consumers and suppliers. The consumer is defined, in the chapeau of Article 2 of the Consumer Code,43 as ‘the final recipient of a service/ product’. A company receiving a product but intending either to resell it or to use it in the chain of production of another output, therefore, is not normally considered a consumer. Therefore, companies that have a working relationship to co-create something would not normally be considered consumers when they receive something from each other, as they will be using these items not for consumption, but to further their productive activities.44 The second regime is established by the Civil Code, governing both civil and commercial relationships. The Civil Code contains no express provision creating a duty to provide information, but contains a general clause stating that good faith applies both in the conclusion and performance of contracts (Article 422). Both in the legal doctrine45 and in the case law,46 this general clause is considered 41 See the conclusion to ch 1 and F Cafaggi, ‘Il Contratto Di Rete Nelle Prassi: Verso Il Consolidamento’ in F Cafaggi, P Iamiceli and G Mosco (eds), Il Contratto di Rete per la Crescita delle Imprese (Giuffrè 2012) 156. 42 C Marques, Contratos No Código de Defesa Do Consumidor (8th edn, Revista dos Tribunais 2016) 873 ff. The main Consumer Code provisions on the duty to provide information are its Arts 6 and 31. 43 Brazilian Consumer Code, Art 2: ‘The consumer is every physical or juridical person who acquires or uses the product as its final recipient’ (free translation). 44 The prevailing position in the case law of the Superior Court of Justice, however, applies a so-called mitigated version of the final recipient theory. This means that the Consumer Code might apply to firms or physical persons in situations of vulnerability (such as small firms, lacking expertise), even when acquiring products to be further used in the chain of production. Therefore, the Consumer Code might exceptionally apply to civil and commercial relationships where the buyer is found to be vulnerable. Recent decisions endorse this view in the Brazilian Superior Court of Justice, eg, Interlocutory appeal in Special Appeal No 601234, Third Chamber, Justice Marco Belizze, judged on 12/05/2015; Interlocutory appeal in Special Appeal No 415244, Fourth Chamber, Justice Minister Antonio Carlos Ferreira, judged on 07/05/2015. 45 C Fabian, O Dever de Informar no Direito Civil (Revista dos Tribunais 2002) 45 ff. 46 See Superior Court of Justice, Special Appeal No 586.316/MG, Second Chamber, Justice Herman Benjamin, judged on 17/04/2007.

Duty to Share Information  173 as the potential basis to imply a duty to provide information. As aforementioned, one of the three functions of the general clause of good faith is to create secondary duties, not explicitly provided by the parties nor directly related to the main contractual performance, but necessary to its adequate performance.47 Among them is the duty to provide information in accordance with the standard of objective good faith. In commercial relationships, this concept will normally be connected with the standard of behaviour expected under commercial usage.48 The duty to provide information, as most duties derived from the good faith principle, presents a non-exhaustive list of applicable situations.49 As in English law, there are special categories of contracts where the parties have duties to provide information.50 Different from English law, however, is the existence of a broad good faith clause providing greater flexibility for judges to find collateral duties to provide information in different relationships, whenever they find this is a behaviour required under objective good faith, both in contract formation and performance.51 The following case provides insights on how this duty to provide information may prevail: a contractual partner claimed the right to terminate the contract with a shopping centre for the installation of a retail outlet in the mall.52 The shopping centre administrator had said that major large stores (‘anchor stores’) would be present in the shopping centre, but failed to inform the counterparty when those major stores decided to give up on opening outlets in the establishment. The claimant was found to be justified in terminating the contract, considering both that the shopping centre had promised that anchor stores would be present in the centre and had failed to inform the claimant about their withdrawal (after the formation of the agreement). There was a need, therefore, to keep the counterparty constantly informed about the deal’s commercial conditions. Beyond the question of the existence of a lateral duty to provide information, there is the question of the intensity of such duty to provide information, either implied through the clause of good faith or inserted in the contract by the parties themselves. In Brazilian law, there are two main variables to determine such intensity: subjective and objective factors.53 47 G Tepedino, Código Civil Interpretado Conforme a Constituição Da República (2nd edn, Renovar 2006) 18. 48 P Forgioni, Contratos Empresariais: Teoria Geral e Aplicação (Revista dos Tribunais 2015) 123 ff. 49 Fabian (n 45) 62–63. 50 eg, insured parties must provide the insurer with full disclosure of relevant information about the condition of the insured person/goods, Art 765/766 Brazilian Civil Code. Agents must provide full information about their acts in representing their principals, for they are in the best position to check the veracity of information; ibid 89 ff. 51 Under Art 422 of the Civil Code. 52 Superior Court of Justice, Special Appeal No 1259210, Third Chamber, Justice Nancy Andrighi, judged on 26/06/2012. 53 J Martins-Costa, ‘Um Aspecto Da Obrigação de Indenizar: Notas Para Uma Sistematização Dos Deveres Pré-Negociais de Proteção No Direito Civil Brasileiro’ (2012) 867 Revista dos Tribunais 11, 40 ff.

174  Legal Interpretation in Contracts The subjective factor refers to symmetry or asymmetry of the parties regarding the ability to have access to certain information. The more asymmetric the relationship is, the greater the presumption that information should be shared.54 The objective factor refers to the existence of special statutory rules regarding the need to share information or maintain confidentiality, the purposes of the contract and the information and the kind of contractual relationship.55 Further limitations may be encountered through the constitutional protection of privacy. i.  Contracts for innovation and duties to share information in Brazilian law First, for the reasons previously exposed,56 it seems that duties to share information should not be automatically implied under contracts for innovation to force the continuation of the cooperation. There must be a clear intention of the parties, established either in the recitals of the contract or in its clauses, demonstrating a willingness to produce something collaboratively, with exchange of information and knowledge and the intention to advance the cooperation by making the relevant information available to each other. The main issue is to determine the intensity of (or give concrete meaning to) broad duties of information established by the parties themselves, in situations where further specification was initially impossible (even in steering committees established by the parties) due to the high uncertainty of the relationship. Again, the variables to analyse these issues for ordinary relationships are insufficient. Consider the subjective factor of symmetry. It is completely non-applicable to fluid relationships of high uncertainty, where none of the parties knows ex ante more than the other since this is a context of innovation and discovery. Information will be developed/discovered as the relationship evolves. The concept of asymmetry, thus, cannot provide a valid guidance. Similarly, it is doubtful to what extent objective factors can provide guidance. There will normally be no statutory rules creating a duty to provide kinds of information that have still not been discovered. On the other hand, the kind of contractual relationship and the incentive structure of the agreement may provide some idea of the intensity that should be attributed to the duty to provide information. Perhaps one of the closest analogies to contracts for innovation (with relevant case law in Brazilian law57), despite significant differences, is the duty to provide information in financial instruments, especially derivative agreements. In such financial instruments there is a great deal of uncertainty as to the profits, 54 ibid 40 ff. This is the case, for instance, of the duty to provide full information about security rights over shares being publicly offered for sale, as the acquirer might have no access to such information before buying them. 55 ibid. 56 See opening of ch 3. 57 Superior Court of Justice, Special Appeal No 1214318, Third Chamber, Justice Sidnei Benetti, judged on 12/06/2012.

Duty to Share Information  175 dividends and interests that may be collected. A certain financial activity may yield a significant profit or result in huge losses. Therefore, there is a duty for the financial institutions concluding these agreements to thoroughly inform their customers about the risks of the financial operation, making clear those risks will be undertaken by the customer.58 The nature of the financial instrument itself is to allocate these activities’ risks to willing parties who, once informed, should be entirely responsible for them. The Superior Court of Justice, following this line of reasoning, refused to invalidate derivative instruments where parties had suffered significant losses during a period of the contract (receiving profits below expected), yet had been duly informed about all the risks involved in the financial operation.59 Despite the similar level of uncertainty, there is a crucial difference between high-risk financial instruments and contracts for innovation, explained by the conceptual distinction between risk and pure uncertainty.60 Whenever the odds of a certain event can be probabilistically estimated, there is a risk. The odds of a ship sinking, of fire or of weather events can be probabilistically established. Whenever it is impossible to use probability, then there is pure uncertainty. One cannot establish the probability in a project in which there is no previous experience, like innovative machines, new chemical compounds, etc. These are projects of pure uncertainty, where partners have no clue about the real possibilities of success and failure of their endeavour. Owing to this high uncertainty, there is often a continuous iterative process of specification of responsibilities, but not blunt acceptance of all risks from the beginning. For this reason, several mechanisms for continuous exchange of information are established, creating a constitutional process where violation is more the result of failure to follow certain procedures than failing substantial obligations that cannot be established. In summary, the analogy with financial instruments involving high risk does not provide a suitable guideline, for in contracts for innovation allocation of risks is normally a continuously evolving process rather than a one-time decision. As in English law, in most of the Brazilian legal doctrine the duty to provide information is considered in the context of conclusion of the contract, not during its performance. There is, however, no obstacle in implying or intensifying a duty to provide information in the context of performance.61

58 See J Martins-Costa, ‘Contratos de Derivativos Cambiais. Contratos Aleatórios. Abuso de Direito e Abusividade Contratual. Boa-Fé Objetiva’ (2012) 55 Revista de Direito Bancário e do Mercado de Capitais 321, para 24 ff, para 33 (mentioning the speculative function of these agreements, where the investor pays in advance a lower value for the financial title, expecting to receive in the future the full value of the financial instrument). 59 Superior Court of Justice, see n [57] above. 60 F Knight, Risk, Uncertainty and Profit (Martino Fine Books 1921) 19–20. 61 For the principle of good faith (Art 422 Civil Code) applies also during the phase of contractual performance.

176  Legal Interpretation in Contracts Under these circumstances, it is crucial to determine under what circumstances a duty would be intensified or not. The next section proposes such criteria, claiming that they could be derived from a contractual interpretation based on the guideline of a duty of loyalty to the network/collaborative project. E.  Identifying Criteria to Assess the Potential Intensification of Duties to Disclose Information under English and Brazilian Law An additional difficulty refers to the need to identify criteria to determine when the intensified duties of disclosure of information should apply. As was clear in Intel, there is a constant tension in these collaborative relationships between the information that should be disclosed to the contractual partner and the information that could be legitimately withheld. It is not possible to claim, in general and for all the kinds of information generated in the relationship, that an intensified duty of disclosure should prevail, even if it may prevail for specific kinds of information. It is important, therefore, to identify the criteria relevant to determine whether some piece of information should be disclosed. For identifying these criteria and the form of their application in each legal system, a general duty of loyalty to the network or to the collaborative project would provide a suitable general interpretative guideline. Any duty of the parties in the agreement, including a duty to share information, should be interpreted in light of the overall network: does it advance the interests of the collaborative project? As previously proposed, this duty could be incorporated in both English and Brazilian law through general principles of contract interpretation, without the need for legal reform.62 Subsequently, criteria are presented based either on the case law or on the logic of collaborative relationships to analyse such duty to share information. Each criterion could indicate a point along a spectrum where the duty of information should be more or less intense. What must be highlighted, however, is that in these relationships of high uncertainty, the parties cannot establish in advance the information that they would like to exchange and that which they should keep for themselves. In the creation of new chemical components, new engines, driverless cars, and so forth, parties often have not yet developed the know-how necessary to distinguish which information will be relevant to their project. Therefore, there is an impossibility to contractually allocate risks or benefits of their project; the parties rather establish processes of collaboration and continuous specification of their obligations. The first criterion would be the contract itself. What did the parties establish? Normally, there will be an inconclusive broad duty to share information ‘relevant to the project’ or ‘obtained in the course of the collaboration’. The next step would be to analyse whether there is an intention to develop a

62 See

Conclusion to ch 3.

Duty to Share Information  177 collaborative legal relationship. Did the parties seek to create a relationship where they would be co-creating something together and sharing its risks and liabilities, even though they remain competitors? Or did they intend to have an adversarial relationship where they could come apart any time? In Baird & Textiles Holdings Ltd v Marks & Spencer plc (2001),63 the lack of a written contract was seen as indicating the lack of intent in creating legal relations, even though the parties maintained a long relationship. In opposition, the existence of a written contract with sophisticated governance mechanisms, such as joint committees for managing uncertainty and the existence of an electronic platform for sharing certain information (present in Intel’s case), would be indicative of this need to share information. A second criterion would be whether the information at stake is essential for the development of the objective of the collaborative project. In Intel, the suppliers needed the specifications of the microprocessors to be able to manufacture the microcomputers in an effective and timely way. There is no reason to acquire a microprocessor from a company to produce microcomputers unless they can be successfully incorporated in the machine. On the other hand, information to be used in a parallel project, completely unrelated to the purpose of the parties’ agreed objective, would fail to comply with this requirement. This seems to be the case in Eli Lilly, where one of the partners used the information disclosed by the other (a carrier compound) to develop a chemical component unrelated to that agreed by the parties. The parties had agreed that the carrier compound should be used to develop a pharmaceutical allowing for the oral ingestion of insulin. Instead, the partner used the same carrier compound to develop a chemical compound to carry another product, a glycoprotein, in a secret research project without the participation of its partner. The court held there was a contractual violation and allowed termination of the joint research project by the aggrieved party. A third potential criterion, related to the logic of these collaborative relationships, would be to consider whether the party provided significant preliminary investments or participation to the discovery process. The need for preliminary investments to analyse the feasibility of a certain venture is a central characteristic of innovative projects.64 The preliminary investment 63 Baird Textile Holdings Ltd v Marks & Spencer plc [2001] EWCA Civ 274. Baird claimed that M&S was precluded from terminating its supply relationship with Baird without prior notice, despite the fact that the parties’ relationship was informal and lacked a formal agreement. Baird argued that the course of dealings between the partners involved a long-term relationship (more than 20 years) in which it was one of the major suppliers of textile to M&S and that there was a reasonable expectation that M&S would continue the relationship. The court refused to imply a duty to provide reasonable notice before the termination because the lack of a formal agreement would indicate the lack of intent to create legal relations. It further highlighted that the relation was too uncertain. M&S was free to request the quantity of clothing it wished from Baird, in the specifications that it wished, according to market fluctuations. There was, therefore, no objective guideline that could be used to imply any term to give certainty to the agreement. 64 See ch 2, section I.

178  Legal Interpretation in Contracts would be evidence of some form of participation in the discovery of the information unless there is an express contractual clause in a contrary sense. Sometimes the process of discovery led by one partner relies on essential information, materials or direct collaboration (such as cross-firm teams of employees) provided by the other. In conclusion, these are neither relationships where the interpretation of duties of cooperation should always be intensified nor relationships that should be presumed to be adversarial, with each party being able to withhold any contractual information not clearly identified to be shared, something difficult in the uncertain environment of innovation. As previously mentioned, governance mechanisms have a crucial role in defining the boundaries of the information to be shared; if they fail and adjudication (or renegotiation) is needed, then a concept of duty of loyalty could provide a suitable guideline to solve such issues.65 In summary, the better approach would be to analyse each duty in light of the overall objective of the common project of the parties, and then propose criteria under which each of these duties could be examined so as to judge whether it should be intensified or not. This is apparently the approach taken by courts in practice (as in Eli Lilly and FTC v Intel). Therefore, most of these criteria can be derived from the case law or, if not, through a consideration of the logic of the experimentalist business model created to innovate. As argued earlier, both English and Brazilian law could develop and apply these criteria of interpretation based on a duty of loyalty to the network, which can be elaborated based on the existing law, shunning the need for legal reform. These criteria would give effectiveness to the evolving expectations of parties in innovative projects. In practice, the parties are developing governance mechanisms addressing and often preventing these conflicts from arriving at the stage of adjudication. F.  Braiding Responses to Allocation of Information through Governance Mechanisms Even though, in limited situations, the legal doctrine may serve to adjudicate the allocation of information between contractual co-developers, it is increasingly common for sophisticated governance mechanisms to be employed to regulate this issue. A discussion about how these mechanisms could serve to potentially prevent a dispute from arriving at an adjudicatory body is presented below. Even though the formal mechanisms established in contracts are often unenforceable, they can nonetheless generate informal incentives (trust between



65 G

Teubner, Networks as Connected Contracts (Hart Publishing 2011) 184–86.

Duty to Share Information  179 the partners, business considerations that deter opportunism or facilitate coordination between the parties) that will serve to assure compliance with the collaborative purpose of the agreement. In other words, formal contracts or contextualising regimes are designed to create an environment where the parties will be encouraged, due to the informal incentives generated, to behave cooperatively. That ‘formal’, it must be emphasised, refers to the contracts established by the parties, not the legislation or case law relevant to a potential dispute. Economist Kenneth Arrow introduced the concept of disclosure paradox66 to describe the difficulty in exchanging information in the market. The buyer may want to know the details of the information before acquiring it, but if the seller discloses this information, then the buyer may absorb the knowledge and then refuse to acquire it formally. While intellectual property rights have been claimed as the best solution to this problem, at least until recently, it is nowadays recognised that other mechanisms can be useful in many situations, including contractual mechanisms.67 This is especially true in cases where the nature of the relationship between the parties requires the information to be constantly exchanged, updated or clarified.68 This is the case of Intel, where the microchip models are constantly updated, and Intel needs to transmit the relevant updated information to the supplied companies. A one-time intellectual property rights licence would not translate the needs of the constantly innovative transaction. In such cases, different forms of governance mechanism may be employed. One of them is establishing the exchange of information in different stages, involving different relational and reputational considerations, braiding informal and formal mechanisms. In pharmaceutical collaborations, for instance, the parties may initially collaborate and exchange information without a formal agreement; as their collaborations show promise they may sign a formal nondisclosure agreement.69 If they are further interested, they may sign a term (contractual or not) through which they will be signalling to the market the seriousness of their collaboration. Even if such a term is not formal, there may be reputational consequences flowing from information leakage, as the parties will have publicly informed the stage and ‘seriousness’ of their collaboration. Such behaviour could mean discredit for the breaching company in the market, likely to create obstacles for future deals with other contractual partners. Therefore, the written formal agreements, even without being enforceable, create relational

66 K Arrow, ‘Economic Welfare and the Allocation of Resources for Invention’, The Rate and Direction of Inventive Activity: Economic and Social Factors (Princeton University Press 1962) 609. 67 MJ Burstein, ‘Exchanging Information Without Intellectual Property’ (2012) 91 Texas Law Review 227, 230 ff. 68 Consider the example of constant need for iterative exchange of information among biotechnological companies for research and development of pharmaceuticals; ibid 232. 69 ibid 266.

180  Legal Interpretation in Contracts incentives (risk of business discredit) that encourage a cooperative behaviour between the contractual partners. Another mechanism that can serve that purpose is joint committees between the collaborating firms. According to Jennejohn,70 the risk of spillovers is one of the major transaction costs that may arise in collaborative development, especially in situations where the parties establish that the IP resulting from their joint venture (foreground IP) will be jointly owned. In such cases, there will be a need to constantly establish the contours of the IP rights, determining what kinds of use may be adequate or not. The parties will then formally establish joint committees with the competence to make these kinds of decision, delineating detailed procedures for their operation, which may require unanimous vote (establishing veto rights) or majority votes or define that some specific partner has the right to determine the outcome. The joint committees may be designed according to different models, each of them embodying a distinct incentive structure. While Jennejohn refers to the role of joint committees in determining the spillovers of foreground IP, it would be theoretically possible to establish that such committees are responsible to determine the scope of broad clauses to disclose information in their agreements, specifying also how the decision will be made within the committee (veto power, majority). By setting a formal decision-making procedure involving significant interactions between the firms, more chances for the generation of informal incentives, such as communication, trust and coordination, are created. The formal braids with the informal. The formal creation of patent pools has also been used as a strategy between competitor companies to avoid litigation over patent infringement and to encourage the creation of new product lines through socialisation of knowledge.71 The companies formally cross-license their patents to each other, creating a pool from which all other companies in the pool will have automatic licences to make use of, often charging a royalty fee commensurate with the number of patents they hold in the pool. In the hard disk drive industry, this strategy has been employed to avoid conflicts between competing firms and to accelerate the process of innovation, with companies cross-licensing their entire patent portfolio to each other.72 This formal strategy, therefore, generates an informal business incentive for the parties to lower their guard, communicate effectively, share know-how relevant to their collaboration and more intensely innovate. The downside of this strategy, however, is a tendency for companies to rush to create new patents to obtain a superior position in the patent pool where

70 M Jennejohn, ‘The Private Order of Innovation Networks’ (2016) 68 Stanford Law Review 281, 315 ff, 338–340, 344 ff. 71 LA DiMatteo, ‘Strategic Contracting: Contract Law as a Source of Competitive Advantage’ (2010) 47 American Business Law Journal 727, 757. 72 ibid 758.

Duty of Non-Discrimination  181 they receive more royalties, lest the ‘membership’ of the pool becomes too costly and they be excluded from it, having to give up on certain technologies or face the danger of patent infringement. II.  DUTY OF NON-DISCRIMINATION IN THE COLLABORATIVE CONTRACTUAL NETWORK

This section is divided into six parts. First, it introduces the issue of nondiscrimination in collaborative contractual networks for innovation (A). Second, it examines a decision by the German Federal Court on this issue (B). Next, it analyses how a similar matter would be potentially examined under both English law (C) and Brazilian law (D). Then, it identifies potential doctrinal criteria to determine when a duty of non-discrimination in the collaborative network should arise (E) and finally, it discusses experimentalist forms of governance suited to deal with this matter (F). A.  Prelude: Similar Opportunities for Competing Companies in Quasi-organisational Collaborative Ventures? The principle of freedom of contract73 in private law tends to reject the existence of a duty of equal treatment between parties in a purely commercial setting, refusing to require agents in the market to extend to all parties alike the most favourable contractual conditions they have offered in contracts for similar goods or services.74 The basic principle is freedom to contract with whoever offers the best opportunities, using influence to close the best possible deal, within certain limits.75 In special circumstances, however, private law may establish a duty of nondiscrimination, requiring similar conditions or opportunities to be equally offered to different partners.76 Such duty is most often established either through

73 Discussing the content of the concept of freedom or autonomy of contract, see G Alpa, ‘Party Autonomy and Freedom of Contract Today’ (2010) 21 European Business Law Review 119, 125–26. 74 There are, in special cases, mandatory obligations to contract (as in the provision of certain public services) or grounds of discrimination that would violate public policy (gender, sexual orientation, race). Discussing the law on anti-discrimination as one of the most important and difficult issues for contract law, see S Grundmann, ‘The Future of Contract Law’ (2011) 7 European Review of Contract Law 490, 506–07. 75 According to neoclassical contract theory, this freedom would ensure competition in the market and (indirectly) advance the best interests of society. On the origins of this idea, in classical economics and especially in Adam Smith, see PS Atiyah, The Rise and Fall of Freedom of Contract (Oxford University Press 1985) 292, 294 ff. 76 J Wiemann, ‘Obligation to Contract and the General Act on Equal Treatment’ (2010) 11 German Law Journal 1131.

182  Legal Interpretation in Contracts competition law or through broader private law rules, acquiring different contours according to the jurisdiction involved. Such a duty of non-discrimination in contractual networks to innovate would translate in the following principle: the leading company or organising body (such as a coordinating steering committee or a third-party external organisation) in the network should provide all the network members with the same opportunities to participate in its activities, unless there is a r­easonable justification allowing one member to receive a more favourable treatment. For instance, two suppliers of a major automobile company have made similar specific investments to provide tailored products to fit the network product. Unless there is a reasonable justification (best technology, more product reliability, etc), the major company should not discriminate against one of the member companies by, for instance, rejecting to share a proportional surplus of profits voluntarily extended to the other supplier. In other words, the network leader should not unjustifiably discriminate between the network members. The issue whether a discrimination is justifiable or not is analysed later.77 In short, the discrimination will be legitimate if it is necessary to fulfil the purpose of the network. In this sense, it refers to a duty of loyalty to the network, that is, giving preference to the activities that will advance the project’s objective. This duty can acquire, according to the situation, either a positive or a negative content. If the discrimination is considered legitimate for network purposes, there should be a positive duty to grant benefits to the party performing better or providing a differentiated performance; if unjustifiable, there should be a negative duty, imposing non-discrimination. In general, the rationale for the duty of non-discrimination established in competition law is to protect free competition in the market, barring situations where dominant parties or parties undertaking agreements may unjustifiably create an anti-competitive framework. In certain cases, other private law rules may go beyond that, establishing the protection of the legitimate interests of the parties where there is an unreasonable restriction of their ability to trade or to perform their expertise or by establishing the protection of special public policy interests. This section analyses whether there should be a duty of non-discrimination in private law in the ambit of quasi-organisational ventures where independent companies are strongly integrated, as in collaborative contractual networks.78 This issue is far from settled, but there are decisions involving similar factual patterns that can provide useful analogies to the subject. The issue is not simply to assure real competition in the market or to regard the parties’ legitimate interests per se, but rather to respect the economic logic established within a group



77 See

section II.E below. this possibility, see Teubner (n 65) 188–89; Wellenhofer (n 4) 127–28.

78 Defending

Duty of Non-Discrimination  183 structure. This argument for a duty of non-discrimination between members of a collaborative network (not erga omnes) becomes particularly strong when the group integration involves duties of collaboration and sharing of risks and profits. Even if parties remain independent and retain an experimental nature in their relationship, they often make specific investments to join the network venture. While there should be no obligation for the ‘centre’ of the network to contract in adverse conditions with the nodes, the least that should be assured to them, in this logic of collaborative experimental network, is to receive the same opportunities to compete with other partner firms (resembling a most favoured nation clause), or to receive justifications on why other firms are being provided more opportunities. Otherwise, the logic of ‘competition’ in the network is breached; one of the firms, having done specific investments and being economically tied to the project, cannot compete in the same standing with other companies in the network due to an arbitrary decision of the chain leader. B.  Integrated Distribution Networks with Collaborative Duties and Sharing of Risks and Profits A leading case of the German Federal Court or BGH (Bundesgerichtshof) regarding the violation of loyalty duties in relationships between producers and distributors involved in a contractual network is the decision of 10 February 1993.79 The defendant was the subsidiary of a Japanese electronics company. It established distribution channels for its monitors and printing machines through several main firms (Haupthändlern). The distributor companies had strong obligations of collaboration with the defendant. Initially, to provide technical support, sales training and assistance with hardware and software for the retailers. Furthermore, they had to provide weekly status reports and monthly market prognostics and created a special department to attend to the defendant’s needs. The relationship, therefore, involved a high degree of collaboration. The contract clearly established that none of the main distributors had an exclusive right of distribution. The issue was whether the defendant had the right to engage in direct distribution of some of its products to retailers without the intermediation of defendants. The BGH, interpreting the contract, stated that the producing company had the freedom to engage other companies in its distribution chain, for the contract established no exclusive distribution right for the claimants. However, since a ‘distribution network’ (Vertriebsnetz) had been established, with strong commercial cooperation, then stronger duties of loyalty (­Treuepflicht) 79 BGH (1993) VIII ZR 47/92. This decision and its facts are described by KJ Hopt, ‘Wettbewerbsfreiheit und Treuepflicht des Unternehmers bei parallelen Vertriebsformen’ [1996] Zeitschrift für Wirtschaftsrecht 1533, 1536.

184  Legal Interpretation in Contracts exceptionally arose, limiting the defendant’s possibility to distribute its products directly into the market. Although the decision did not establish a formula, it presented potential criteria (discussed below) to guide the application of this duty of loyalty. According to the BGH, The more the merchant is integrated in the distribution organisation of the defendant and supports it through capital and human resources, the more consideration s/he might expect to its legitimate market interests (free translation).80

Suppose, for instance, that, in the circumstances of this case, the supplying company engages a new distributor, providing it with the same product for a slightly lower price or with more favourable payment conditions. This resembles a ‘price discrimination’ practice (although this violation normally happens in a different background, involving the abuse of dominant power by a monopolistic company).81 The claimant may not even be ‘tied’ to the contract formally, but it is in fact, whenever it has made significant investments in building capabilities specific to perform for the supplier. The issue, therefore, is whether a similar intensification of duties of loyalty would apply in certain circumstances between companies establishing collaborative networks for innovation. Do the parties have an obligation not to discriminate unjustifiably or to provide equal opportunities to different companies in their collaborative network and, if so, which circumstances deploy such need? These kinds of arrangements display an intense interdependency between the parties, created by the sunk investments in their relationship, the information exchanged and the actual direct working relationship. Once more, however, this need for greater cooperation must be balanced with the flexibility to experiment required to innovate. This means that the parties should not be constrained from establishing cooperation and giving prevalence to those partners most prepared in the network to deliver a certain service, rewarding them for their meritorious contribution. This network ‘meritocracy’, which allows giving greater rewards for those parties who can provide the best performance, should be justified and not serve as an excuse for an unjustifiable discrimination in favour of certain companies. This would follow the business logic inherent in network relationships, into which parties enter having the expectation to be able to compete and cooperate simultaneously. As mentioned in chapter three, sections II.A and II.C, the concept of loyalty to the network refers to the business logic of the deal.

80 ibid. ‘Je mehr die Händler sich in die Vertriebsorganisation der Beklagten eingliederten und diese durch den Einsatz von Kapital und Personal unterstützten, um so mehr Rücksicht auf ihre legitimen Marktinteressen durften sie erwarten.’ 81 D Geradin and N Petit, ‘Price Discrimination Under EC Competition Law: Another Antitrust Doctrine in Search of Limiting Principles?’ (2006) 2 Journal of Competition Law and Economics 479.

Duty of Non-Discrimination  185 C.  English Law i.  Competition Law: Unlikely Applicability to Collaborative Relationships to Innovate In English law, the applicability of a potential duty of non-discrimination should be considered on two levels: first, in the level of competition law; and second, on the level of the common law, through the doctrine of restraint of trade and through contractual interpretation. Until recently, a decision issued by the ECJ applying EU competition law would take precedence over any decision by a UK court applying the doctrine of restraint of trade.82 When the UK was still an EU member, in undertakings involving and having an impact on different EU Member States, therefore, the potential application of the doctrine of restraint of trade could be prevented by EU law, as long as the matter fell within its jurisdiction.83 Even with Brexit, however, the judicial precedents from EU competition law may present relevant insights for understanding this matter under UK competition law. As further pointed out, there are similar provisions and the results would probably be similar under both legal orderings. The relevant provision for the case at hand is Article 101 of the Treaty on the Functioning of the European Union (TFEU)84 (relevant parts equivalent to ss 2(1) and 2(2)(d) of the UK Competition Act), which establishes that certain agreements between companies may be illegal whenever they affect trade between Member States and distort competition. More specifically, Article 101(1)(d) is relevant for this section because it establishes that such agreements should not create dissimilar conditions for the same kinds of transaction between different trading parties. A difficulty in exploring the relevance of EU competition law for experimentalist collaborative relationships is determining whether these rules apply to them. One premise for the application of Article 101 TFEU (mirrored in Article 2(1)(b) of the UK Competition Act) is that certain behaviours have ‘as their object or effect the prevention, restriction or distortion of competition within the common market’. There is no clear approach to be followed in all cases,

82 On the interaction between EU law and UK common law on this topic, see MC Lucey, ‘Europeanisation and the Restraint of Trade Doctrine’ (2012) 32 Legal Studies 623. 83 On the applicability of EU Competition rules, especially of Art 101 TFEU, which might overlap with the restraint of trade doctrine, see M Furse, Competition Law of the EC and UK (Oxford University Press 2008) 167 ff. 84 Art 101 TFEU: ‘1) The following shall be prohibited as incompatible with the common market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market, and in particular those which: … (d) apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage.’

186  Legal Interpretation in Contracts but criteria have been elaborated to assess this effect, such as the market position of the supplier and the buyer, entry barriers, maturity of the market, level of trade and nature of product, among others.85 The Communication from the [EU] Commission, Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal cooperation agreements,86 sets out types of horizontal joint venture that, in its view, are not covered under Article 101.87 It claims that: Consequently, horizontal cooperation agreements between competitors that, on the basis of objective factors, would not be able to independently carry out the project or activity covered by the cooperation, for instance, due to the limited technical capabilities of the parties, will normally not give rise to restrictive effects on competition within the meaning of Article 101(1) unless the parties could have carried out the project with less stringent restrictions.

Other factors are relevant,88 but the above-mentioned specifically creates significant obstacles for the applicability of competition rules on horizontal experimentalist collaborations to innovate (in the same phase of the production or distribution). These projects involve the inability of one company performing them alone, whether for the commercial risks, for the lack of expertise, for the level of investments needed or other factors. In relation to vertical agreements (parties located in different phases of production/distribution), other obstacles make difficult the application of Article 101 TFEU.89 Foremost, the Block Exemption Regulation, which establishes in Article 3 that, unless the buyer’s market share in the relevant purchasing market and the supplier’s market share in the relevant selling market are above 30 per cent, then vertical agreements between companies are exempt from the Article 101 TFEU scope of application.90 This clearly restricts the applicability of Article 101 TFEU to collaborations of considerable magnitude. An additional limitation is the ECJ jurisdiction, limited to cases where ‘the agreement in question may have an influence, direct or indirect, actual or potential, on the pattern of trade between the Member States’.91 These observations serve to indicate that there are significant challenges for a discriminatory practice in a collaborative network to amount to an 85 Furse (n 83) 181. 86 Available at eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX%3A52011XC011404)#ntc31C_2011011EN.01000101-E0031. 87 A Kamerling and C Osman, Restrictive Covenants Under Common and Competition Law (Sweet & Maxwell Ltd 2004) 214. 88 ibid 214 (further discussing relevant factors in examining the applicability of Art 101 [then Art 81] TFEU). 89 On the approach of the Commission, see EU Commission Guidelines on Vertical Restraints, available at eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=OJ:C:2010:130:FULL&fro m=EN. 90 ibid, para 23 ff. 91 Case 56/65 STM v Maschinenbau Ulm [1966] ECR 234; Joined Cases 56 & 58/64 Consten and Grundig [1966] ECR 299 and Case 126/80 Salonia v Poidomani [1981] ECR 1563.

Duty of Non-Discrimination  187 a­ nti-competitive practice. The topic of restrictive clauses in UK competition law will not be further examined, but it suffices to say that, similar to EU law, normally they will not represent an actionable issue in joint ventures.92 Perhaps this legal absence may relate to the fact that English common law has a doctrine of restraint of trade applicable to similar situations. ii.  Common Law: Doctrine of Restraint of Trade and Contractual Interpretation The doctrine of restraint of trade in English law is a manifestation of the doctrine of illegality in private law, ‘an intricate web of tangled rules that are difficult to ascertain and distinguish’ but providing a justification for the denial of relief to a party to prevent protecting a wrongdoer or an inadequate behaviour.93 The doctrine of restraint of trade developed in the common law to protect parties against unjustifiable restrictions to the exercise of their economic activities in the market.94 This doctrine’s rationale is that, for the benefit of society, parties should be able to perform their trade or to employ their knowledge and expertise freely.95 To prevent such activities would create a public policy violation. However, every restraint should be analysed case by case, to assess whether there is reasonable justification for it. In general, for the restraint to be legal, the interest protected must be legitimate and the reasonableness justifiable from two different perspectives:96 1) it must be reasonable having in view the parties’ interests;97 2) it must be reasonable from a public policy perspective.98 Although there is not a closed list of types of contracts where restraint of trade can be configured, this doctrine is often applied in employment contracts, in sale of business, in exclusive supplier agreements, in joint ventures and in commercial vertical agreements, among others.99 92 Kamerling and Osman (n 87) 217. For a broader discussion, see ibid, 313 ff. 93 Andrews (n 15) 563. 94 Beale (n 20) 16-087 ff. 95 This doctrine in the English common law has a counterpart in competition law where, however, different requirements and consequences might flow from a similar behaviour. Consider, for instance, Art 101(1) Treaty on the Functioning of the European Union (TFEU), which prohibits parties from establishing cooperation agreements that might lead to distortion of competition in the market. See M Lorenz, An Introduction to EU Competition Law (Cambridge University Press 2013) 128 ff. On the interaction between EU law and UK legal rules on competition law and on the common law doctrine of restraint of trade, see Lucey (n 82) 623. 96 This test was developed in Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535. See also Andrews (n 15) 579. 97 Beale (n 20) 16-103, 16-104. 98 ibid 16-105. 99 In each context, the analysis of the doctrine of restraint of trade will involve different rules and interests protected. In employment contracts, limitations found to be in restraint of trade include unreasonably lengthy non-compete clauses, preventing parties finding similar jobs for an unreasonable period of time after leaving a company. See Stenhouse Australia v Philips [1974] AC 391; Printers & Finishers Ltd v Holloway (No 2) [1965] 1 WLR 1. Similarly, restraint of trade was found

188  Legal Interpretation in Contracts There is, to this day, one English case on restraint of trade specifically dealing with joint ventures (however, involving a corporate joint venture): Dawnay Day & Co Ltd v D’Alphen (1997).100 In this case, three European brokers entered into a shareholders’ agreement with a company to create a ‘joint bond broking’ firm (DDS). The shareholders’ agreement contained a non-compete clause establishing that, after leaving the company, the defendants were prevented for a period from engaging in business competition. The Court of Appeals considered that one limitation, to entice away employees of the firm, was too broad and unenforceable. The Court of Appeals, however, considered that the other limitations were enforceable, rejecting the defendants’ argument that there was no protected interest in the case: relying on Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd (1967)101 and Office Angels Ltd v Rainer Thomas and O’Connor (1991),102 it stated that there were no established or rigid categories of interests that should be protected, opening the possibility for the protection of legitimate interests of joint ventures. In other cases, courts considered that reasonable justifications allowed for the discriminatory behaviour to prevail. Nonetheless, courts also required a second element: the discriminatory measure application should be ‘adequate’ and ‘proportional’ to attain the objective of protecting the interest.103 Notably, English cases providing useful analogies are those involving price discrimination in solus agreements, in litigations between oil suppliers and supplied firms. These cases could provide a relevant analogy for conflicts internal to a contractual network. They involve cooperation between the partners to provide a service in the market and raise a conflict whether the actions of one of the members would illegally affect the other party’s position or profitability in the market. Two relevant cases are Shell UK Ltd v Lostock Garages Ltd (1976)104 and Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd (1967). In Shell, a gas petrol station had a solus contract with Shell for exclusive oil supply for a fixed resale price. With the oil crisis, the prices dropped unreasonably below in contracts giving publishers exclusive rights over the creations of their hired songwriters plus the right to decide whether and when to publish the work, without the songwriters being able to escape the deal: Macaulay v Schroeder Music Publishing Co Ltd [1974] 1 WLR 1308. For a broad examination of these different possibilities, see Kamerling and Osman (n 87) 214. 100 Dawnay Day & Co Ltd v D’Alphen [1997] IRLR 442, CA. This case is discussed in ibid 211. 101 Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1967] 1 All ER 699. 102 Office Angels Ltd v Rainer Thomas and O’Connor [1991] IRLR 214. 103 See Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1891–94] All ER Rep 18: ‘Restraints of trade and interference with individual liberty of action, may be justified by the special circumstances of a particular case. It is a sufficient justification, and indeed, it is the only justification, if the restriction is reasonable – reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to the interests of the public, so framed and so guarded as to afford adequate protection to the party in whose favour it is imposed, while at the same time it is in no way injurious to the public.’ Enforcing a similar position, see Lord Morris in Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1967] 1 All ER 699, at 716: ‘The appellants allege that the agreements were reasonable as between the parties. The onus is on them to show that this is so. They must show that the restraint affords them no more than adequate protection for those interests which they have a right to have protected.’ 104 Shell UK Ltd v Lostock Garages Ltd [1976] 1 WLR 1187.

Duty of Non-Discrimination  189 the market reality. To compensate, Shell created a special discount scheme to several of its supplied companies but argued that Lostock was ineligible for that discount. Lostock then sought oil from another supplier offering a lower price and Shell sued Lostock, claiming breach of the exclusivity of the agreement. The court held that the fixed price had become, during the oil crisis, an unreasonable restraint of trade and, therefore, was unenforceable during this period. Regarding the period before and after the discount scheme was offered to other companies, however, the court considered that the fixed price was reasonable and valid (especially having in view the temporal limitation of the term). The court refused to imply a term that contract clauses rendering a partner’s commerce unviable are invalid and upheld the agreement’s express terms. In Esso, the garage Harpers concluded two agreements to buy petrol exclusively from Esso. In the first, the counter-benefit for four and a half years’ exclusivity would be a discount price for the petrol. In the second, the counter-benefit for 21 years’ exclusivity would be a mortgage loan of £7,000. The court held that the first agreement was valid, but not the second, for the length of time of protection was beyond that reasonable to protect Esso’s interests. In summary, competition law rules seem to be mostly inapplicable to innovation contracts, but the restraint of trade doctrine could provide a legal basis for a network member arguing against discriminatory behaviour in an innovation network. The restraint of trade doctrine, however, has two limitations previously analysed (in chapter three, section II.2.C): 1) it simply restricts certain kinds of behaviour, instead of identifying through contractual interpretation positive duties of the parties; and 2) it is based on a logic of ‘separation’ of spheres that hardly mirrors experimentalist relationships mingling cooperation and competition. Thus, it seems insufficient to deal with collaborative contracts to innovate. A better avenue would be to identify criteria that would justify finding a duty not to discriminate in the network, based on duty of loyalty to the network, a potential guideline for contractual interpretation within the current English contract law.105 D.  Brazilian Law The starting point to analyse this issue in Brazilian law is Article 170 of the Brazilian Constitution, setting out the principle of free competition as a pillar of the economic order. This principle must be balanced with whatever behaviours affect it in the market and, in certain circumstances, with freedom of contract. As in English law, restrictions to competition are analysed in two main realms. First, in competition law (especially Law 12.529/2011). Second, in the general private law, particularly the Civil Code general clauses (such as good faith).



105 See

section II.E, below.

190  Legal Interpretation in Contracts i.  Competition Law In most situations, Brazilian competition law rules would not apply to collaborative contractual networks for innovation. The relevant article regarding anti-competitive behaviour is Article 36 Law 12.529. In assessing anti-competitive behaviour, both the doctrine and the case law recognise that the guiding principle should be reasonableness,106 that is, a behaviour’s negative effects should be balanced with potential benefits in the market (for customers, for instance); only when the overall result is negative should such behaviour be sanctioned. This principle applies in general, except for situations where there are behaviours that are per se considered anti-competitive (cartels, for example). In practice, potential forms of collaborative networks of contracts for innovation will hardly fall under the scope of competition law. Regarding horizontal cooperation agreements between competitive companies, it has been recognised that these cooperative contracts may represent acts of economic concentration107 and be subject to a previous legality examination by a competition authority (the ‘CADE’) or to an ex post examination of potential anti-competitive conduct, under Article 36.108 A previous legality examination would require the cooperation agreement to comprise at least 20 per cent of the relevant market, significantly limiting the scope of its application.109 Regarding an ex post analysis, there are few guidelines to undertake this examination and few cases have been litigated.110 The more anti-competitive effects these conducts have, coming close to the effects of a cartel, the more potential they have to be sanctioned. Relevant criteria include the market share of the parties, their allocation of clients or geographical markets and fixing of prices to the market, among others.111 In relation to vertical agreements, again it appears that the infraction is limited to cases where one party has a dominant position over the other(s) and uses this position to abuse them.112 In competition law, this dominant position involves monopoly or a situation where ‘a company or a group of companies are capable of unilaterally or coordinately altering the market conditions or when it controls 20 per cent or more of the relevant market’.113 Therefore, a discrimination within a vertical collaborative contractual relationship, in competition law, will not exist without a dominant position.

106 CM Pereira Neto and PL Casagrande, Direito Concorrencial (Saraiva 2016) 72. 107 Under Art 2, §1, I of Resolution 10/2014. 108 Pereira Neto and Casagrande (n 106) 96. 109 Under Art 2, §1, I Resolution 10/2014. 110 Pereira Neto and Casagrande (n 106) 97. 111 ibid. 112 GS Diniz, ‘Dependência econômica nos acordos verticais’ (2014) 15 Revista de Direito Privado 91, 103 ff. 113 Art 36, §2 Law 12.529/11. Regarding the concept of dominant position in Brazilian law, see Pereira Neto and Casagrande (n 106) 102.

Duty of Non-Discrimination  191 In summary, Brazilian competition law seems to narrow down its applicability to situations where the opportunistic behaviour of a certain party in a collaborative contractual network would be hardly sanctioned. Discrimination between network members would be allowed in most cases under Brazilian competition law, with certain limitations for the cases where there is a significant market share involved in the operation undertaken or the leading company exerts a dominant position. ii.  General Principles of Private Law A discriminatory behaviour in a collaborative contractual network could also be analysed under (or by analogy with) general private law principles. The initial difficulty is to find a legal basis to sanction a freely agreed contract. The concept that comes to the forefront is the notion of abuse of economic dependence, which could potentially be applied to a collaborative contractual network. This concept has not been formally established in the Brazilian legislation but has been developed in the legal doctrine as a derivation of the good faith principle. This concept could be applied by courts to the situation under analysis without the need for legal reform. It should be embraced through a contractual interpretation considering these agreements’ specificities, under the good faith principle. The concept of economic dependence was characterised as a ‘decisive power influence from one party to impose conditions and circumstances upon the other, who accepts them to remain in the contract and in the market’.114 As in many commercial relationships, economic dependence is created by the contract requiring specific investments from the parties to fulfil the contractual obligations.115 Different Civil Code provisions translate this idea.116 The potential basis for abuse of economic dependence would be the notion of objective good faith (potentially applicable in the phase of contractual performance) or the concept of abuse of rights, already examined.117 The notion of objective good faith requires from the contractual partner a behaviour expected under the commercial standard. The concept of abuse of rights would be translated into the notion that a contractual party should not act beyond the social economic aim of its rights. In distribution contracts, Forgioni claims that the criteria for assessing the social economic aim should be legal efficiency: the

114 Diniz (n 112) 96. 115 Forgioni (n 48) 168–70. 116 eg, the prohibition of clauses providing a party with the power to unilaterally establish contractual terms (Art 122), unjustified enrichment (Art 84), provisions on burdensome contracts (‘lesão’ – Art 157 CC), abuse of rights (Art 187), unilateral termination of a contract (Art 473) and good faith. See Diniz (n 112) 98. Notably, according to Art 473, a party to a long-term contract is prevented from terminating the relationship until its counterparty has recouped its investments in the joint venture. 117 Discussing these concepts, see ch 3, section II.B.i and ii.

192  Legal Interpretation in Contracts global gains from a certain action should surpass the potential losses for an individual firm resulting from the contested behaviour.118 Otherwise, there may be indicia of abuse of rights. On the other side, there is the argument that the parties may have established a contractual architecture knowingly allocating their venture risks, i.e. specific investments were a risky gamble in a project without guaranteed return. In the backdrop of contracts for innovation, this allocation of risks should be closely examined as, in many cases, it involves pure uncertainty and not risk.119 This discussion leads to the conclusion that one single behaviour may be interpreted either as an abuse of a firm in a situation of economic dependence or as a legitimate contractual allocation of risk. Once more, there is a need to identify criteria that could serve to distinguish both. Once again, the notion of a duty of loyalty plays a central role. E.  Criteria to Identify an Unjustifiable Discrimination in the Network As argued before, both Brazilian and English laws of contract could potentially adopt a duty of loyalty to the network through contractual interpretation principles.120 This guideline could serve to determine in which situations the discriminatory behaviour, at first glance allowed under freedom of contract, amounts to an unjustifiable discrimination. This interference with the freedom of contractual parties would be exceptional and applicable specifically to situations where a close network of companies has been developed, ‘tying’ (to a certain extent) the resources of companies in the network. A duty of loyalty to the network could provide a guideline to determine when the interests of the discriminated party should be given more consideration. The core idea, as defended by Hopt,121 is that the greater the level of integration of one company in the other firm’s activities, the more consideration should be given to its interests and, consequently, to the need not to discriminate against it in relation to other firms providing similar products/services. More than simply a duty not to harm the other party, this is a duty to take into consideration, to a certain extent, the other party’s interests. The author points out potential criteria to identify a greater level of integration which could lead to a duty to treat different parties in the network equally. While these are meant for the context of a collaborative network of distribution, the same criteria could apply analogically to other collaborative relationships.

118 Forgioni (n 48) 431–32. 119 Knight (n 60). This evokes the category of aleatory contracts in civil law, where the outcome of the contract is dependent upon unknown contingencies and the contractual partners accept the risk of failure. O Gomes, Contratos (26th edn, Forense 2008) 88–90. 120 See conclusion to ch 3. 121 Hopt (n 79) 1536.

Duty of Non-Discrimination  193 They include: the establishment of a duty to distribute exclusively products by the other party, the imposition of contractual obligations to support the transfer of goods, the assumption of certain risks related to the product/service to the distributor or intermediate agent and the alignment of their line of business to the needs of the products of the producer.122 In English cases of solus agreements, in fact, the existence of commitment to exclusively distribute products from a certain supplier was considered a factor that could lead to an unreasonable restraint of trade if the same products are being offered to other suppliers for better prices, without reasonable justification. This approach has been followed in Esso, for instance. In cases involving solus agreement, the differential resale price established for third-party customers, by affecting the supplied companies’ profit margins and competitiveness, represented a discrimination between the supplied companies themselves. For that reason, those could serve as an analogy to cases involving a discrimination within the network. Regarding the imposition of contractual obligations, Article 122 of the Civil Code sanctions one party’s unilateral power to impose contractual conditions upon its counterparty. This rule has been applied, for instance, in situations where the guarantor has renounced the right to terminate the surety given to rent contracts in favour of third parties after their expiration (allowing automatic renewal). To accept this waiver would amount to giving the tenant an arbitrary indeterminate power over the guarantor.123 In the BGH case, similarly, the existence of a tailored performance and investments of the distributor to better serve the needs of the network were factors giving more weight to the interests of the distributors. The need to protect specific investments is given importance in different legal systems, especially through rules governing long-term contracts, sometimes barring termination before the recoupment of investments. In situations involving stronger integration, with the parties having made preliminary investments in each other, being interdependent, there should be a presumption that different network members should be provided with equal opportunities to produce/distribute. That does not mean that discrimination should not be possible based on reasonable commercial criteria, such as the capabilities of the different parties, costs of production and expertise, among others. The different parties, however, should be offered at least the possibility of freely competing among themselves to participate in the network activities. However, at the same time, a certain level of justifiable discrimination should be accepted; for meritorious parties with special expertise, capabilities and potential in the network should be given preference if that brings greater benefits to the network project. Therefore, this duty can assume, according to the situation, 122 ibid 1538–39. 123 Superior Court of Justice, Special Appeal No 1426857/RJ, 5th Chamber, Justice Regina Helena Costa, judged on 13/05/2014.

194  Legal Interpretation in Contracts either a positive or a negative content. If the discrimination is considered legitimate for the network purposes, there should be a positive duty to grant benefits to the party performing better or providing a differentiated performance; if illegitimate or inadequate, there should be a negative duty imposing non-discrimination. The issue is to determine when the discrimination is adequate. This notion of adequacy is similar to the application of the principle of proportionality to analyse the legitimacy of certain discriminatory behaviour, present in different contexts and legal jurisdictions – for instance, German public law – and recognised as a general principle of law by the European Court of Justice.124 This principle serves to analyse whether the exercise of a certain power or right conferred on a party must be restricted because it is disproportional with other applicable legal principles. For instance, the right to freedom of expression is guaranteed in many national constitutions but may be limited in certain cases, if this limitation is proportional to the need of protecting another ‘pressing social need’ in a democratic society.125 For present purposes, the issue is whether a discrimination of one network member would bring more benefits to the overall network project or whether equal treatment should be assured based on the level of inter-firm integration. The proportionality principle comprises three steps.126 In the first step, the adequacy of the measure is considered: does it achieve the intended purpose? Second, the necessity of the measure is analysed, that is, whether there are alternative measures less restrictive to achieve the envisaged purposes. Third, the proportionality strictu sensu is considered: does the overall benefit brought by the measure surpass the potential burdens that it carries? A similar framework could be used to analyse whether discriminatory measures aimed at safeguarding legitimate interests are being applied in a proportional way. Kennedy has claimed that this same analytical tool, generated in the context of public law, can be applicable in European private law.127 Thus, discrimination should be allowed only to give to each according to its merit. Therefore, it is important that the leader of a chain treating different suppliers or customers differently should provide a justification of its actions, allowing for potential rebuttal and perhaps even reconsideration of certain behaviour. This is where, once more, governance mechanisms acquire importance. 124 See F Jacobs, ‘Recent Developments in the Principle of Proportionality in European Community Law’ in E Ellis (ed), The principle of proportionality in the laws of Europe (Hart Publishing 1999) 1. 125 L Hoffmann, ‘The Influence of the European Principle of Proportionality upon UK Law’ in E Ellis (ed), The Principle of Proportionality in the Laws of Europe (Hart Publishing 1999) 108. 126 ibid 107. 127 D Kennedy, ‘A Transnational Genealogy of Proportionality in Private Law’ in R Brownsword and others (eds), Foundations of European Private Law (Hart Publishing 2011) 185–86, 219 (arguing that the European Draft Common of Frame Reference has established contrasting principles underlying private law – such as freedom versus legal security – and the DCFR itself has established that whenever these conflicts arise, there must be a balancing of these principles in the different applicable rules, a claim endorsed by most European private law scholars involved in the formulation of the DCFR).

Duty of Non-Discrimination  195 F.  Governance to Prevent Abusive Discrimination The difficulty encountered by the parties regarding this issue is to create a framework that allows freedom to meritoriously reward members of the network with more abilities or better performance, but nonetheless prevents unjustified discrimination against parties who have undertaken preliminary investments to design their performances to the network. In terms of braiding governance, a few strategies could be employed. They are created through the formal contracts (and governance inserted therein), generating informal incentives (trust, relational and business considerations). They represent an alternative to solutions based on the legislation/case law (mentioned in the previous sections). First, steering committees128 would be responsible for overseeing certain decisions and allocations of opportunities in the context of the activities of the network. The decision-making process in these committees can be fashioned in different forms, as already mentioned, and encourage the generation of (informal) communications and relational constraints as the parties work closely together. Second, monitoring mechanisms would enhance transparency and discourage unjustified discrimination. One example is the interaction of formal ‘hard’ and ‘soft’ rules establishing that all the parties in the network should be provided with the same opportunities/benefits to perform certain work.129 If certain benefits are conceded to one member in detriment to another, there is no automatic flowing liability, but there is an obligation to disclose a document explaining and justifying the reasons why a certain member has been provided with certain benefits not extended to others. If this justification is not forthcoming, it may be considered a contractual violation subject to punishment through certain remedies. The justification, however, must be accepted with a reasonably broad degree of discretion as to relevant criteria to discriminate. This would be a way to provide the parties with freedom to make choices while requiring wide transparency, creating an informal constraint for the parties to act in good faith. Furthermore, if the justifications seem inadequate, they may constitute an evidentiary basis which a potential court could rely on to make an informed decision in adjudication.

128 See ch 2, section II.B.i. 129 This is similar to the example given by P Krebs and S Jung, ‘Governance Structures in Business Networks’ in S Jung, P Krebs and G Teubner (eds), Business networks reloaded (Nomos 2015) 146–47. The example is the combination of the hard rule of §161 German stock corporation law establishing a hard rule creating an obligation for corporations to elaborate a corporate governance statement. The German corporate governance codex, however, created a framework where parties are given the option to ‘comply or explain’. If they do not want to follow the guidelines of the codex, they might adopt a different line, but must justify their reasons. However, if the parties do not provide any governance statement at all, that will constitute a violation of the German law.

196  Legal Interpretation in Contracts Third, leaders of a contractual network can establish criteria in a contractual framework (eg, a master supply agreement) to determine how opportunities of investment and innovation will be allocated to the members of the network. Bernstein mentions how buyers establish key performance indicators in service level agreements and statements of work to clarify their expectations from buyers.130 More specifically, they can include ‘supplier scorecards’ as a formal contract administration mechanism, which rate each supplier in terms of their compliance with relatively objective performance metrics as well as the buyer’s assessment of the quality of the contracting relationship more generally. The core metrics that make up the bulk of most scorecards are on-time performance, cost, quality, and customer service. The buyer uses these metrics to create a quarterly composite score, which it then uses to determine the business opportunities (if any) that it will make available to the supplier in the next quarter.131

If the ratings of the suppliers on the scorecard are not positive, they tend to analyse these results with the assistance of consulting services to improve their performance, thus incentivising learning; if the performance is not improved after a certain time, graduated monetary sanctions may be imposed upon the supplier.132 At the same time, suppliers who perform well will have increased business opportunities with the network. The supplier scorecards and the criteria to assess performance are discussed regularly between the buyers and suppliers to create transparency.133 Fourth, to mitigate the economic dependence of one of the parties there is contractual provision of nested options (allocation of contractual decision rights to a certain party after the cooperation phase). These provisions are perceptible in pharmaceutical collaborations. One example referred by Gilson et al is the collaboration between Warner-Lambert and Ligand.134 In this situation, a research laboratory develops a collaboration to develop a certain component with a pharmaceutical company that is entitled to later commercialise it with exclusivity. While the research laboratory has received significant funding from the pharma company to support the development of the chemical, a significant part of its reimbursement is expected to come from a potential successful commercialisation of the chemical by the pharma, from which it will collect a certain royalty amount. There is a risk, however, that later the pharmaceutical company, for opportunistic reasons, will attempt to renegotiate the

130 L Bernstein, ‘Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts’ (2015) 7 Journal of Legal Analysis 561, 579. 131 ibid 580. 132 ibid. 133 ibid 581. 134 RJ Gilson, CF Sabel and RE Scott, ‘Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration’ (2009) 109 Columbia Law Review 431, 490 ff.

Sharing of Profits  197 terms, and may threaten not to pursue the development of a drug based on the chemical component created by the laboratory. It may do so to lower the royalties to be paid to Ligand once the compound is developed,135 undermining its profit expectation. To counteract this possibility, however, the contract contains a provision (a ‘nested’ option) stating that, if the pharmaceutical company fails to commercialise the component developed by the laboratory within a certain period (by failing to extend the contract), then the option to explore the chemical passes from the pharmaceutical company back to the research laboratory.136 The laboratory may then either pursue the development itself or establish a new cooperation with another pharmaceutical company willing to do so. In this case, if one considers the existence of a discrimination of a leader chain against one specific company among the many collaborating with it, this discrimination is counterbalanced (or mitigated) through this nested option. There are also the traditional mechanisms, particularly non-compete clauses. In this context of experimentalism, however, non-compete clauses can be ‘modulated’ by the parties to fit the flexible character of the relationship. One example refers to a clause contained in the biotech collaboration between Big Pharma and Biotech.137 Instead of preventing the collaborating companies from developing parallel drugs (which would block their capabilities to innovate), they determined that any similar drug developed or commercialised by one of the parties in isolation would be subject to the terms of the contract. In the collaboration between TestCo and SemiCo for the development of semiconductors testers, SemiCo required the parties to establish a second source to purchase the testers, as is common in this context, to whom TestCo would have to license its technology.138 The parties then determined that SemiCo could purchase testers from a specific third company selected by TestCo who it trusted not to steal its technology.139 These legally formal mechanisms would serve to protect the companies’ informal trust in making significant investments in the collaboration. III.  SHARING OF PROFITS

This section deals with the issue of sharing of unexpected profits between members of a collaborative contractual network. After the Introduction (A), it examines the case law on the subject, setting out the problematic legal issues (B). Second, it analyses how English law (C) and Brazilian law (D) would likely solve 135 ibid 491. 136 ibid. 137 M Klausner, ‘Governance Mechanism in Long-Term Contract’ in S Grundmann, F Möslein and K Riesenhuber (eds), Contract Governance: Dimensions in Law and Interdisciplinary Research (Oxford University Press 2015) 231–32. 138 ibid 227 ff. 139 ibid 229.

198  Legal Interpretation in Contracts them, evidencing possibilities and limitations. Next, it examines the court’s role in these disputes (E). Finally, it suggests governance mechanisms to address these difficulties (F). A. Introduction Legal studies on contractual networks often discuss profit-sharing issues among network members.140 Sometimes, advantages are obtained by one network member or by the ‘leader’ of the project accruing from the work of all (or some) network members, or from the fact that the leader is using the overall network bargaining power. Conversely, one network member may have produced an innovation/improvement to its own component, largely due to the exchange of know-how and technology with other members. Then, the issue arises whether and under which circumstances there should be a sharing of these advantages between the network members and whether this division hinges upon express contractual profit-sharing provisions or could somehow be implied by courts.141 The initial dilemma is the inadequacy for dynamic contractual networks of both a corporate logic, imposing the equal profit distribution, and the exchange logic, prima facie rejecting any distribution not contractually established in detail.142 In contractual networks, a single company’s profit interest must be balanced with the need to share profits resulting from the network collective learning. Most likely, these potential profits will be retained by the leading company in the network that assembles a product or provides the final service to customers in the market and receives the payment from them.143 There is no specific evidence on the use of patrimonial funds to pool monetary resources received for network goods; most studies indicate that patrimonial funds are established to respond for the risks of the network activities, shielding the rest of the company’s assets,144 but not to pool profits of the whole ‘network’.145 It is more likely that a potential sharing of profits may occur through contractual

140 See, eg, S Grundmann, F Möslein and K Riesenhuber, ‘Contract Governance: Dimensions in Law and Interdisciplinary Research’ in S Grundmann, F Möslein and K Riesenhuber (eds), Contract governance: dimensions in law and interdisciplinary research (Oxford University Press 2015) 14–16. 141 R Böhner, ‘Asset-Sharing in Franchise Networks: The Obligation to Pass on Network Benefits’ in M Amstutz and G Teubner (eds), Networks: legal issues of multilateral cooperation (Hart Publishing 2009) 170 ff. 142 Teubner (n 65) 191. 143 eg, Boeing for airplanes, Toyota for cars. 144 On patrimonial funds, see ch 2, section II.B.iv. 145 Pooling might also serve, in certain cases, to share the use of the collaboratively produced goods. P Krebs and others, ‘The Modular System of Network Activities’ in S Jung, P Krebs and G Teubner (eds), Business Networks Reloaded (1st edn, Nomos Verlagsgesellschaft mbH & Co KG 2015) 94–95. For instance, different chemical companies might cooperate to solve a common technical problem in the industry. If they are successful, the reward of each one will be the ability to use the resulting technology to develop and commercialise their own products separately.

Sharing of Profits  199 mechanisms creating a duty to transfer a certain monetary amount from the leading network company to another firm in the chain. Legal rules and case law on profit sharing are scant, perhaps because distributive equality is not a practical problem in all contractual networks;146 in some, the cooperation may not involve any sharing of profits and risks.147 In others, there may be ‘coordination tools’ closely pre-establishing the distribution of profits.148 The most cited cases on this issue relate to franchising, with relevant decisions by the German Federal Court.149 The issue of profit sharing becomes particularly complex in collaborative working relationships under high uncertainty, undermining parties’ capability to accurately evaluate the importance of their contribution and reasonable share of profit in the project. Different clauses can be designed to address these complexities. The traditional clause establishes ex ante the percentage of the profits due to each party from the commercialisation of the co-created output, or perhaps establishes that one party may receive a fixed fee and the other the full amount of the commercialisation. Sometimes, the future profits are proportional with the amount of investments made by each party.150 Contracts could further establish a proportional share of profits up to a certain amount and then establish that exceeding profits should benefit one specific party, perhaps the one having made greater investments. In different industries, a variety of forms of clause may be employed and the ability to establish different governance mechanisms may differ. The higher the level of uncertainty, the more difficult it will be to establish ex ante the division of profits. The above-mentioned governance mechanisms may undermine this uncertainty. However, the most useful tools in this context are those with a dynamic character, discussed below in section III.E. In general, profit sharing is not statutorily regulated, due to the assumption that the parties themselves should allocate risks/profits in their activities. In specific areas, like English law partnerships, default provisions establish that profits deriving from the common activity should be divided equally between the partners. Unjust enrichment normally does not apply to a relationship where a contract has established a risk allocation (lest it may disrupt the parties’ contract), unless there is a broad clause providing room for interpretation. Even in such cases, unjust enrichment will normally be limited to the restitution of sunk investments in the relationship or other benefits directly transferred by the claimant, but not regarding disgorgement of profits coming from elsewhere. 146 P Krebs, K Aedtner and M Schultes, ‘Company Networks Reloaded: Putting a General Functional Approach to Defining Complex Problems to the Text’ in P Krebs, S Jung and G Teubner (eds), Business Network Reloaded (Nomos 2015) 66–67. 147 Consider, eg, the pre-competitive projects related in the empirical analysis of Brazilian collaborative innovation projects, see ch 2, III.C.i. 148 Krebs, Aedtner and Schultes (n 146) 66–67. 149 Böhner (n 141); Teubner (n 65) 191 ff. 150 As indicated by some of the Brazilian interviewees, ch 2, section III.C.vi.

200  Legal Interpretation in Contracts These approaches fail because they are designed to establish the sharing of profits flowing from stable property (sales of goods, receivables from corporations, real estate) where there are clear boundaries delimiting the activities from which profits should be shared. This does not apply for collaborative relationships to innovate, where the project boundaries and generated rights themselves remain open to definition.151 The starting point to analyse profit sharing should be the contractual design freely established by the parties. Legislative provisions are supplementary, and courts should be cautious to intervene in the risk allocation contractually designed. The situation should be viewed with different lenses regarding contractual clauses established in one-sided standard agreements imposed by a leading company upon the rest of a network. In that case, the incentive structure of the agreement should justify finding, in particular cases, a duty to share profits among the network members, even if not expressly established in the contract. Otherwise the leading company could be taking advantage of the member’s contribution to the network through a standard contract imposed upon it. This section’s overall argument is that a duty to share profits may be implied to this kind of contract whenever it flows from the incentive structure of the agreement. The parties may exclude this possibility through contractual clauses/ governance mechanisms jointly designed or negotiated by them, establishing a different risk allocation. Such risk allocation would not be configured in the case of one-sided standard agreements imposed by a leading company in the network, establishing clauses favouring one of the parties. Apart from this situation, in general, courts should not interfere with the contractually established risk allocation, leaving the profit with the party directly receiving the benefit, except in one situation. Whenever the agreement contains a broad or vaguely drafted clause of profit sharing, perhaps mentioning ‘reasonable’ and ‘fair’ division of profits, and there is strong inter-firm integration, courts should then be able to issue a decision if the parties have not been able to solve the matter themselves. B.  Case Law The most discussed cases regarding profit sharing in contractual networks are decisions from the German Federal Court on franchising disputes; two of them are discussed below. The first, Sixt, involves a rental car company with several rental branches and with franchisees offering rental cars under Sixt’s label.152 Sixt attracted 151 See above, ch 2, section I, on the problem of spillovers. 152 The final decision on this case was issued by the German Federal Court: BGH (1999) 52 NJW 2671. The sequence of decisions is described by Böhner (n 141) 154 ff. The disclosure and sharing of benefits were secondary matters in this case. The focus was on whether the franchisor had breached German competition law rules, especially a provision forbidding franchisors from establishing fixed rent prices for franchisees undertaking their own risks. In this case, the franchisor had allegedly

Sharing of Profits  201 franchisees promising to make ‘key account purchase prices available’ to them,153 that is more favourable car purchase conditions for franchisee companies. The purchase benefits were passed on to the franchisees, but not an additional benefit received by Sixt: ‘advertising contributions’, calculated based on the overall network purchases. Advertising contributions were kept secret and not passed on to the franchisees. A ‘graduated action’154 was initiated by the franchisees, first, for disclosure of information regarding the advertising contributions received by Sixt, then for determination whether these potential additional benefits should be shared with the franchisees. The BGH endorsed the Court of Appeal’s opinion, based entirely on an objective interpretation of the contract, that there should be full disclosure on the benefits received. It further considered that the benefits received by Sixt amounted to ‘purchase advantages’ that, under the contract, should be passed on to the franchisees. However, the contract contained a ‘manufacturers’ exception clause’, establishing that the transfer of benefits to the franchisees depended upon previous consent by the manufacturer. The BGH held that this clause was valid and exempted the franchisor from liability for not passing on the discounts.155 The crucial fact that led to this decision was that the franchisees were not obliged to buy goods/services from a list of suppliers provided by Sixt; they had autonomy to buy from whomever they preferred.156 In this sense, there was no interference in the freedom of the franchisees. As Böhner recognises, this decision may lead to further controversies for allowing the creation of exceptions unilaterally dependent upon manufacturers’ decisions. The second line of cases involved Optik, an optics company franchisor in the field of retail eyewear, with both branches and franchisees operating under its supervision.157 In contrast to the Sixt franchise, Optik’s franchisees must ‘follow the directives to purchase goods only from listed suppliers’.158 Therefore, their own purchasing power is subject to the dominance of the franchisor. In this case, Optik was receiving rebates up to 52 per cent from suppliers selling to its whole franchising company but was informing the franchisees that the maximum rebate was only 38 per cent. Some franchisees started a collective claim, first requesting full disclosure on the rebates, then requesting the additional discounts to be passed on to them. The contract contained a broad clause done so by its practice of advertising broadly in the market that certain prices would be offered by the general brand to customers across the market. The court decided that this practice represented a violation of competition law rules by the franchisor. 153 ibid 155. 154 ibid. 155 ibid 157. 156 ibid 158, 159. 157 There is a list of judgments by different German courts of appeal deciding these facts, in distinct claims initiated by different franchisees of Optik, discussed in ibid 159 ff. The final decisions (‘three test cases’) were issued by the German Federal Court, BGH (2003) 57 BB 2254 and 2258, and KZR 29/02. 158 ibid 163.

202  Legal Interpretation in Contracts (section 3.6) stating that the franchisor had ‘the obligation to pass on network advantages in order to obtain best business results’, as a compensation for the franchisees’ obligation to buy only from the franchisor’s list of suppliers.159 The BGH interpreted this clause as meaning that the discounts had to be disclosed and passed on to the franchisees. The core distinction with Sixt seems to be the fact that, in this case, the franchisees had the obligation to buy only from listed suppliers. In a third case, Hertz, a similar decision was reached.160 These cases were decided based upon contractual clauses,161 often establishing the duty for these benefits/discounts to be passed on to the franchisees.162 There is no clear definition of what would be the expected ‘profit’ flowing from the franchising activity (and whether it includes the discounts in the cases above): it will depend on the parties’ agreement. There is a discussion under German law whether, absent these clauses, any right for these discounts could be based on the parties’ intention, as evidenced by the incentive structure of the contract. The issue remains unresolved in German courts.163 Under high uncertainty, the problem becomes more complex. Consider the following hypothetical case. Leading Company A plans to produce an innovative machine (such as a new-generation driverless vehicle or a drone customised for precision agriculture) and needs to ally with other independent companies with special expertise to undertake the project. Company A will assemble the final complex machine, coordinating the performances of the companies, and continuously re-conceptualise the final product to reflect the different components’ features. Parties mutually communicate and learn throughout the co-creation. Under uncertainty, the parties cannot be sure initially about the components’ configuration, about their interaction with each other or about the final price. Contracts estimate an allocation of the profits, but this may change as the input’s development and commercialisation evolves. Suppose that, in this context, one company producing a component for this complex machine accomplishes a design or feature that lowers the machine’s overall cost. Consequently, the overall profits from the product’s commercialisation increase. In the contract, the company producing the component sells it to leading Company A for a price that is, in principle, unalterable. Should these extra profits be shared by Company A with the company producing the innovative component? Should these profits be shared with the overall network producing the complex machine? Or should they be retained by leading Company A? In collaborative contexts, commonly an advancement is the result of the exchange of knowledge 159 ibid. 160 The Court of Appeal of Stuttgart upheld the claim that Hertz Germany had an obligation to pass certain benefits to Hertz franchisees. BGH NJW 2002 RR 1554 at 1556. 161 Although in Hertz there is a discussion about applying the commercial code and the law of mandate by default whenever no contractual rules exist on the matter, which would require the franchisor to restitute any advantage that it had obtained (see §667 and 675 BGB). 162 Böhner (n 141) 170 ff. 163 ibid 173.

Sharing of Profits  203 between the different companies, thus, it would be arguable that some form of sharing should occur. C.  English Law This study has not identified English cases on profit sharing dealing with collaborations to innovate. Nevertheless, limited analogies can be drawn from English decisions involving similar patterns or from other common law jurisdictions. Even though sharing of profits is not mandatory in partnerships (the partner can receive a fixed remuneration or waive the share and remain partner if there was an intention to form a partnership),164 it often occurs. The partnership agreement will usually establish the proportion of shares and the time for this division to occur.165 Absent such a clause, the default rule is the equal division of profits between partnership members.166 The concept of partnership is once again revealed as inadequate for analogies with contractual networks between parties competing and collaborating simultaneously.167 The logic of equal apportionment of profits fails to reflect the original and innovative contributions each party made to the venture and which should be valued in the profit sharing. Furthermore, it is based on the premise of clearly divisible assets (such as participation in sales of goods or modular supply of machines), instead of co-creation activities where parties’ contributions are constantly reshaped to generate innovation. A further potentially relevant area is unjust enrichment. Arguably, in co-creation, the partner failing to share profits adequately flowing from a project with the co-creator would be unjustly enriched. For unjust enrichment to prevail under English law, three requirements must be fulfilled.168 First, actual enrichment (normally, in financial terms). Second, the enrichment must be at the claimant’s expense. Third, it must be unjust under English law, depending on the fulfilment of specifically established grounds (although there is a possibility of extending them analogically). Even if these factors are fulfilled, still the unjust enrichment could be justified by a defence. In other words, in the sharing of profits, the gain is unlikely to be unjust. In the case of sharing of profits in networks of collaborative contracts for innovation, it is both unlikely that there would be an unjust enrichment and, even if there were, a defence could still justify the enrichment in most cases: a contractual allocation of profits.

164 M Young Legal Associates Ltd v Zahid and others [2006] EWCA Civ 613 and Hodson v Hodson [2009] EWCA Civ 1042. 165 Banks (n 39) 21-06. 166 ibid 10-78; see also Popat v Shonchhatra [1997] 1 WLR 1367 (CA). 167 Teubner (n 65) 120. 168 R Goff and L Jones, The Law of Unjust Enrichment (9th edn, Sweet & Maxwell 2016) 1–09.

204  Legal Interpretation in Contracts Unjust enrichment would not be likely to apply because it ‘is not concerned with the disgorgement of gains by defendants, nor with compensation for losses sustained by claimants, but with the reversal of transfers of benefits between claimants and defendants’.169 In the words of Andrews, ‘[t]he claim is not for the claimant’s loss, but for the defendant’s enrichment at the claimant’s expense’.170 In the situations previously described, the parties in a contractual network have not made any transfer to the defendant, but are claiming a participation in the unexpected surplus made from a product/service co-created. In this hypothetical situation, the defendant was clearly enriched by receiving higher profitability from the network activities, with a potential contribution by the claimant. However, it is unconvincing that this enrichment results from a direct transfer from the claimant. In bilateral relationships, a transfer is easily ascertainable,171 but not in multiparty relationships. The Supreme Court recently analysed the matter in Investment Trust Companies (In Liquidation) v HMRC (2017),172 indicating that, in a tax law context, without the existence of a direct transfer of benefits (or a clear equivalent) between the parties it is not possible to find that there was an enrichment at the claimant’s expense.173 Therefore, the fact that a higher profitability was obtained through a contribution of the claimant to higher productivity or for the bargaining power of the network seems not to indicate, per se, that such benefit is ‘at the claimants’ expense’. The voluntary exchange of ideas, know-how and technology in the relationship does not create per se an unjust enrichment. Furthermore, it is unlikely that the case would fulfil any unjust factor or positive grounds for restitution in English law, set out in by Lord Mansfield in Moses v Macferlan (1760).174 For Andrews, unjust enrichment may be relevant for contract law in three situations: 1) in the total absence of consideration; 2) to claim the return of goods/services in the absence of agreement or whenever a contract is invalid; 3) to disgorge profits made in breach of contract.175 For the purposes of this section, the only potentially applicable rule would be the third one, requiring a

169 ibid 1-17. 170 Andrews (n 15) 520. 171 Goff and Jones (n 168) para 6.02. 172 Investment Trust Companies (In Liquidation) v HMRC [2017] UKSC 29. 173 ibid, para 51. For a discussion on the genealogy of cases dealing with this issue and presenting a more nuanced perspective on the possibility of indirect transfers justifying unjust enrichment (but before the 2017 decision on Investment Trust Companies), see Goff and Jones (n 168) paras 6.13, 6.30 ff. 174 Moses v Macferlan [1760] 2 Burr 1005, 97 ER 676 (KB). See also G Virgo, Principles of the Law of Restitution (3rd edn, Oxford University Press 2015) 120. In contrast with civilian jurisdictions, where it is most common to analyse whether there are justified grounds for a transfer and to allow a claim for unjustified enrichment in their absence, English law requires the identification of an unjust factor to allow for a claim. Goff and Jones (n 168) para 1.21; see Banque Financière de la Cité v Parc (Battersea) Ltd [1999] 1 AC 221. 175 Andrews (n 15) 520.

Sharing of Profits  205 disgorgement of profits if there is a contractual violation. For this purpose, the mere breach would justify recovery, shunning the need for finding a fiduciary duty.176 The relevant case for the issue of disgorgement of profits is Attorney General v Blake (2000) (barely influential in the ensuing case law).177 The concept of disgorgement, beyond that of expectation interest, allows taking the profits obtained by the party due to the contractual breach.178 However, it requires an actual contractual breach, either in itself or caused by another duty’s violation, that is, the breach of a fiduciary duty, as in the case of a bribe or an army sergeant paid by smugglers.179 The difficulty is interpreting whether the act of not passing a certain advantage in the network represented a breach of contract. This doctrine does not clarify whether there is a duty to provide such profits; it rather focuses on the issue of damages. Moreover, the contract seems a legitimate defence against unjustified enrichment. Regarding contracts still in force, the rationale for generally denying the application of unjust enrichment is that it would disrupt the contractual allocation of risks.180 Where the contract has already been discharged, in principle there can be no remedy for transfer undertaken in conformity with the contract.181 Collins182 analyses the issue by tracing a parallel with franchising cases from South Africa, New Zealand and the US. It generally remains undecided how such a situation would be dealt with under English law. Even though decisions from other jurisdictions do not represent binding precedent, they have often been relied upon by English courts to support English law propositions or to develop the law.183 In the South African case of Seven Eleven Corporation of SA (PTY) Ltd v Cancun Trading No 150 CC (2005),184 the franchisor led a chain of convenience stores. The franchisees had an obligation to acquire their products from the companies indicated by the franchisor. In the first contract, there was no

176 ibid 522–23. 177 Attorney General v Blake [2000] UKHL 45, [2001] 1 AC 268. 178 M Siems, ‘Disgorgement of Profits for Breach of Contract: A Comparative Analysis’ (2003) 7 Edinburgh Law Review 27, 29. 179 ibid 30. 180 Goff and Jones (n 168) para 3-16. 181 ibid para 3-23 and 3-24; see Stoomvaart Maatschappij Nederlandsche Lloyd v General Mercantile Co Ltd (The Olanda) [1919] 2 KB 728n; Taylor v Motability Finance Ltd [2004] EWHC 2619 (Comm). 182 H Collins, ‘Introduction to Networks as Connected Contracts’, Networks as Connected Contracts (Hart Publishing 2011) 41 ff. 183 A Burrows, ‘The Influence of Comparative Law on the English Law of Obligations’ [2015] Oxford Legal Studies 1, 32–35 (with a survey on the House of Lords decisions regarding Contract Law between 1989 and 2014, revealing that 51% of the cases made reference to the law in other common law jurisdictions). 184 Seven Eleven Corporation of SA (PTY) Ltd v Cancun Trading No 150 CC, Case No 108/2004, 24 March 2005.

206  Legal Interpretation in Contracts explicit clause stating the obligation to pass on price benefits obtained by the franchisor for the franchisees, but publicity material indicated it as an advantage of entering the franchising system. The second contract (not in dispute), however, stated that any benefits would be passed on according to the discretion of the franchisor. The franchisees were in fact receiving the discounts specifically concerning bulk discounts. They started a claim, however, requesting from Seven Eleven further discounts the franchisor was receiving from suppliers: rebates for targets attained (eg number of franchises or sales targets) and early payment discounts. Among other grounds, the claimants stated that it was an implied term in the contract that these discounts should be shared, as reinforced by the disclosure agreement and by the fact that these discounts were related to the group structure. The court refused to find such obligation to share. It considered first the lack of an express contractual obligation and the fact that this term was not necessary to the business structure of the franchise. Instead, the rebates and early discounts were both important for the franchisor’s business to be profitable and did not comprise bulk discounts, which were being passed on to the franchisees. The Seven Eleven case thus represents an attempt to decide on profit sharing that neither seeks to create a universal duty to share all franchising profits, nor refuses this possibility right away. It sought to find, within the agreement incentive structure, the most suitable solution. According to Collins: the court develops an intelligible strategy of dividing up the benefits or ‘profit sharing’, so that the network both protects the incentives for the franchisor by letting him retain the rebates, but at the same time forces a distribution of other benefits from discounts throughout the network on the ground that those benefits can only be secured by the cooperation of all the participants in the network.185

In Dymocks v Todds (2002),186 Dymocks, an Australian bookstore chain, had Todds as franchisees of three stores in New Zealand. The main issue was whether the contract had been repudiated by Todds, allowing for a legitimate termination by the franchisor. The franchisee had contacted other franchisees, complaining about the franchisor and stating it would no longer cooperate with the business endeavour. The franchisee refused to pay one of the contract instalments, putting the relevant value in a deposit under escrow. The Privy Council considered that this behaviour amounted to a violation of the express cooperation duty established in the franchise contract. As Collins emphasises, the court remarked on the importance of bulk purchasing for the success of the business structure of franchising. In American law, there is a discussion whether duties of good faith recognised in franchising agreements are not too restrictive, by not requiring

185 Collins,

‘Introduction to Networks as Connected Contracts’ (n 182) 46. Franchise Systems (NSW) Py Ltd v Todd [2002] UKPC 50.

186 Dymocks

Sharing of Profits  207 parties to consider their partners’ interests, even though there have been sunk investments.187 Under English law, there is no authoritative statement on the topic, but a justifiable resistance in establishing profit sharing beyond what was contractually agreed, potentially leading to a distortion in the contractual allocation of risks and profits. Nonetheless, it would be advisable to create room for courts to proceed to profit sharing whenever a contract may have an incentive structure in line with such provision, particularly when it provides a vague clause on the subject, giving room for interpretation, and there is strong inter-firm integration, pointing towards the possibility of finding a duty of loyalty to the contractual network or collaborative project (not between the parties) previously referred to.188 This duty of loyalty to the network would serve as a contractual guideline to interpret the parties’ agreement. D.  Brazilian Law The discussion about sharing of profits is underdeveloped in the Brazilian legal doctrine and case law, for two reasons. First, sharing of profits may be established through sophisticated clauses in commercial agreements (dispensing court interpretation). Second, there are few inter-firm collaborations in Brazil involving actual co-creation.189 Moreover, most complex commercial relationships involving a deeper level of inter-firm collaboration are solved either informally or submitted to arbitration.190 Ulhôa Coelho proposes two main variants of inter-firm cooperation in Brazilian law: cooperation through intermediation or through approximation.191 In intermediation, sharing of profits simply does not occur: the parties can clearly establish the price of the product that will be sold and the other firm, alone, shall have to make its profits from sales to third parties. In approximation as well, the issue does not present much difficulty; normally the agent or

187 GK Hadfield, ‘Problematic Relations: Franchising and the Law of Incomplete Contracts’ (1990) 42 Stanford Law Review 927, 985 ff. The author defends that American courts apply the ‘business judgment rule’ (more pro-franchisor). The better perspective, for the author, would be a relational one, more open to consider specificities and facts, without a hard rule and without favouring either of the parties. 188 See conclusion to ch 3. 189 ‘Pesquisa de Inovação (PINTEC)’ (2014) Instituto Brasileiro de Geografia e Estatística 57. 190 See ch 2, section III.B.ix. 191 In intermediation, one company acquires from the other firm a certain product to resell in the market for a higher price – that will be its source of profits. In approximation, one firm makes the commercial connections of the customer to the other firm (eg agency). In neither variant, however, is there actual co-creation: the parties are not cooperating in the production process or creating common marketing or organisational processes. They seem distant from the inter-firm collaborations to innovate dealt with in this book. F Coelho, Curso de Direito Comercial: Direito de Empresas (Saraiva 2007) 93.

208  Legal Interpretation in Contracts commercial representative will receive a fee (either fixed or proportional to the commercialised product/service value). These contexts leave no room for a profit-sharing logic. One example is the prohibition of the clause del credere in contracts for commercial agents, a clause creating joint liability between the agent and the principal for the insolvency or lack of payment by the customer.192 Therefore, if there is no payment for the products intermediated by the agent to the principal, this clause would allow the agent to remain without remuneration for its services. This clause, however, is barred under a legal statute and the case law has consistently followed this position.193 In practice, as indicated by the empirical analysis, some co-creation collaborative relationships to generate innovation in Brazil, which are of limited number, do not present at all issues of profit sharing to be solved by courts. This could be further related to the fact that, in Brazilian scenarios, some of these relationships are pre-competitive (although collaboration is also present between producers and suppliers in the competitive commercialisation phase).194 That is, they involve a strategic inter-firm alliance to find the solution to a common problem in a certain industry. Once the solution to this industry-level problem is achieved, each firm develops and commercialises separate products, dispelling conflicts about profit sharing. There are few companies, as previously reported in the empirical analysis, undertaking commercial co-creation of products. In these cases, the parties have referred to specific forms of structured profit sharing. As mentioned before, often the value of the profits to be shared is defined in proportion with the value of investments undertaken by each party or to another proportion previously established.195 Theoretically, it is worth considering the likely position of Brazilian law on the interpretation of a duty to share profits in quasi-organisational ventures. The easiest case would be where parties inserted in their agreement, as broad as it may be, a duty to share profits/benefits jointly collected through their cooperation. The issue would be most difficult in situations where such a clause does not exist. In these tasks of interpretation, the principle of objective good faith (Article 422 Civil Code) would permeate the understanding of the agreement.196 In this 192 Art 43, Law 4.886/1965. 193 eg Superior Court of Justice, Special Appeal No 605157, Third Chamber, Justice CA Menezes Direito, judged on 7/6/2005. 194 See ch 2, section III.C.i. 195 As related by some interviewees, ibid. 196 As previously mentioned, it seems that the traditional applications of good faith evaluate situations mostly from the perspective of bilateral contractual relationships. Even when good faith is used as a guideline to analyse contractual relationships from a multilateral perspective, recognising that different contractual relationships may share a single economic objective, it still fails to apprehend the network logic involving simultaneous competition and cooperation, which is typical of the relationships examined in this book.

Sharing of Profits  209 case, network logic would involve an apportionment of profits coherent with the party’s participation in the reduction of costs of the overall final product.197 Teubner’s notion of a loyalty duty towards the network goes further than the traditional concept of good faith. For instance, analysing what would be the relevant time extension of a contract under the perspective not only of compensating the investments in a bilateral relationship but considering the impact that the termination would have on the entire network.198 Another possibility would be to conceptualise this issue as one of unjust enrichment. Rules on the topic have been integrated into the Brazilian legislation with the entry into force of the Civil Code of 2002. Nonetheless, decisions based on a general principle of prohibition of unjust enrichment were issued by Brazilian courts long before that.199 The rules on restitution embrace three different groups of doctrines, all rooted in the principle of static conservation of patrimony; each should keep its own unless there is a justified reason for the transfer.200 First, rules on the restitution for damages caused by the manager to the principal in a negotiorum gestio.201 Second, rules on overpayment. Third, general rules on unjust enrichment strictu sensu, which are the relevant ones for this book. Unjust enrichment is regulated by the Civil Code in Articles 884–886.202 The legal doctrine identifies four cumulative requirements for an unjustified enrichment to be found. First, the enrichment itself. Second, a corresponding ‘impoverishment’ (empobrecimento) of the claimant. This impoverishment does not require a direct patrimonial loss by the claimant but can exist when there is an intervention by the defendant over the claimant’s business that absorbs value from a right to which the claimant would be entitled.203 Third, a causal relation between the enrichment and the impoverishment. Fourth, the absence of a justifying factor for the enrichment. In the present case, two requirements seem unfulfilled. First, it is unlikely that the claimant has been impoverished by the defendant, unless it becomes very clear that the claimant had a claim over the extra profits flowing from the collaborative project. Once again, this becomes an issue of interpreting in the contract what was the division of profits to be established in the agreement.

197 Teubner (n 65) 184. 198 ibid 190. 199 C Michelon, Direito Restituitório: Enriquecimento Sem Causa, Pagamento Indevido, Gestão de Negócios (Revista dos Tribunais 2007) 36. 200 ibid 18, 26 ff. 201 R Zimmermann, The Law of Obligations: Roman Foundations of the Civilian Tradition (Oxford University Press 1996) 433 ff. 202 Art 884. The individual who, without a justified cause, is enriched at the expense of another is obliged to restitute that which was unjustifiably earned. 203 One example would be the use by the defendant of a deposit owned by the claimant without his authorisation. The deposit was not in use by the claimant and its use did not cause any damage at all; but still it was the claimant, as owner, who had the right to use and benefit from the deposit. By using it, the defendant becomes liable for unjust enrichment towards the claimant. Michelon (n 199) 199.

210  Legal Interpretation in Contracts Only if, for a matter of contractual interpretation, it is found that the claimant had a right to extra profits, would this requirement be fulfilled. Second, it is most probable that the existence of a contract may point towards the existence of a risk allocation as a defence against the application of rules on unjust enrichment. The parties freely allocated the profits contractually; if they failed to do so, this would arguably indicate that profits are to be earned by the party directly receiving certain benefits. Nevertheless, exceptionally, there should be room for courts to have a more significant role. E.  The Sharing of Profits: What Role for the Courts From all issues in contractual networks for innovation, sharing of profits is the one where there should be greater care in allowing for court intervention. Under high uncertainty, in contrast with ‘stable’ commercial contexts, it is difficult to determine what is an equitable division of profits. The possibility for a court intervention should initially consider the existence of profit-sharing provisions establishing a conscious allocation of profits. Teubner claims that a duty to pass on advantages should be imposed where there is ‘an intense degree of vertical integration’.204 There is a warranted general proposition that the higher the vertical integration, the stronger is the presumption towards sharing of profits. Nonetheless, still the contractual clauses inserted in the contract may represent, particularly in the innovation context, where there is a need for flexibility, the level of risk and division of profits that the parties knowingly decided to share.205 In such cases, whenever the parties have freely negotiated these clauses, they should not be read out of the contract. However, a duty to share profits ascertained in the incentive structure of the contract should prevail over potential standard agreements that have not been negotiated by the parties, lest the leading company in a network may have the ability to one-sidedly acquire an advantage over contributions to the network of other members. Moreover, profit-sharing clauses should only prevail where there is transparency regarding the risks undertaken. Such would not be the case where one party hid from the other profits based on the network’s overall power or when the clauses establish a very broad command to share profits, requiring further interpretation, ‘in the light of market and organisational relations’.206 204 Teubner (n 65) 181. 205 Böhner (n 141) 173. In the first place, the purposes and the expectations of the parties have to be considered, in the manner in which they are expressed in the individual agreement, because the agreement finds its basis in private autonomy. If the purposes cannot be gleaned from the individual agreements, the purposes which are typically pursued in the relevant business have to be taken into account, ie those who guide an average, reasonable observer at the moment of the conclusion of the agreement and convince him to sign it. 206 Teubner (n 65) 181.

Sharing of Profits  211 The higher the uncertainty, the more the parties may be cautious about establishing a precise division of profits without governance mechanisms allowing for an adequate adjustment. In exceptional situations, courts may intervene in the contractually allocated sharing of profits, when the parties established vague, ‘open’ clauses requiring a passing of the benefits accrued to the collective efforts of the network.207 As argued by Teubner, the criteria to determine whether profit sharing should occur depends on the level of organisational integration between the parties and how much this integration was crucial for attaining certain target cost or enhancement of profitability. This is justifiable because a company that makes specific investments to tailor its performances to the needs of the network becomes more vulnerable to the counterparties’ opportunism. Not only could its products or service not be marketable to third parties, but the company may even have created organisational routines, programmed machines, to fit the specific network needs. It is necessary, in this case, to protect the specific investments of the network member. The same criteria to ascertain the degree of organisational integration previously mentioned are relevant for this section.208 As argued, both English and Brazilian laws could apply these criteria through a duty of loyalty to the network.209 F.  Governance Mechanisms: Profit-sharing Agreements, Relational Incentives, Target Costing and Open-Book Management Different arrangements may be designed and combined to regulate profit sharing, ranging from traditional mechanisms to elaborated braided governance instruments interweaving business and legal incentives. As previously mentioned, it is common to establish the value of the profits proportionally to each partner’s investments in the venture.210 This may be a suitable solution especially when the innovations and achievements reached are the result of a joint effort where it is difficult to differentiate each parties’ contribution to the project. Empirical studies in technology contexts also refer to the existence of financial rewards established once certain milestones or targets are met by a 207 See cases mentioned above, section III.B. 208 eg, the degree of openness and flexibility of the contract, indicating a significant value for the parties’ relational context in specifying uncertainty; the degree of dependency of the parties on each other to accomplish the general objective of the contract; the level of information and know-how exchanged; the evidence of integration provided by the governance and communication mechanisms in the contract; the assumption or sharing of typical overall networks risks; the power to impose certain conditions upon the counterparty and potential duties of exclusivity; and the level of preliminary investments and preparation to align one company’s business to the other’s needs. 209 See conclusion to ch 3. 210 See empirical interviews, ch 2, section III.

212  Legal Interpretation in Contracts partner.211 Supporting this position, a senior partner at a law firm in London, a specialist in technology transactions, pointed out that it is common to create a proactive approach with a clean formula at the outset and then reward individuals with a premium or fee for certain contributions.212 The partners may receive a certain reward once a certain target is achieved, such as completing a stage of the project successfully or achieving a planned innovation that was, initially, very uncertain. The receipt of a certain value before the end of the agreement undermines the risks of each party acting opportunistically with each other. Further empirical studies (specifically in the automotive industry)213 surveyed the relationship between leading automotive companies with its suppliers, for the continuous improvement and innovation in the final products. In relation to Chrysler, it has been noted that the improvements achieved by the parties (in the relevant period) may lead to a division and renegotiation of profits that is seemingly unordered and largely structured on a relational basis.214 The long-term trusted parties renegotiate between themselves the conditions and rewards each will retain from the contract once they achieve a certain innovation. At Honda, it has been observed that the cost savings achieved by suppliers through innovations and improvements, but largely incentivised by the leading companies who send their teams of specialists to the suppliers to pass on technology and know-how, must be shared on a 50/50 basis.215 In relational environments, there is a growing tendency for supplier involvement in the target costing of a certain product, with an open-book management policy.216 The parties formally establish a high transparency policy, sharing accountancy books and management information to permit a transparent and negotiated reasonable division of profits if the parties achieve a certain improvement in overall profitability. The transparency may facilitate relational incentives for the parties to renegotiate a reasonable value for their performance: There is broad agreement in the target costing literature that supplier involvement in cost reduction is the key to achieving target costs. Most of the research describes good practices used by leading target costing practitioners. The Japanese literature 211 Klausner (n 137) 225. 212 Interview with author. 213 JH Dyer and K Nobeoka, ‘Creating and Managing a High-Performance Knowledge-Sharing Network: The Toyota Case’ (2000) 21 Strategic Management Journal 345. 214 JH Dyer, ‘How Chrysler Created an American Keiretsu’ [1996] Harvard Business Review 46. 215 ‘Honda, for example, has stationed a number of engineers in the US, and they lead kaizen (continuous improvement) events at suppliers’ facilities … That dedication to follow-through pays off: Honda’s Best Practices program has increased suppliers’ productivity by about 50%, improved quality by 30%, and reduced costs by 7%. That isn’t entirely altruistic; suppliers have to share 50% of the cost savings with Honda. The reduced costs also become the baseline for new contracts that suppliers sign with Honda. However, the suppliers benefit, too, because they can apply what they have learned to their other product lines for Honda and its competitors and keep all those cost savings.’ J Liker and TA Choi, ‘Building Deep Supplier Relationships’ [2004] Harvard Business Review 2. 216 Different target costing strategies exist; there is no evidence that this practice is wide enough to constitute an industry custom.

Termination  213 describes how leading companies such as Toyota deal with suppliers … Their major findings are that leading practitioners involve key suppliers early in the product design process, treat suppliers as partners, and maintain an open book relationship in which cost and profit data is shared. For example, in the case of Chrysler, suppliers come on board 2 years before the launch of a new model, maintain open books, and participate in Chrysler’s SCORE (supplier cost-reduction efforts) program. Key suppliers are on long-term contracts. There are also formal metrics to measure supplier performance. Despite many descriptions, there is little formal research on what works best with suppliers and how issues of trust and open sharing of books and data are resolved.217

In situations of higher economic interdependency involving cross-shareholding, the challenges of sharing profits are undermined. As the parties have mutual equity participation, the profits from the other company will also flow to them, at least to a certain degree, minimising possibilities of opportunism. Furthermore, any corporate/partnership governance strategy can be combined in the contractual context to build a suitable incentive structure.218 IV.  TERMINATION: POTENTIAL DESIGN AND ‘FUNDAMENTAL BREACH’

This section is structured in the following way. First, it introduces the distinctive issues regarding termination in collaborative contracts to innovate (A). Second, it discusses a hypothetical dispute (based on an actual contract to innovate) involving termination (B). Next, it examines how this dispute is likely to be solved under English law (C) and Brazilian law (D). It concludes by discussing the importance of employing governance mechanisms to design the possibilities of termination and to specify the core contractual interest (E). A.  Prelude: Distinctiveness of Termination in Collaborative Contractual Networks The structure of collaborative contractual networks to innovate presents particularities regarding the possibility of termination motivated by a contractual

217 S Boyron, J Bell and H Okano, ‘Target Costing: Uncharted Research Territory’, Handbooks of Management Accounting Research, Vol 2 (Elsevier 2006) 507, 515. 218 Some of the strategies for sharing of profits in partnerships – potentially applicable in contracts for innovation – are: ‘(a) preferential “salaries” expressed as a first charge on profits; (b) sharing ratios varying according to the level of the firm’s profits, ie where differing ratios are applied to each tranche of profits …; (d) sharing ratios directly related to capital contributions; (e) incentive or “merit” profit pools, consisting of a set proportion of the firm’s profits distributable at the discretion of a particular partner or committee of partners; (f)“target” based sharing ratios, which are subject to reduction if the target is not met; and (g) ad hoc sharing ratios agreed shortly after the year end.’ Banks (n 39) 6.

214  Legal Interpretation in Contracts breach.219 Initially, there will be difficulties in determining the parties’ duties in this fluid scenario and, subsequently, in identifying what will be a breach serious enough to allowing contractual termination. Given the project’s specific investments and inherent uncertainty, there is a risk that termination will be used opportunistically, either giving leverage to parties to renegotiate the contract abusively or to leave the network unjustifiably after their counterparties’ significant investments.220 This problem is intensified if the party leaving the network possesses technology/expertise crucial for the project’s continuation. The protection of preliminary investments by preventing or delaying termination is recognised as a relevant principle in comparative contract law.221 Experimentalist productive endeavours, however, call for a compromise between the parties’ protection against opportunism, the need for coordination and the freedom to step back from projects developing unpromisingly, normally sought through contractual design, shunning court intervention. In specific cases (see Model 3 below), however, contractual interpretation may be necessary; the common difficulty in the legal systems analysed is to determine what constitutes a ‘fundamental’ breach in an incomplete contract where the parties are constantly re-designing their obligations. A doctrinal approach is insufficient per se to solve this issue, unless backed by some information exchange regime created through governance. In inter-firm collaborations to innovate, parties often design some variation of these termination clauses’ models to balance freedom with cooperation:222 Model 1: Clause establishing a price for the agreement’s termination, gradually rising in later stages of the project, as the parties invest more time and resources in the collaboration. The possibility of termination is clearly regulated, ruling out difficulties of interpretation. However, the liquidated damages, under high uncertainty, may greatly undermine or overestimate the reasonable value to exit the agreement. Model 2: The contract is divided into milestones – the parties must make investments at the outset of each stage, after which the relationship’s continuation depends upon the parties’ further agreement and renewed investment. The extension may be subject to a unanimous decision, to a steering committee decision, reuniting members of different companies in the network, or to a third-party entity in a multiparty supply chain. According to braiding theory, this model is often employed in contracts to innovate, providing parties with greater flexibility. However, where investments are significant and there is a long period of experimentation/effort required in the initial

219 F Cafaggi, S Grundmann and G Vettori, ‘The Contractual Basis of Long-Term Organization – the Overall Architecture’ in S Grundmann, F Cafaggi and G Vettori (eds), The Organizational Contract (Ashgate 2013) 33–34. 220 See ch 2, section I. 221 See Unidroit Principles of International Commercial Contracts, commentary on Art 5.1.8, establishing that the reasonable termination of a long-term indeterminate contract will hinge upon the ‘importance of [the parties’] relative investment in the relationship’. 222 These models have been referred to by the interviewees in Brazil and have been observed in some of the contracts publicly available through the US SEC.

Termination  215 phases of the project, either a milestone may have a very long duration or the possibility of terminating the agreement can be more strictly limited, as in Model 3. Model 3: Termination is not allowed unless there are major breaches or other events leading to frustration or impossibility of performance. The contract may also specify particular scenarios where termination is exceptionally allowed. Monetary compensations are established for minor breaches.

In this section, only Model 3 is considered (termination does not present similar difficulties in Models 1 and 2), focusing on a real contract for innovation and considering a hypothetical dispute. This is the only model where contractual interpretation is likely to have a relevant role regarding the agreement’s termination. Besides carefully drafted termination clauses, the design of such contracts would provide223 strong informal incentives for the parties to continue their cooperation through their mutual investments in the collaboration. In the hypothetical case discussed below, however, Company B seems not to be fully engaged in the relationship and there is another suitable partner in the market, undermining the informal incentives and propelling Company A to leave the agreement. Such governance mechanisms, in this situation, would have been of limited efficacy. The argument of this chapter is that, in many cases, termination in collaborative contracts for innovation will not be an issue, as in Models 1 and 2 above. In many cases, clauses and governance mechanisms can be employed by the parties to determine whether termination is lawful, some including complex information exchange mechanisms with decision making assigned to steering committees. Absent these mechanisms or whenever they reveal insufficiencies to solve controversies, courts (both under English and Brazilian law) will have to analyse whether termination is possible by examining if it goes to the ‘roots of the contract’ or affects the useful interest of the creditor in the agreement. In contracts for innovation, the criteria to assess a material breach should be whether there has been a failure to follow and cooperate with the contractually established governance procedures. The differential is that in incomplete agreements it is not possible to determine ex ante the substantive obligations of the parties; therefore, the thorough compliance/cooperation with the established contractual procedure becomes the agreement’s centrepiece. B.  Contractual Termination and Material Breach in Experimental Innovative Relationships This hypothetical case is based on a contract between two companies for the joint research and development of a large form of energy storage based on

223 See

ch 2, section II.B. i.

216  Legal Interpretation in Contracts nanophosphate technology,224 with duties to collaborate closely in the product development. It develops a situation that, according to interviewees, has been a source of dispute in collaborative projects; the departure of one party from a cooperative project where it has an important role in innovation development.225 Companies A and B collaborate to develop a large form of energy storage. Company A provides the nanophosphate technology and related know-how and Company B provides the expertise and prototypes for the energy grid accommodating this technology. The contract’s duration is four years, with the possibility of one-year extensions at a time by written agreement. However, the contract provides for ‘default termination’ when one of the parties ‘materially breaches or materially fails to perform’ its obligations, allowing the non-breaching party discretion to terminate the agreement. After two years, Company A claims that Company B materially breached the contract by continuously failing to provide materials for the ‘initial fullscale project’ within the established deadlines in the ‘statement of work’. The contract allows the reduction of the fee to be paid by Company A for those materials for every month of delay, but only to a certain minimum value. The reduction has already reached this minimum threshold as Company B has delayed several times already. As a result, persistent delays by Company B are not further compensated under the contract. Company A claims that this represents a material breach allowing the termination of the agreement, significantly undermining its profitability and immobilising research resources that could be employed otherwise. Company B justifies the delays based on difficulties in obtaining the components with third-party suppliers. It claims that Company A tried to escape the contract (a ‘bad bargain’) to cooperate with a competitor developing a similar product. Company B claims that Company A will commit an anticipatory breach by terminating the relationship before the initial four-year milestone. Its withdrawal would leave Company B without a suitable partner to undertake the project. Company B undertook specific investments in the project. Company A also undertook investments, but the advancements achieved in the technology development can be re-directed to other companies developing different prototypes. Other contractors furnishing nanophosphate technology are unavailable in the market. Company A claims that this was an experimental project and none of the parties should remain tied if they fail to be compatible. This case’s main issue is whether Company A is justified in terminating the collaborative contract considering Company B’s persistent delays.

224 ie high-performance batteries for electric cars. ‘Joint Development and Supply Agreement – A123 Systems Inc and AES Energy Storage LLC’, available at contracts.onecle.com/a123/ aes-development-2008-02-06.shtml. 225 According to the report of an interviewee and partner at a technology department in a law firm at London (on file with author).

Termination  217 The imposition of continued cooperation (specific performance) clearly should not be allowed in this context. English law does not contemplate claims for the specific performance of obligations to perform or, in other terms, personal services or continuing personal relationships for which the existence of trust is paramount for the success of the relationship.226 Brazilian law takes a similar position.227 This result is compatible with braiding theory’s rejection of the imposition by courts of the continuation of the relationship through terms dictated by judges, since innovation depends on the parties’ voluntary willingness to cooperate and trust each other.228 The best way to remedy the broken-down relationship would be the collection of reliance damages. C.  English Law The analysis proceeds in two stages. First, it considers what is a ‘material breach’ expressly established in a contractual clause. Second, it examines what is a ‘material breach’ allowing for termination under the common law rules. Each step examines whether Company B’s persistent delays would allow termination of the agreement. If not, Company A would be in anticipatory breach for refusing to continue the collaborative project. This section argues that the traditional rules on termination are insufficient to deal with incomplete agreements under high uncertainty. The ultimate rule to determine whether termination is lawful in most of these cases, whether it goes to ‘the roots of the contract’, requires resorting to information collected through governance mechanisms. The general English law rule provides the parties with freedom to draft termination clauses without subjecting them to a control of fairness/reasonableness, except in limited circumstances.229 Therefore, clauses establishing that a ‘material breach’ will lead to the termination of a contract are, in principle, valid. Notably, the test to examine a contractually stipulated material breach is different from the test to ascertain the existence of a repudiatory breach under English common law. In English law, there are two main recurrent forms of designing termination clauses, with different criteria of analysis and effects.230 First, to establish that the violation of a specific clause will create the possibility to terminate the contract or, more specifically, that it represents a contractual ‘condition’.231 226 Beale (n 18) 27-027, 27-025. See exceptions in 27-026. 227 CC Silva, A obrigação como processo (FGV 2006) 132–33. 228 See opening of ch 3. 229 S Whittaker, ‘Termination Clauses’ in A Burrows and E Peel (eds), Contract Terms (Oxford University Press 2007) 253–54. 230 ibid 257, 258. 231 On express clauses for termination, a subject little explored in contractual doctrine, see John Randall, ‘Express Termination Clauses in Contracts’ (2014) 73 The Cambridge Law Journal 113, which does not focus, however, on ‘material breach’ clauses.

218  Legal Interpretation in Contracts For instance, parties may establish that even minor delays from the contractual deadlines allow termination by spelling out that ‘time is of the essence’ in the contract.232 Second, to establish in general that any material or substantial breach allows for termination by the aggrieved party. This clause gives more flexibility for the contract to be interpreted according to the circumstances, but also creates greater possibility that courts will read down such clauses. Rowan has noted that ambiguous termination clauses tend to be construed narrowly by courts.233 Furthermore, the repudiation of contracts takes effect by the parties’ own initiative and does not depend on an application to a court requesting termination.234 A ‘material breach’ expressed in a contract means more than a trivial breach and its configuration will mostly depend on the context and surrounding words.235 It resembles the English common law rule on innominate terms to analyse a breach of contract whenever the parties have not drafted a termination clause.236 Several cases have helpfully indicated criteria to examine the existence of a material breach.237 In Glolite Ltd v Jasper Conran Ltd (1998),238 Neuberger J considered that the breach of an ‘anti-copying clause’ through the irregular use of a logo for a period of 10 days, with limited publicity and geographical impact, in a contract with a duration of at least 10 years, could not be considered material. Neuberger mentioned that the commercial consequences of the breach should be considered in the assessment of materiality. Furthermore, in National Power plc v United Gas Company Ltd (1998),239 Colman J held there was no material breach of a contractual clause requiring remedying of a breach within seven days of

232 On the concept of ‘time of the essence’, see ch 2 in J Stannard, Delay in the Performance of Contractual Obligations (Oxford University Press 2007) 29 ff. 233 S Rowan, Remedies for Breach of Contract: A Comparative Analysis of the Protection of Performance (Oxford University Press 2012) 77 (citing Rice [t/a Garden Guardian] v Great Yarmouth Borough Council [2003] TCLR 1 [CA]). 234 On a comparative perspective, consider the different approach in French law, where contract termination due to a ‘imputable non-performance’, in general, depends on court application; see J Bell, S Boyron and S Whittaker, Principles of French Law (2nd edn, Oxford University Press 2008) 356. 235 N Andrews, Chapter 9 in A Tettenborn and others (eds), Contractual Duties: Performance, Breach, Termination and Remedies (2nd edn, Sweet & Maxwell 2017) Chapter 9, 9-018. 236 Whenever the parties establish a condition in their contract, its violation allows for termination regardless of its seriousness; whenever they create an innominate term, then there must be an analysis of whether this violation goes to the roots of the contract. See below, in the coming paragraphs of the main text. 237 Dalkia Utilities Services plc v Celtech International Ltd [2006] EWHC 63 (Comm); [2006] 1 Lloyd’s Rep 599; [2006] 2 P & CR 9. In this case, Christopher Clarke J held that a contractual party that failed to pay an instalment covering a fourth of the annual amount due under a 15-year contract had undertaken a ‘material breach’ under the agreement. Clarke J highlighted that ‘[i]n assessing the materiality of any breach it is relevant to consider not only of what the breach consists but also the circumstances in which the breach arises, including any explanation given or apparent as to why it has occurred’. In a similar vein, Fortman Holdings Ltd v Modem Holdings Ltd [2001] EWCA Civ 1235. See a summary of some of these cases at Andrews (n 235) 180–84. 238 Glolite Ltd v Jasper Conran Ltd, The Times, 28 January 1998 10. 239 National Power plc v United Gas Company Ltd [1998] All ER (D) 321.

Termination  219 its notice by the counterparty if the breaching party failed to inform the other party about past breaches. This was considered an ancillary obligation, with little commercial detriment. Colman J further stated that a material breach had to be assessed according to the magnitude of the commercial consequences for the innocent party of an unremedied breach.240 It would be considered serious in accordance with the ‘effect on the benefit which the innocent party would otherwise derive from performance of the contract in accordance with its terms’. From these cases, two main considerations emerge in the analysis of the existence of a ‘non-trivial’ material breach established in contractual clauses. First, whether there are reasonable justifications for a breach. Second, the commercial consequences (and its magnitude) of the breach for the innocent party. Under these criteria, the present case could be analysed as follows. First, in the explanation provided for the breach, Company B claimed that the persistent delays were justified by the unavailability of certain materials in the market. The contract seems to allow delays, providing minor penalty fees for them, but provides a cap for the maximum penalty fee to apply. The implicit deal seems to be that damages, and not termination, are an acceptable remedy for this situation. If the damages, however, are beyond the cap established contractually and no longer find compensation, arguably, Company B’s delays constitute an action that demonstrates their incapacity to cooperate in the contract. If such delays, however, can be proved to be completely unrelated to Company B’s actions (or inactions), it seems difficult to claim that the risk for such delays can be attributable to it. Rather, the contract gives indication that the parties have shared the risk on delays in the contract in the following manner: up to a certain number of months, Company B would undertake the risk for such delays, by paying compensation to Company A. However, beyond a certain value, the risk for delays not caused by the actions or inaction of the parties would be not compensated, and, therefore, would be equally shared by the parties. If the delays were somehow caused by Company B, the situation would be different, but if it can be proved not to be so, it seems that the explanation is reasonable. This first criterion, therefore, is likely to favour Company B. Second, on the existence of a commercial consequence of magnitude, the situation is likely to be as follows. The nature of a joint and development agreement is highly uncertain and experimental, thus, both parties are aware that the final product may not develop as expected and the level of profits is uncertain. To assess the commercial consequences from the standpoint of the final profits expected in experimental projects in course is too uncertain. Rather, the procedural character of contracts for innovation plays a significant role. The commercial consequences should be evaluated from the viewpoint of the earnestness of the cooperation between the parties, assessed through the governance mechanisms established to coordinate their activities. If one party is not



240 Andrews

(n 235) para 9-026.

220  Legal Interpretation in Contracts duly cooperating with the contractual schedule of activities and following the instructions potentially provided by steering committees, for instance, there is evidence of an undue commercial effect on the other party: freezing the research and development potentialities that could be better used in other projects. The issue, therefore, is whether Company B is unduly freezing Company A’s assets by failing to duly cooperate. This could be analysed considering whether Company B has been timely and adequately participating in other cooperative activities provided for in the schedule of activities, whether it has consistently communicated and responded to communications by Company A through contractually established mechanisms of governance and whether it has followed decisions potentially issued through steering committees. These actions are the best evidence that a party has duly cooperated. Lack of such actions would, in contrast, indicate both a lack of cooperation and a commercial deleterious effect by freezing the learning and development capabilities of a partner. These observations serve to emphasise the importance of employing governance mechanisms in collaborative relationships. Without them, to assess cooperation under high uncertainty becomes an almost impossible task. Under the second criterion, if Company B can show to have consistently complied with the governance procedures of cooperation in the agreement, it is unlikely that its actions amount to a material breach. Although experimental relationships require freedom to withdraw from unpromising relationships, partners can design the most suitable agreement for their business.241 In the present case, it was a model where the parties seemingly wanted to restrict the exit of the contract, except in cases of major breach, to protect significant investments in the venture. Such major breaches, considering the justification provided by Company B and the commercial effect of their breach, however, seem unlikely to be configured. Even if there is no material breach, there could still be a repudiatory breach under English common law, justifying the termination of the contract under the common law rules. The baseline principle regarding contractual termination in English common law is the concept that not all breaches allow the termination of a contract.242 Parties should not escape ‘bad bargains’ only because the counterparty committed a minor violation. In general, English law allows the recovery of damages for a breach but limits the possibility for an innocent party to terminate the contract only for paramount breaches, going to the roots of the contract.243

241 See above, ch 4, section IV.A, on different possibilities for designing termination clauses in the agreement. 242 ‘The rule is usually stated as follows: “[a]ny breach of contract gives rise to a cause of action; not every breach gives a discharge from liability”. Thus the main question discussed in this section is whether a party who admittedly has a claim for damages is also relieved from further performance by the other party’s breach.’ Beale (n 18) 24-001. 243 Besides the possibility of discharging the contract due to a contractual breach, there is the further possibility of discharging it due to the renunciation of the other party of its contractual liabilities or due to impossibility created by the other party’s own acts. ibid 24-017.

Termination  221 Under English common law, not every contractual breach automatically leads to the possibility of termination. Rather, the options available to the party who suffered the breach will depend on whether there was a breach of a contractual term classified as a condition, as an innominate term or as a warranty.244 Conditions go to the core of the contract, while warranties are secondary obligations. Innominate terms are an intermediate third category.245 If there is a breach of any of these categories, damages may be possible. However, only in certain circumstances will the party have the additional possibility to terminate the agreement. If there is a breach of contractual condition, the party may opt between requesting damages or terminating the relationship, with the possibility of additionally requesting damages – the so-called right of election.246 If the term breached is a warranty, the party is limited to request damages and cannot terminate the contract. If the term is innominate, there will be situations under which the party may terminate the contract and others where only damages are available. The criterion to determine whether the breach of innominate term allows termination depends on whether it has severe consequences.247 Whether the breach is serious is not an issue to be judged by a court’s own criteria, but to be examined considering the parties’ intentions.248 There are four main criteria to identify whether a contractual term represents a condition,249 referred to by Waller LJ in BS & N Ltd v Micado Shipping Ltd (The ‘Seaflower’) (2001).250 Under none of these criteria do the delays by Company B clearly represent a condition. Regarding precedents, English law established that deadlines should be strictly enforced when the parties stipulated that time is of the essence251 or, absent such determination, the nature of the contract requires it and a reasonable time elapsed after the deadline without the promised performance.252 In casu, the contract allows minor delays, providing 244 McKendrick (n 15) 332–33. 245 Andrews (n 15) 464 ff. 246 McKendrick (n 15) 334 ff. 247 Andrews (n 15) 464–66. 248 L Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235, at 256–57. 249 Beale (n 20) 13-040. Proposing that the third criteria can be subdivided into two different situations, see Andrews (n 15) 455–56. 250 These are: ‘(i) a statute provision stating that a certain term represents a condition; (ii) categorizations of conditions established in judicial precedent; (iii) expressly contractual stipulations that a certain term represents a condition; and (iv) where circumstances/subject matter/nature of the contract imply the parties’ intention that the party should be completely discharged from the contract in case of violation of that specific term.’ BS & N Ltd v Micado Shipping Ltd (The ‘Seaflower’) [2001] 1 Lloyd’s Rep 341, at para [42]. 251 Union Eagle Ltd v Golden Achievement Ltd [1997] 2 All ER 215; Hare v Nicholl [1966] 1 All ER 285. 252 ‘In equity, and now in the fused system, performance had or has, in the absence of time being made of the essence, to be within a reasonable time. What is reasonable time is a question of fact to be determined in the light of all the circumstances. After the lapse of a reasonable time for performance the promisee could and can give notice fixing a time for performance. This must itself be reasonable.’ United Scientific Holdings Ltd v Burnley Borough Council [1978] AC 904.

222  Legal Interpretation in Contracts for fee reductions for the innocent party. Prima facie, time is not as essential to automatically justify termination. Neither have the parties established that minor delays represent a contractual condition nor that they intended termination for such violations. Therefore, it is unlikely that there is any contractual condition in this case. As The Seaflower states, if none of these criteria are fulfilled, there is a presumption that the contractual term is an innominate term. For the breach of an innominate term to allow an innocent party to terminate the contract a high bar must be met;253 the breach must ‘go to the root of the contract’, according to a multi-factorial,254 fact-sensitive assessment.255 In the words of Lord Diplock in Hongkong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd (1962):256 Does the occurrence of the event deprive the party who has further undertakings to perform of substantially the whole benefit which it was the intention of the parties as expressed in the contract that he should obtain as the consideration for performing those undertakings?

This approach may favour the breaching party by preventing the innocent party from terminating the contract for minor breaches, opportunistically seeking to terminate a ‘bad bargain’.257 Carter258 suggested some factors considered by courts defining whether the breach of innominate terms allows termination. First, whether the breach caused detriment to the other party. Second, whether it caused delay. Third, the effect on the value of the performance for the innocent party. Fourth, the cost of making the performance to conform with the contract’s requirements. Fifth, the opportunity given to the breaching party to remedy the breach. Sixth, consequences of prior breaches and likelihood of future ones given the existing breach. Seventh, the ability of damages alone in fully compensating the aggrieved party. Does the breach in this case of the contractual deadlines established by reference to the parties’ statement of work constitute a fundamental breach, depriving Company A of the whole benefit it should obtain as the consideration for its performance? It is unlikely that obvious monetary damage can be identified in 253 Beale (n 20) para 24-041. 254 ibid. 255 Andrews (n 15) 464. 256 Hongkong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26, 66. 257 Andrews claims that this doctrine has a double price to pay: first, to encourage underperformance of the agreement by parties who know they will not have their contracts terminated. Second, by introducing uncertainty among decision makers on whether a specific innominate term justifies termination. These negative effects are especially problematic in a collaborative contract, where the main obligation is a general duty to earnestly cooperate with the other party in seeking to develop innovation. Andrews (n 15) 468. 258 Mentioned by McKendrick (n 15) 181.

Termination  223 high-risk experimental relationships. It cannot be argued that the delays deprive the counterparty of the contract’s benefit, arguably, each partners’ best efforts towards the joint development of innovation. A delay that cannot be ascribed to Company B would be unlikely to have deprived Company A from such benefit if Company B duly performed its obligations and governance arrangements. This delay appears to be rather an inherent contractual risk. There is another possibility for termination: repeated breaches in a continuing contract may allow for termination when courts consider them serious enough,259 as recognised in Alan Auld Associates Ltd v Rick Pollard Associates (2008).260 Again, this precedent does not seem to sufficiently support Company A’s position. The explanation given by Company B is reasonable, the delays are not malicious and are not as significant as to completely undermine Company A’s interest in developing the product. The project may not be as smooth as Company A may have expected, but the breaches are not considered serious enough to allow termination. In summary, it does not seem plausible that termination would be allowed in this situation for the minimal delays by Company B, considering that there is no ‘material breach’ under the contract or a repudiatory breach under common law rules. In conclusion, under the terms of the analysed contract, termination should not prevail if Company B has shown to have cooperated with the project. An accurate analysis of such cooperation and the mechanisms to enhance communication of the parties in such an endeavour is a task of governance mechanisms. A parallel question is whether, absent a breach, the parties would be able to terminate the contract at any time under Staffordshire Area Health Authority v South Staffordshire Waterworks Co (1978).261 In this case, the parties were entitled to terminate contracts with indeterminate terms at any time by giving notice with a reasonable time to allow the other party to readjust to the new situation.262 In most cases, however, the rule in Staffordshire would not apply to contracts to innovate, where the agreement has often a determined term of duration or perhaps is organised in contractual milestones. Once those are reached, there is

259 Andrews (n 15) 450. 260 The Court of Appeals allowed termination because the breaches were considered ‘substantial, persistent and cynical’. In this case, the defendant terminated an ongoing consulting contract with the claimant due to the persistent delays in receiving the payment instalments on the due dates, despite recurrent complaints. The claimant was considered to have repudiated the contract because he continued to delay the payments, despite the recurrent complaints, because he gave an insufficient explanation and because the claimant’s payments were the defendants’ only source of income. Alan Auld Associates Ltd v Rick Pollard Associates [2008] EWCA Civ 655. 261 Staffordshire Area Health Authority v South Staffordshire Waterworks Co [1978] 1 WLR 138. 262 Winter Garden Theatre (London) Ltd v Millennium Productions Ltd [1948] AC 173. Cartwright (n 15) 255.

224  Legal Interpretation in Contracts a need to formally renew the agreement for the relationship to continue. In the case discussed, the contractual term was determined. In summary, English law is mostly settled on the issue of termination of contracts to innovate, and there is no need for legal reform. What is necessary is the development of criteria or governance mechanisms to generate information to determine when there has been a material breach allowing for termination (see section E, below). D.  Brazilian Law The Brazilian Civil Code contains the applicable rules regarding contractual non-compliance. Article 475 establishes that ‘[t]he party who was aggrieved by the default can request the termination (resolução) of the contract, unless it prefers to request its performance. In both situations, the aggrieved party may request damages’ (free translation). Therefore, the aggrieved party, in principle, will have the option between requesting specific performance or contract termination, with damages granted in both cases.263 Nonetheless, in relation to obligations to perform, Brazilian law does not allow claims for specific performance.264 Regarding the possibility to terminate the contract, the kind of contractual default (or non-compliance) allowing for termination before its contractually stipulated term is a fundamental or absolute default, as opposed to a relative default. A fundamental default is one falling under any of the following three situations.265 First, where performance became impossible, for example, the object of the contract perished due to the debtor’s fault. Second, where performance was still possible, but became useless to attaining the legal transaction’s objective. Third, in radical change of circumstances in long-term contracts (Article 478 Civil Code). The default will be relative when the actual possibility for the contract to be effectively performed stands, such as where the performance was only temporarily delayed.266 It has been recognised in the case law that only a fundamental default allows for the termination of the contract.267 However, regarding contracts with indeterminate duration, such as contracts of continued performance, one of the parties has the right to unilaterally

263 Tepedino (n 47) 122. 264 See ch 3, section I.C, on Brazilian law. 265 GC Haical, ‘O inadimplemento pelo descumprimento exclusivo de dever lateral advindo da boa-fé objetiva’ (2010) 99 Revista dos Tribunais 45, section 3.2. 266 E Fachin, ‘Inadimplemento Contractual Relativo e Absoluto à Luz Do Código Civil Brasileiro’ (2012) 1 Revista dos Tribunais 277, 279–80. 267 ibid 283. See, eg, Rio Grande do Sul Court of Appeals, Civil Appeal 1900001297, Third Civil Chamber, Judge Araken de Assis, judged on 28/8/1990 and Paraná Court of Appeals, Appeal 0244067-7, Seventh Civil Chamber, Judge Laertes de Oliveira, judged on 18/12/2003.

Termination  225 terminate the agreement,268 unless one party has made specific investments in the transaction.269 In most cases regarding contracts for innovation, however, the contract will have a determinate term of duration, with the performance of the contract divided into phases of cooperation. Therefore, in most cases, Article 473 will not apply at all. Even if it did, it is understood that these investments are risky and that the forced continuation of the relationship will not create a framework conducive to innovation. The next issue, therefore, is to determine the situations when there will be a fundamental default in a contract for innovation. For this purpose, theoretical concepts in the doctrine and case law are explored, and, subsequently, specific criteria applicable to these innovative transactions are identified. Two concepts must be delineated for this purpose: the concept of substantial performance (adimplemento substancial) and that of positive violation of the contract (violação positiva do contrato). The concept of positive violation of the contract states that a contract can be breached not only through the violation of its core obligations, but through the violation of accessory duties (not expressly provided for), deriving from the principle of objective good faith (Article 422 Civil Code).270 According to this concept of positive violation of the contract, growingly accepted in the doctrine and in the case law,271 even a violation of one such accessory (or lateral) duties can amount to a breach in certain circumstances. It will only constitute a fundamental default, however, if the violation of the lateral duty prevents the adequate

268 Tepedino (n 47) 115–16. 269 The sole paragraph of Art 473 Brazilian Civil Code states that: ‘If, given the nature of the transaction, one of the parties has undertaken significant investments for its performance, the unilateral termination will produce its effects only after a reasonable term has lapsed according to the nature and amount of investments.’ In this case, good faith conveys the idea that the parties had legitimate expectations that their contractual transactions would last long enough to compensate specific investments undertaken. Rio Grande do Sul Court of Appeals, Civil Appeal No. 70047383237, Ninth Civil Chamber, Judge I Nogueira, judged on 14/8/2013. In Tostines v Bom Retiro, the Superior Court of Justice held that the judge has discretion to define the reasonable term for the contract to continue and the value of damages. In this case, the defendant terminated a 30-year-long verbal contract with the claimant for the exclusive supply of food products without previous notification. The defendant alleged that the claimant delayed payments in relation to the agreed contractual term. The court held that the delayed payment had been accepted for years and the defendant had reasonable expectations that it was lawful to make payments on a different date. It held the defendant liable for not providing notification of the termination of the contract in a reasonable time, leading the claimant to serious financial difficulties. Superior Court of Justice, Special Appeal No 401.704, Fourth Chamber, Justice Honildo Castro, published on 2/9/2009. 270 As previously mentioned, one function of objective good faith is to establish in the contract duties to secure the adequate performance of the agreement’s core obligations, in accordance with the expected commercial standards. These may involve, eg, duties to provide information, to behave loyally, not to unjustly contradict one’s own previous behaviour, even though there are no contractual provisions requiring that. JC Ferreira da Silva, A Boa-Fé e a Violação Positiva Do Contrato (Renovar 2002) 233 ff. 271 Tepedino (n 44) 123, stating the principle and citing case law in support.

226  Legal Interpretation in Contracts attainment of the core objective of the contract.272 Otherwise, only damages can be requested. The second relevant concept is that of substantial performance (similar to the common law concept).273 This legal doctrine, embraced in the case law,274 recognises that, when a party has substantially performed the contract, even though there may be a minor contractual violation, insignificant in relation to the overall socio-economic function of the agreement, the counterparty will not be able to terminate the contract, but may only request damages. The core concept identified to distinguish between a fundamental default and a relative default (one where there may have been a substantial performance) is the concept of ‘useful interest of the creditor’.275 The termination of a contract for innovation, which hinges upon the existence of a fundamental default, should focus on the concept of ‘useful interest of the creditor’. The other two possibilities for finding a fundamental default mentioned above, the performance’s absolute impossibility and the radical change of circumstances, would not apply in most circumstances to these agreements. First, a court would hardly find an absolute impossibility under high uncertainty. The parties set out to create something novel or innovative, challenging the limits of possibility. Only in the case of blatant impossibility would a court be able to step in and declare the contract terminated for this reason. Second, the finding of a radical change of circumstances also seems unwarranted. Following several continental European legal systems,276 the Brazilian Civil Code contains a few rules specifically aimed at long-term contracts, allowing for court revision in special circumstances. The theory of radical change in circumstances is established in Article 317 and Articles 478–480 Civil Code.277 In innovative industries, a court intervention imposing revised terms does not seem a suitable commercial solution. On the one hand, in very specialised

272 Ferreira da Silva (n 270) 264. The author gives as an example the collaborative development of an aircraft, where the violation of lateral duties (not contractually provided for) to make preparations for its production can amount to an absolute breach if they prevent or delay its construction. 273 F Pontes de Miranda, Tratado de Direito Privado, Tomo XXXVIII (Revista dos Tribunais 2012) 472. 274 Ferreira da Silva (n 270) 264, mentioning case law from the Superior Court of Justice endorsing this position. 275 ibid. 276 N Borges, ‘Aspectos Positivos e Negativos Da Revisão Contratual No Novo Código Civil’ (2006) 95 Revista dos Tribunais 80. 277 The four cumulative conditions for applicability of this doctrine are the following: (1) the existence of a long-term contract; (2) the performance of the contract becomes too burdensome for one of the parties; (3) for the other party, the contract becomes extremely advantageous; (4) this happens due to an unpredictable or extraordinary event. G Tepedino, ‘Requisitos Para a Aplicação Da Teoria Da Imprevisão No Direito Brasileiro’, Soluções Práticas de Direito, Vol 2 (Revista dos Tribunais 2011).

Termination  227 settings, generalist courts may be ill-suited to redesign the contract adequately, which would be better designed by the parties themselves, experts on their businesses and commercial context. On the other hand, there is a need for continuous re-evaluation of the terms of the contract, which are normally open-term clauses from the beginning.278 Even if a court could define, from its perspective and at a certain moment, what are the adequate and suitable terms for a contract, in a highly uncertain environment such as that of radical innovation, this equilibrium may change suddenly as time progresses.279 Therefore, the possibility to find an absolute/fundamental default will depend on the concept of the ‘useful interest of the creditor’. The Civil Code embraces this concept in Article 395, sole paragraph: ‘If the performance, due to the delay (mora), becomes useless to the creditor, s/he might reject it and require damages.’ The usefulness of the performance shall be assessed according to the contract’s objective as well as in view of the prevailing commercial standard.280 The analysis of the usefulness of performance acquires different features in long-term contracts, where cooperation and trust are important for the success of the relationship.281 In this background, the fulfilment of accessory duties acquires primary importance, for those will secure a relationship of actual cooperation and trust.282 Context matters in defining what will be ‘useful’ for the creditor. Therefore, under the hypothesis, the possibility of termination of the agreement by Company A will hinge upon the existence of a fundamental default by Company B, which affects Company A’s useful interest in the transaction. The same difficulties prevailing in English law283 apply to Brazilian law: in a fluid scenario, the core contractual obligations can only be interpreted in the presence of information exchange regimes created by governance mechanisms. The next section examines what are the relevant criteria that could be raised in analysing whether, in a contract for innovation, there is a fundamental breach that goes to the roots of the contract or affects the useful interest of the creditor, allowing termination.

278 Gilson, Sabel and Scott (n 134) 456–57. 279 The example of a computer company buying components from partner companies illustrates this dilemma. The object and price of the components are expected to change constantly, as the parties collaborate on improving the product. This points out for a need for elaborate contractual governance instruments among the parties, rather than resorting to court orders imposing contractual terms. 280 Haical (n 265) section 3.2. 281 ibid. 282 This is observable in contracts of employment, where the leakage of some relevant information of the company or the omission of a manager about its kinship with a subordinate can provide justified reasons for dismissal. Similarly, in an agency contract, the breach of a collateral duty for the agent to provide the principal with some information might legitimately lead to dismissal. ibid section 3.2. 283 See section IV.C, above.

228  Legal Interpretation in Contracts E.  Criteria of Interpretation and Governance In practice, there are two main possible scenarios in this case. First, Company A is an innovative company with valuable expertise who is deterred by Company B, an underperforming partner who is either incompetent or reckless in the contractual performance. In this case, for experimentation to thrive, Company A should be allowed to break free and cooperate with another partner. In the second scenario, Company B is a competent firm that has significantly invested in the project, cooperated with all duties set out in the ‘statement of work’, but cannot avoid third-party business delays. Company A, in this case, would be an impatient, unreasonable firm wanting to take the opportunity of minor delays, even if persistent, to destroy a valuable project for Company B. How to distinguish one from the other? Maybe both parties earnestly believe each of the most favourable positions for them is the true one, especially under high uncertainty. Both English and Brazilian law have similar concepts identified as criteria to determine whether a default/breach is ‘fundamental’. The breach must go to the roots of the contract, affecting the endeavour’s profitability directly, or it must affect the usefulness of the creditor’s performance, having in view the socioeconomic function of the legal transaction. As mentioned before in contracts for innovation involving high risk, it is not possible to assess the usefulness of the transaction through its profitability or other absolute measure. These are experimental relationships where each party should do its best, but both know that success is not guaranteed. The essence of the fundamental default should be the failure to cooperate duly and earnestly during the joint endeavour. The difficulty, then, is how to clarify what is due cooperation in the fluid environment of innovation. In practice, that distinction could be made through governance mechanisms to refine the communication between the parties and signal to adjudicators, should a dispute arise, which one is right. They could establish, for instance, that parties are required to come together in steering committees and give reports of their progress so far and reasons for delays, common electronic platforms for the sharing of data and information relevant for the project, discuss jointly the need to revise the statement of work deadlines taking into account the availability of raw materials in the market and evaluating their factual ability in undertaking the project considering the stages already undergone. If one of the parties does not engage fully in such processes of cooperation, then it may be possible to say that there is an underperformer binding the other party. If there is full cooperation according to the governance clauses, however, the presumption is that the contingencies are the normal ones in an innovative project. It should be noticed that the parties could have fashioned their contract in milestones (Model 2), requiring further renewal of the agreement at certain stages if the parties were to continue collaborating. In this case, they chose

Conclusions  229 not to.284 The reasons could be that, first, the project involves significant investments and they did not wish to encourage defection by their counterparty in case a better deal showed up, or they were confident that the other company had the abilities to perform the work. Whatever the reasons, the best form to harmonise strict rules limiting termination with the needed flexibility in experimental relationships would be through governance mechanisms, perhaps preventing a dispute. In any case, they would provide more accurate and reliable information for decision makers to adjudicate potential disputes. They will respond to this uncertainty either by allocating risks or creating mechanisms to jointly respond to uncertainty as the project evolves. However, if they do not establish this collaborative governance and they knowingly choose to respond to this uncertainty by allocating risks, such allocation should be honoured. Is this result reasonable considering the practical requirements of innovative projects? In most innovative projects it may not be, in these situations, termination will likely be established in more lenient terms by allowing exit after certain (shorter) milestones or given the payment of a certain price. There is no rigid rule in such projects, however. In this case, the most important concern when the contract was concluded seemed to be to guarantee the parties’ preliminary investments and the assurance of mutual commitment to the project, especially given the needed technological expertise. V. CONCLUSIONS

This chapter analysed four different kinds of potential conflict in the context of collaborative contractual networks to innovate. In all of them, it sought to demonstrate that two different avenues may be pursued. First, governance mechanisms could seek to avoid disputes. Second, if disputes happen or need to be settled among the parties themselves, it is necessary for the law and the legal doctrine to clarify what the parties’ rights will be in the situation. In the latter context, the importance of considering the legal doctrine rests on two factors. First, legal doctrine regulates the background of legal transactions even in the absence of a dispute, especially when the parties are unable, due to high uncertainty, to allocate risks in their relationship. Besides guiding courts in adjudication, legal rules and doctrine establish the incentive structure and the strategic leverage that each party will have in the continuous (re)negotiations to shape the obligations of network members.285 284 It is arguable, however, that the initial four years of cooperation are a first (long) milestone, after which renewal is dependent on the parties’ express manifestation. 285 eg, what meaning would a tribunal ascribe to a duty of good faith expressly in these agreements? The companies with a stronger position under the existing legal framework will have more potential

230  Legal Interpretation in Contracts Second, legal doctrine must deal with potential disputes, especially when established governance mechanisms reveal insufficiencies. The importance of fostering collaborative production has been acknowledged by international institutions.286 It is expected that the number of collaborative relationships and related disputes should increase in the near future. Additionally, the chapter has argued that there is no need for legal reform in English law nor in Brazilian law of contract to solve the difficulties presented. In most cases what is needed is a form of contractual interpretation of the agreement based on the notion of a duty of loyalty to the network/collaborative project. As previously claimed, both English and Brazilian law could adopt this guideline through their existing principles of contractual interpretation.287 There is also a need to understand the logic of contracts to innovate in different scenarios, mingling competition and cooperation and requiring high trust coupled with a significant degree of flexibility. For each of the scenarios examined, potential criteria were proposed to determine whether duties of loyalty and cooperation should be intensified or not. In conclusion, it should be emphasised that, as a general rule (but subject to exceptions and other relevant doctrines that may apply for each case), a violation of any of these duties should at most give way to the recovery of reliance damages. Courts forcing cooperation under high uncertainty would not be able to foster successful ventures, for innovation requires experimentalism based on trust and on the freedom to come apart in case of unpromising business relationships. In that sense, governance mechanisms should be preferred to formal legal rules in establishing the way forward in the parties’ cooperation and, whenever possible, in avoiding potential disputes among them.

to adapt the relationship to their design, perhaps renegotiating terms or clarifying, along the parties’ relationship, the practical meaning of vague standards or intentional gaps. See H Collins, Contract Law (4th edn, Cambridge University Press 2008) 2: ‘The legal analysis of market transactions holds particular interest, of course, for practising lawyers who may be brought in to advise businesses on how to best organise their transactions.’ 286 World Economic Forum, Collaborative Innovation, Transforming Business, Driving Growth – Regional Report (2015). 287 See conclusion to ch 3.

5 Conclusion I.  THE REVERBERATIONS OF VARIETIES OF CAPITALISM ON INTER-FIRM INNOVATION

T

his book has analysed whether and if so what adaptations to the law of contract and contract governance are required to deal with inter-firm transactions to collaboratively co-create advanced innovation. Through a comparative approach, the book has sought to identify a repertoire of governance mechanisms and further develop an approach for contractual interpretation to rule contractual networks to innovate, addressing the latter issue from the perspective of English and Brazilian law. Nevertheless, it is questionable whether countries privileging distinct modes of production should require distinct legal approaches. In that sense, in an influential study of comparative political economy on ‘varieties of capitalism’, Hall and Soskice argue that the firms under different ideal models of market economy develop distinct forms of innovation and inter-firm contracting practices.1 The two ideal market-economy types are the liberal market economies (LMEs, such as the United States, the United Kingdom and Canada) and the coordinated market economies (CMEs, such as Germany and Japan). According to the authors, consortia and inter-firm arrangements would have more importance for innovation in CMEs than in LMEs.2 In LMEs, inter-firm relations would be conducted preponderantly under ‘standard market relations and enforceable formal contracts’.3 Relational contracting would be less possible due to the lack of dense business associations and networks, undermining the flow of information and monitoring of reputation. Inter-firm innovation would be less observable and companies, therefore, would mostly innovate either by acquiring technology (sale or licensing) or through the flow of knowledge resulting from the scientists and experts moving from one company to another, facilitated by the fluid labour markets in LMEs. In contrast, in CMEs, such as Germany or Japan, industrial production would be organised through a dense network of either business or trade associations (the German model) 1 PA Hall, ‘An Introduction to Varieties of Capitalism’ in PA Hall and D Soskice (eds), Varieties of Capitalism: The Institutional Foundations of Comparative Advantage (Oxford University Press 2001) 17–21. 2 ibid 31. 3 ibid 30.

232  Conclusion or through a group of interlocked companies through cross-shareholding (the Japanese model, the Keiretsu), facilitating the flow of information and reputation sanctioning. This would facilitate relational contracting in CMEs. Thus, long-term inter-firm relations would be mostly conducted through incomplete contracts, often to be supplemented by courts under good faith clauses and standards provided by business and industry-level associations.4 As a result, Hall and Soskice claim, each model of market economy would facilitate a certain kind of innovation.5 In LMEs, radical innovation (important in fast-moving technology sectors and complex systems – as in the creation of aeroplanes) would be prominent, as a result of the possibility to quickly rearrange the factors of production. In CMEs, incremental innovation (in small steps, improving existing processes, products and services) would predominate, due to the stability of the workforce, long-term relations between different firms, suggesting improvements to the collaboration among other factors. Following this description of the varieties of capitalism approach, the emerging picture in terms of contracting practices is as follows. In LMEs such as the United Kingdom and the United States, inter-firm collaboration would be mostly undertaken at arm’s length, and with different forms of radical innovation developed by individual firms, facilitated by flexible labour markets and sale and licensing of technology. Contracts would be formal, enforceable, detailed. Relational incentives would be minimal, due to the lack of stable relationships between the partners. In CMEs, such as Japan and Germany, inter-firm collaboration would be uppermost, channelled through industry associations and locked alliances between the firms, leading to relational contracting. Contracts are incomplete, sparse, but complemented by industry standards and sometimes by courts imposing implied terms under standards of good faith. The stable relationship between the different stakeholders permits incremental innovation of the existing productive process to develop. In between those ideal models, other countries adopt different or ‘hybrid’ ‘varieties of capitalism’ that would lead to different forms of innovation. In sum, companies in CMEs solve the problems of inter-firm coordination through relational contracting. LMEs employ formal enforceable contracts and are not really concerned about solving complex issues of coordination in innovative ventures, as they acquire technology and know-how by other means than inter-firm collaboration. In relationships to co-create advanced innovations, however, this narrative seems to be more nuanced.6 The high uncertainty in these relationships unsettles both the typical arm’s length approach of LMEs and the cooperative approach

4 G Teubner, ‘Legal Irritants: Good Faith in British Law or How Unifying Law Ends up in New Divergences’ (1998) 61 The Modern Law Review 11, 25–26. 5 Hall (n 1) 38–39. 6 See RJ Gilson, CF Sabel and RE Scott, ‘Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine’ (2010) 110 Columbia Law Review 1377, 1410 ff.

The Relevance of a Comparative Perspective  233 of CMEs. On the one side, high uncertainty requires that companies in LMEs adopt a contract that can serve as a guiding plan for the relationship – filled with governance mechanisms – establishing a relationship where the parties can cooperate closely to innovate. In fact, the early attempts at achieving collaborative innovation in the United States by establishing long-term commitments (emulating practices of Japanese firms) were unsuccessful – and had to be adapted to the more flexible American context.7 On the other hand, companies in CMEs under high uncertainty cannot be as tied to each other as in the traditional relational, long-term, stable relationships: there has to be more flexibility for the companies to come apart and to conclude the relationship in case the project does not evolve promisingly. This seems to bring closer both models in order to deal with the main problem of high uncertainty in relationships of productive co-creation. The liberal model has to incorporate mechanisms to facilitate coordination. The coordinated model has to allow for more flexibility. This approximation has support in the fact that similar governance mechanisms are employed in contracts for innovating both in the US and Brazil, for instance. While more empirical research would be necessary to analyse to what extent such design of contracts for innovation is widespread, particularly in CMEs (as most research on contracting for innovating was undertaken in the US, an LME), a residual approach of these models remains marked in different countries. In LMEs such as the United States there seems to prevail a perspective focused on governance mechanisms, emphasising that the parties have freedom to design their agreements and mostly – but with disagreements – suggesting a minimalist approach to contract law. In CMEs, studies on contractual networks tend to focus more on the role of legal doctrine, perhaps sometimes implying terms into the parties’ relationship and giving relatively less attention to the potential governance structures to be employed. This book, to a certain extent, reaches a compromise between both approaches. This does not mean, however, that a single formula could or should be applied to different jurisdictions in terms of how these different legal concepts and governance mechanisms could be adopted. Any legal transplant would have to be worked out in the context of the particular legal system and adapted to ensure its internal coherence. II.  THE RELEVANCE OF A COMPARATIVE PERSPECTIVE

The comparative analysis between Brazilian and English law indicated the following. First, the common/civil law divide is less significant in the regulation of inter-firm relationships to innovate than expected under the



7 ibid

1414.

234  Conclusion varieties of capitalism approach. Both a more solidaristic contract law perspective (supposedly closer to Brazilian law) and a more liberal perspective (supposedly closer to English law) seem to be conceptually inadequate to deal with hybrids such as contractual networks to innovate, where there is a constant tension between competition and cooperation and high uncertainty. The coexistence of a significant degree of freedom with an intense level of trust in these relationships requires a logic diverging from these two perspectives. In practice, the legal difficulties and possibilities in solving conflicts in networks to innovate in each of these legal systems are not far apart. In both systems, the traditional legal constructs tend to fall short from dealing with the challenges presented. In principle, the concept of a duty of loyalty to the network is more prone to be adapted in a civil law system (like Brazilian law), where general principles such as good faith (extensible to the phase of contractual performance) provide a greater level of discretion for courts to incorporate this concept. It does not seem, however, as previously argued, that there is an obstacle for English law to adapt a same or similar concept through its current principles of contractual interpretation. Second, the category developed/developing countries does not appear to be crucial concerning the contractual regulation of these relationships. The existence of rule of law, of course, is important for inter-firm innovation to flourish, especially if one accepts that ‘low-powered’ enforcement has significance in these relationships. Apart from the existence of a legal system that enforces both contract and property rights (available in most countries, including most mid-developed countries), the crucial source of inspiration to analyse these relationships is the countries where this innovative production in networks of firms is occurring more frequently, such as the US, Italy and Germany. Nevertheless, as mentioned, there are examples of similar ventures both in the UK and Brazil, as well as in other countries. Productive vanguards can be found scattered throughout the world, although they are present more frequently in some developed countries (and in regions within those countries, such as Silicon Valley in the US). Nonetheless, the comparative perspective in this book has provided further insights. First, it demonstrated that the relevance of inter-firm innovation and its legal regulation is not idiosyncratic to the US and to some other countries in Europe; examples have been provided from different parts of the world (particularly from Brazil) on how these projects are being conducted and legally structured. Second, a comparative perspective looking at contracting practices, case law and legal studies from different jurisdictions (not only England and Brazil), as the one followed in this study, may be more promising than focusing on only one or two countries. Since productive vanguards represent a fringe of companies in most of the countries in the world, a comprehensive picture could be provided by a broader comparative view.

The Role of Legal Studies  235 III.  THE ROLE OF LEGAL STUDIES: INSTITUTIONAL IMAGINATION OF POTENTIAL FORMS OF CONTRACTUAL COLLABORATION

In the world of production, a new paradigm is emerging: one where the most repeatable and easily learned tasks can be undertaken by machines. For humans, higher tasks will be reserved, mainly involving cognitive and interpersonal abilities, creativity, logical reasoning, complex problem solving and critical thinking.8 In the last decades, the key breakthroughs allowing for the acceleration of technological progress and automatisation have been the exponential growth of data storage capacity in chips and the consequent digitisation of almost all kinds of information,9 creating a potentially vast amount of data to be explored by the industry.10 As a result, automatisation has been ever increasing, with the adoption of algorithm embedded formulas guiding machines in repeatable tasks. The rise of artificial intelligence has also been significant in the past few years.11 In this emerging world where companies are in a state of constant innovation, the key competitive value becomes the ability to learn rapidly. As knowledge becomes obsolete within a short time frame, companies’ success at innovating will be determinant of their success. Furthermore, a firm’s open innovation strategy will be essential for success, aiming to look for the best ideas developed across different (public and private) companies and for the actual co-creation of outputs, beyond one’s own corporate borders.12 Contracts for innovation and corporate governance to promote innovation require a rethinking of the traditional roles of contracts and of the corporation. For contracts, the key purpose of allocating risk seems to give room for a procedure to continually specify uncertainty. This book has examined a number of empirical studies (and undertaken an original empirical assessment in the Brazilian context) analysing the interfirm contracting practices to co-create advanced innovation. This empirical analysis indicates that there is no fixed formula to establish these forms of cooperation, but rather a variety of practices employed for this purpose. In general,

8 ‘The Future of Jobs – Employment, Skills and Workforce Strategy for the Fourth Industrial Revolution’ (World Economic Forum 2015) 20 ff www3.weforum.org/docs/WEF_Future_of_Jobs. 9 E Brynjolfsson and A McAfee, The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies (WW Norton & Co 2014) 38 ff. 10 ibid 56 ff. 11 For specific tasks such as face recognition and speech learning, machines and software are quickly evolving and becoming able to learn by themselves. A recent study claimed that, in major American cities, autonomous transportation will become mainstream in the near future: ‘Artificial Intelligence and Life in 2030: One Hundred Year Study on Artificial Intelligence: Report of the 2015–2016 Study Panel’ (Stanford University 2016), available at ai100.stanford.edu/sites/g/files/ sbiybj9861/f/ai100report10032016fnl_singles.pdf. The actual timeline for developments involving artificial intelligence, however, remains a subject of controversy. 12 HW Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology (1st edn, Harvard Business School Press 2003).

236  Conclusion governance mechanisms are employed to specify the content of uncertain obligations contained in incomplete agreements. The logic of these mechanisms is experimental (creating a continuous procedure for learning and for the revision of the obligations in light of the accumulated knowledge), participatory (involving the different parties in an information-exchange process to set the joint obligations and to implement revisions) and braids formal and informal contracting (creating, through formal legal obligations, an environment that is conducive to the parties’ cooperation by generating trust in the procedure established in the agreement as a device to navigate this uncertain relationship, but avoiding imposing obligations to pursue the contract until completion, which would probably discourage experimentalist, uncertain projects). There are a different number of governance mechanisms employed for this purpose, which may be designed and interact in different ways. For instance, steering committees, reuniting members of the different companies, escalated disputeresolution mechanisms, open-book management practices and nested options contractually established. In multiparty relationships, these practices may be implemented through a contextualising regime, developed by leaders of supply chains, delivery organisations or even by public regulators, in special cases, among others. In this context, the role of the legal doctrine should be modulated not to force the parties’ cooperation to move forward when one of them is unwilling to do so. Innovative joint projects, to be successful, require a voluntary willingness to continue to cooperate, since the high uncertainty of the field can only be superseded if there is mutual trust and compatibility. In this sense, the argument developed in this book supports the proposition that enforcement of these agreements should be – at least as a default rule –‘low powered’ (granting only reliance damages for clear violations of the agreement to compensate for specific investments lost due to the other party’s lack of cooperation). However, there is a need to further elaborate how contractual interpretation should look upon contracts to innovate to find whether a substantial violation has occurred, once the cooperation has broken down, especially considering these are normally incomplete agreements filled with abstract cooperation duties. In these cases, a duty of loyalty to the collaborative project/network should be used as an interpretation guideline to assess these agreements. Through this guideline, the contract’s clauses (established by the contractual partners themselves) could be interpreted to determine whether an intensification of the obligations of loyalty, good faith, information-sharing and non-discrimination (among others) should be justified or not. This guideline would look upon low-level analogies with cases with similar facts through which criteria could be developed to determine whether the duties of loyalty should be intensified or not in each case. This would be the most adequate form of legal doctrine for these kinds of contract. First, it would avoid an idealised (and non-contextualist) form of contract law that would hardly be able to deal with the constant tension between competition and cooperation, as well as with the high uncertainty in these varied relationships.

The Role of Legal Studies  237 Second, this form of legal doctrine would avoid imposing upon the parties the continuation of their relationship and discouraging experimentalism, which requires flexibility. This doctrine simply reimburses specific investments that have been squandered by the other party’s lack of earnest cooperation in the agreement. The issue in these relationships is ‘how to learn together’ in unstable and ever-changing scenarios. Contracts, as it has been claimed, have an essential purpose in guiding these relationships, in creating incentives that will promote learning and cooperation. There is not a one-closed formula applicable to all varying forms of cooperation typical of the knowledge economy. In this perspective, the role of legal studies should be to enrich the repertoire of governance mechanisms available to the parties and to promote a form of contractual interpretation oriented by a notion of duty of loyalty to the purpose of the collaborative project of the parties, guided by low-level analogies but without imposing continued cooperation. The law, then, empowers parties to create new forms of collaboration, not only transcending the borders of the firm, but beyond the limits of the imagined institutional models of contractual collaboration.

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248

Index Abuse of rights see under Loyalty to network Aerospace industry Boeing, 15, 32 de-verticalisation of productive activities, 15 governance structure, 100 inter-firm alliances, 32–3 monitoring process in contract, 100 relational elements, weight given to, 111 Arbitration generally, 115 Automatisation growth, 235 Brazil abuse of rights, 151 collaborative projects, lack, 86 comparative contract governance in see under Comparative contract governance cosmetic companies, 113–14 de-industrialisation, acceleration, 86 EMBRAPII, 113–14 finance, 112–13 Fordist model approach, 86 managing internal coordination, law as to see Managing internal coordination (Brazilian law) pre-competitive ventures, 114 real estate market, monograph on networks in, 124 relational contracts, 124–5 scientific workforces, location, 111–12 stagnant economy, 86 Capitalism coordinated market economies, 231–3 innovation, effect on, 231–3 liberal market economies, 231–3 reverberations of varieties, 231–3 Chrysler collaborative network, 8–9, 32 restructuring— benefits, 9 effect, 9 purpose, 8

Collaborating company independence, maintenance of, 5 Collaborative network alternative institutional frameworks, 18 challenges and opportunities— collective action problem, overcoming, 18 de-verticalisation of productive activities see De-verticalisation of productive activities economic aspects, 16–18 generally, 28 mass production approach see Mass production sociological and economic perspective— generally, 18–22 see also Social relations trust, need for, 19 example, 8–9 generally, 28 human action, under socialised conception of, 20 internal issues, dealing with, 27–8 law’s role— context, 18–22 different categories of law, coexistence, 19 generally, 116 importance of regulation, 22–4 internal conflicts, and, 28–9 limitations of current legal concepts, 25–7 potential levels of regulation, 24–5 see also Contract law legal concept, search for see Legal concept legal studies, 237 loyalty to see Loyalty to network management see Managing internal coordination new forms of collaboration, creation, 237 new institutional economics, and, 18, 19 recurrent conflicts, 29 social relations, and see Social relations transaction costs see Transaction costs

250 Index Common patrimony fund contributions, 85 creation, 85 frequency, 85 generally, 85 governance, 85 liability for damage, 85 management, 85 use, 85 Comparative approach Brazilian and English law, analysis— generally, 12 insights provided by, 234 relevance, 233–4 similarities, 233–4 see also Comparative contract governance (Brazil, in) generally, 29, 233–4 reasons for pursuing, 11–12 Comparative contract governance Brazil, in— advanced incremental innovation, 88 background to empirical field and methodology, 86–8 bilateral collaborations, 92–3 co-creation working relationships, lack of, 91–2 contract versus trust, 89–90 contracts, negotiation and drafting, 98 contractual co-creation of innovation, 88–9 dispute resolution, 97, 98 division of production into phases or milestones, 95, 98 fixed-term collaborative relationships, 92 formal contracts, importance, 93–4 generally, 12, 85–6, 98–9, 110–13 governmental support, importance, 97 international collaborations, 96 interviewing process, 87, 88, 91 milestones, importance, 95, 98 multilateral collaborations, 92–3 national collaborations, 96 preliminary investments, limited use of mechanisms to protect, 95–6, 98 productive chains, importance, 89 SMEs, difficulties establishing collaborations with, 98 State and law, relevant role, 90–1 steering committee’s role, 94–5 termination provisions, 98 uncertainty, management, 94–5

England, in— aerospace industry, 100 approach to analysis, 99 construction industry, case studies see Construction industry good faith, 100 generally, 114 institutional factors, importance, 99 legal studies, evidence from, 99–101 rational conflict resolution, 99 trust, factors establishing, 99 uncertainty, ventures involving, 100 Competitiveness innovation, need for, 1, 62 Conflict arbitration, 115 English and Brazilian law, no need for reform, 230 generally, 162–3, 229–30 governance mechanism to avoid, 229, 230 information, duty to share see Disclosure of information management see Managing internal coordination (legal doctrine) non-discrimination, duty see Duty of non-discrimination potential, legal doctrine dealing with, 230 reliance damages, 163 termination see Termination Construction industry changing strategies, 103 collaborative alliance contracts, analysis, 126 delivery organisations— Crossrail, 104–5 generally, 104 Heathrow Terminal, 5, 106 London 2012 Olympic Project, 105 Thames Tideway Tunnel, 105–6 generally, 101 integrated project teams— Crossrail, 109 generally, 108 Heathrow Terminal, 5, 109 London 2012 Olympic Project, 109–10 risk-sharing contracts— Crossrail, 107 generally, 106 Heathrow Terminal, 5, 107 London 2012 Olympic Project, 108 Thames Tideway Tunnel, 108

Index  251 standard agreements and megaprojects— common information systems, 102 Crossrail, 102, 103–4, 104–5, 107, 109 delivery organisations see delivery organisations above early warning system, 101–2 generally, 101–4 Heathrow Terminal, 5, 102, 103, 106, 107, 109 innovation— avoidance, 103 search for, 103 integrated project teams see integrated project teams above late delivery and over budget, 102 London 2012 Olympic Project, 102, 104, 105, 108, 109–10 New Engineering Contract, 101, 107, 108 open-book management practices, where, 102 Optimised Contractor Involvement, 107 pain/gain sharing provisions, 102 Project Partnering (PPC 2000), 101 risk management, 102 risk-sharing contracts see risk-sharing contracts above supply chains, management, 102 tested methods and practices, use, 103 Thames Tideway Tunnel, 102, 104, 105–6, 108 Contract law adaptations necessary, 5, 24 benefits, 26 challenges to— addressing, approach, 10 balancing legal formalisation with relational incentives, 10 generally, 10–12, 27–9 production practices, presented by, 3 uncertain nature of agreements, 10 different categories, coexistence, 19 disadvantages, 26–7 general use, 9 good faith, clauses to negotiate in, 23, 24 importance, 22–4 incomplete contracts, and, 68 indefiniteness rule, 27 interpretation, nature of, 10 joint ventures, 26 limitations of current legal concepts, 25–7 party’s incentive structure, effect on, 23–4

potential levels of regulation, 24–5 preliminary agreements, 23 Contracting for innovation clauses— aspirational, 127 obligations of means, 127, 131–2 precise and enforceable, 127 vague and difficult to interpret express terms, 127 confidentiality agreement, 82 cooperation duties— establishment, 82 evaluation by steering committee, 82–3 critique of theories on— braiding theory, and, 77–81 courts, assisting, 81 generally, 77–81 institution-creating interpretation, 81 institutional contextualism, analysis, 80–1 law, importance, 77–8 relational contracting, relevance, 78–81 sanctions for violations, 78 written agreement, importance, 80 feasibility study, 82 human role, 235 legal obligations— confidentiality, 82 cooperation duties see cooperation duties above division of foreground IP, 83 equality between members, 84 generally, 81–4 good faith principle, and, 83 information exchange, 83 Joint Development Agreement, 82 Memorandum of Understanding, 82 non-discrimination between members, 84 profit-sharing, 84 Schedule of Activities, 82 termination, on, 83 machines’ role, 235 management see Managing internal coordination Memorandum of Understanding, 82 Schedule of Activities, 82 termination, 83 Contractual network autopoietic theory, analysis, 125 company law, difficulties using, 35 competition and cooperation, 43 conflict in see Conflict

252 Index constant tension in, 42 corporate-like structures, similarities with see Loyalty to network (corporate law insights) corporations distinguished, 33 distinguishing features, 36 duties owed— generally, 143 see also Loyalty to network features— generally, 43–5, 51 Jung’s analysis, 43 retained by each company, 33–4 see generally under Productive network fraud by one company in group, 33 governance mechanisms see Governance mechanisms identification, 54 internal coordination see Internal coordination issues of coordination, 42 legal concept, search for see Legal concept legal constructs to govern see Productive network (legal constructs) legal studies, 237 linked contract see Linked contract loyalty see Loyalty to network neither contract nor corporation, 32 productive network see Productive network profit-sharing problems, 41–2 reasons for choosing partners, 33 relational contract see Relational contract self-equilibrating relationships, consequences, 36 self-regulation, 36 sincere cooperation see Loyalty to network symbiotic contract see Symbiotic contract traditional practices, distinction between, 34 working concept, nature of, 50–5 Contractual practice experimentalism in see Experimentalism Cooperation abstract nature of duty, 162 defection, distinguished from, 73 governance mechanism see under Governance mechanism loyalty to network see under Loyalty to network

managing internal coordination— generally, 128, 129, 131 matters for consideration, 131 relational contract, in, 142, 143 De-verticalisation of productive activities benefits, 15 Boeing as example, 15 continuous innovation practices— Bangalore, in, 16 interactions based on, 16 law, challenges for, 16 Shenzhen, in, 16 Silicon Valley, in, 15–16 West Germany, in, 16 world economy, as part of, 15 defects, rapid detection, 15 generally, 14–16 mass production paradigm, as challenge to, 15 open innovation, rising nature, 14 problem-solving approach, 15 ‘Toyota’ system of production, benefits, 15 Diamond industry Bernstein’s analysis, 40 self-regulation in, 40 Disclosure of information braiding responses, through governance mechanisms— constant exchange, updating etc, 179 different stages, establishing, 179–80 disclosure paradox, 179 formal decision-making procedure, setting, 180 formal incentives, effect, 178–9 generally, 178–81 joint committees, 180 patent pools, use, 180–1 relational incentives, creation, 179–80 spillovers, dealing with, 180 Brazilian law, under— case example, 173 Civil Code, 172 conclusion of contract, context, 175 Consumer Code, 172 contracts, relevant, 173 duty to share, 174–6 financial instruments, analogy with, 174–5 generally, 172–4 good faith, 172–3

Index  253 intensity of duty see intensification of duty to disclose below lateral duty, 173 no implied duty, 174 objective factor, 174 performance, during, 175 privacy, protection, 174 regimes, 172–3 subjective factor, 174 symmetry as factor, 174 uncertainty, effect, 175 case law, 164–5 constant exchange of information, 163–4 contract formation, during, 170 cooperation, heightened duties of, 163–4 disputes, case law, 164–5 duties, types, 164 English law, under— false information— duty not to provide, 169 penalties, 166 provision, 168–9 fiduciary relationships, 167 general approach, 166–8 generally, 166 intensity of duty see intensification of duty to disclose below positive duty, whether see positive duty below relational contracts, 167–8 types of contracts, 167 utmost good faith contracts etc, 167 excluded information, 164 generally, 163 Intel, to, 165 intensification of duty to disclose— criteria, identifying— analysis, approach to, 178 case law, use, 178 contract, contents etc, 176–7 essential nature of information, 177 generally, 176, 178 governance mechanisms, role, 178 guideline, 176, 178 lack of contract, where, 177 manner of presentation, 176 significant investments or participation, 177–8 generally, 173, 174, 175, 176 governance mechanisms, crucial role, 178 negative duty, 171 network loyalty, and, 171–2

positive duty— classification of contracts, 168 competition and cooperation, where mingled, 169, 171 false information, not to provide, 169 fiduciary relationships, 170–1 generally, 168–70 good faith, and, 169–70, 171 joint enterprise, where, 170 legitimate withholding, 169 partnership, 171 performance, during, 170–2 relational contracts, 168–70 types of information, 171 uberrimae fidei contracts, 168 protected information, exchange, 165 real-life example, 163 relevant in formation, 164 secret project, where, 165 Discrete contract nature, 38 Dispute see Conflict Duty of non-discrimination adequate discrimination, 194 Brazilian law— Civil Code, 189, 193 competition law— Article 36, 190 Article 170, 189 generally, 190–1 horizontal cooperation agreements, 190 inapplicability, 190, 191 opportunistic behaviour, 191 reasonableness, as guiding principle, 190 vertical agreements, 190 Constitution, as starting point, 189 criteria see criteria below economic dependence, abuse, 191–2 generally, 189 private law, general principles, 191–2 venture risks, allocation, 192 case law, 183–4 common law, restraint of trade under— applicability, 189 case by case analysis, need for, 187 contracts applicable to, 187 generally, 187–9 illegality in private law, and, 187 joint ventures, case law on, 188 legitimate interest, need for, 187, 188

254 Index limitations on doctrine, 189 price discrimination, analogy with, 188–9 purpose, 187 rationale, 187 reasonableness, justifiable, 187, 188 competition law— Brazilian law see under Brazilian law above English law see under English law below content, positive or negative, 182 criteria— adequate discrimination, 194 contractual framework, in, 196 contractual obligations, imposition, 193 duty of loyalty, benefits of adopting, 192 English solus agreements, 193 equal opportunity to produce or distribute, 193 examples, 193 exclusive distribution of products, 193 generally, 192–4 justifiable discrimination, 193–4 proportionality principle, use, 194 search for, 189, 192 English law— applicability under, 185, 189 Brexit, effect, 185 common law see common law, restraint of trade under above competition law— applicability, 185–7 effect, 181–2 see also restraint of trade below criteria see criteria above restraint of trade— ECJ jurisdiction, 186 EU law, effect, 185–6 horizontal cooperation agreements, 186 solus agreements, 193 vertical agreements, 186 example, 182 freedom of contract, effect, 181 generally, 181 governance to prevent discrimination— braiding governance, 195 contractual framework, criteria in, 196 generally, 195–7 monitoring mechanisms, 195 nested options, 196–7 non-compete clauses, 197 rewards, whilst ensuring, 195

steering committees, 195 strategies, 195 supplier scorecards, 196 innovation needs, balanced with, 184 integrated distribution networks sharing risks and profits, 183–4 investments made by parties, where, 183 joint bond broking firm, limitations on leaving, 188 justifiable discrimination, 193–4 legitimate discrimination, 182 loyalty to network: meaning, 184 meritocracy within network, justification for, 184 network members, no discrimination between, 182 price discrimination practice, example, 184 private law, effect, 181–2 quasi-organisational ventures, 182 rationale for, 182–3 solus agreements, 193 unjustifiable discrimination— criteria see criteria above no excuse for, 184 EMBRAER relationship with other companies, nature of, 9 Experimental economy see Knowledge economy Experimentalism contractual practices, in, 12–14 development, 12 features, 13–14 hindered, where, 112 purpose, 12 revisable procedure, 14 traditional contract mechanisms distinguished, 12–14 trust and flexibility, need for, 119 Finance Brazilian corporate market, 113 developing economies, in, 112 EMBRAPII, 113–114 private equity, lack, 113 public finance, need for, 112, 113 venture capital, 113 Flexible production special treatment, need for, 38

Index  255 Future developments allocation of risk, effect, 235 automatisation growth, 235 fast-changing knowledge, 235 human role, 235 machines’ role, 235 open innovation strategy, importance, 235 Global economy changing nature— consequences, 18 generally, 17 regulation of networks, different approaches to, 17–18 Good faith Britain, in, 100 Germany, in, 99 Italy, in, 99 Governance mechanism administration mechanisms, 72 bilateral context, 62, 63, 64 braiding theory, 10, 21, 28, 67, 68, 74 challenges in drafting agreements, 70 codes of conduct, use, 72–3, 111 committees, collaborative decisions by, 75 comparative contract governance see Comparative contract governance compensation of incurred costs, 69 contextualising regimes, studies, 64–5 contracting for innovation— critique of theories on see under Contracting for innovation legal obligations see under Contracting for innovation organisational contract, 111 proceduralisation, 111 contractual milestones, 69, 70 cooperation— defection, distinguished from, 73 termination, 71–2 voluntary, 69 coordination, enhancement methods, 70–1 damages, apportionment of liability, 84–5 decentralised monitoring, 63 defection— behaviour mistaken for, 77 cooperation, distinguished from, 73 discrimination, to prevent see under Duty of non-discrimination disputes, to avoid, 229, 230 entropy costs, 75 factors for consideration, 63–4

formal and informal mechanisms, combination, 76 formal and informal sanctions, restriction on combination, 68 generally, 59, 62–6, 110–14, 236 generative contracting, 74 interdependence, 75 Japanese model, 67 legal studies, 237 liability— apportionment, 84–5 chain leader, 84 joint patrimonial fund see Common patrimony fund limitations of traditional contract design— generally, 59–62 solutions— bonding and monitoring mechanisms, 61 contract renegotiation, 60 explicit allocation of control rights, 61 formal hard rules, 60 initial consensus on risk allocation, avoiding, 60–1 predicting possible outcomes etc, 60 preliminary agreement, 62 reasonable behaviour, clause specifying, 61 specific investments, protecting, 59–60 two-tier procedure, 61 low-powered enforcement, 70 management of uncertain projects see Managing internal coordination miscommunication and misinterpretation problems, 77 modularisation advantages, achieving, 75 monitoring, 63, 65 multilateral context, 62, 63, 64 multiparty contracts, 63 multi-valent contracting, 74, 75 need for, 59 nested options, 72, 236 new opportunity, party seeking, 76 opportunism— alignment, 75 arising, where, 71 minimising risk, 72 underpinning, 69 performance, coordination, 65–6 private ordering, 64

256 Index procurement contracts, 72–3 profit sharing see under Profit sharing public finance, need for, 112 referee mechanism, 75 relational incentives, 70 research and development projects, 63 routinisation advantages, achieving, 75 social relations, institutions with, 64–5 software, transnational supply sale, 65 ‘spider in the web’, 65 spiderless networks, 66 steering committees— appropriate, where, 75 generally, 236 purpose, 75–6, 110 types, 71 structural social capital, 73–4 studies, 66–77 supply chains, 63 thickness of market, relevance, 111 Toyota Production System, 65–6 transparency and communication, achieving, 71 trust see Trust uncertainty— effect, 73 relevance, 111 US studies, 66–77 vertical integration, 75 veto, 74 weak ties as source of innovation, 76 Information disclosure see Disclosure of information Innovation Brazil, in see Comparative contract governance (Brazil, in) capitalism, and see Capitalism competitiveness, for, 1 continuous see under De-verticalisation of productive activities contracting for see Contracting for innovation England, in see Comparative contract governance (England, in) faster cycles, effect, 1 hindered, where, 112 open— need for, 62 rising nature, 14 paradox of innovation and inequality etc, 2 permanent learning, 119

re-interpreting challenges for innovation practices, 57–9 shared characteristics of contracts, 68 success, factors relevant to, 236 uncertain projects, management see Managing internal coordination Inter-firm collaboration adequate legal institutions, need for, 5 Brazil, in see Comparative contract governance (Brazil, in) comparative contract governance see Comparative contract governance England, in see Comparative contract governance (England, in) future developments, 29 governance mechanisms see Governance mechanisms independence, maintenance of, 5 knowledge economy see Knowledge economy models— co-design, 8 generally, 6, 8–9 iterative, 8 modular, 6–7 relational, 7–8 Internal coordination difficulties arising, examples, 56 entropy, 59 generally, 56 governance mechanisms see Governance mechanisms internal legal challenges— additional profits or risks, division, 58–9 flexibility of privity of contract, 58 incentive structure, nature, 58 inherent uncertainty as to future events, 57 opportunism, prevention, 57–8 transaction costs, 59 management see Managing internal coordination re-interpreting challenges for innovation practices, 57–9 spillovers, 59 Joint venture analysis in legal studies, 26 classification, 26 common forms, 26 partner-like institutions, use, 35

Index  257 Knowledge economy adequate legal institutions, need for, 5 changing nature of economic models, 3–4 contractual doctrine, need to develop, 6 cooperative approach, 4 development, search for partners, 4 economic and technological capabilities, firms lacking, 2 European perspective, literature on, 5–6, 11 experimental practices, replication throughout economy, 2–3 faster innovation cycles, effect, 1 governance mechanisms, importance, 6 hyper-insularity, 3 inequality and exclusion, reasons for, 2 innovation, importance, 1 lateral tasks, collaboration to achieve, 4 methods of promoting, search for, 2 networks of contracts, organisation by way of, 5 non-innovative tasks, outsourcing, 4 paradox of innovation and inequality etc, 2 production as practice of constant learning, 1 US perspective, literature on, 5, 11 Legal concept approach to search for, 30–2 benefits to establishing, 51–5 civil law systems, development in, 54–5 classical contract law, use, 38 common law system, in, 55 contract nor corporation— networks not comprising, 32–5 other possible classifications, 35–43 desirable, whether, 30 difficulties in using traditional concepts, 35 establishment, 54 European context, in, 31 features of network suitable to build, 43–5 inter-firm alliances, 32, 33 linked contract see Linked contract minimal trans-typical— benefits, 32 generally, 54 neoclassical contract law, 38–9 network not comprising, 36 networks neither contract nor corporation, effect, 32–5 non-legal mechanisms, use, 37 relational contract see Relational contract self-regulation, need for, 36

studies in 1990s, 35–6 symbiotic contract see Symbiotic contract US approach, 31 Legal studies, role, 235–7 Linked contract benefits, 42 collaborative contracts distinguished, 41 double attribution, 41 Draft Common Frame of Reference, 41 examples, 41 generally, 40–2 issues of coordination, avoidance, 42 lack of legal governance, 41 legal issues arising, 41 meaning, 40 profit-sharing problems, avoidance, 41–2 Loyalty to network abstract nature, 161 abuse of rights— abstract nature, 151 Brazilian Civil Code, 151 diffusion around civil law world, 150 EU law, as part of, 150 France, in, 150 generally, 150–1 Germany, in, 150 origination of concept, 150 purpose, 150 uncertainty, and, 151 bilateral relationships, where, 143 Brazilian law, finding duty under, 159, 161 breach, assessment, 149 co-creation project, difficulties of coordination in, 149–50 common objective of project, to— EU states, in, 156 fidelity to federation in German law, 156, 158, 159 generally, 156–9 good faith, general notion, 159 member states’ loyalty to EU, 156, 157, 158, 159 pacta sunt servanda, 157 shared competences, 158 sincere cooperation in EU law, 157 conflictual situations, application in, 146–7 cooperation duty— intensification, 144, 145 positive concept, as, 146, 149 sum of individual aims, as, 149

258 Index corporate law insights— best interest of company, 154–6 collective interests, preference, 156 continued collaboration after ‘milestone’ reached, 155–6 courts’ powers to resolve conflicts, 155 corporate law and organisational contracts, connections between, 153–4 duties of care, 155 duties of loyalty, 155 fiduciary principles, directors etc constrained by, 154 generally, 152–3 minority shareholders, protection, 155 principal agent theory, 153 questioning of board, 155 shareholders’ interests, protection, 154, 155 termination regime, 153–4 Teubner’s analysis, 156 effectiveness, contract given maximum, 149 English law, finding duty under, 159–61 examples of duties, 145 exchange contract, and, 149, 150 existence, ascertaining, 146 fair dealing see good faith duty below features justifying, 144 fiduciary logic, 152 generally, 118, 143 good faith duty— generally, 143, 144 loyalty as derivation of, 148 negative nature of concept, 146 objective see objective good faith below subjective, 147 institutional contextualisation, 144–5 intensified level of commitment, creation, 145 interpretive guideline, as, 14 justification for, 144–7 legal studies, 236–7 need to identify specific situations, 145 objective good faith— development of concept, 147 disputes, as aid to adjudicating, 150 dynamic perspective of obligations, 148 exchange contract, and, 149, 150 functions, 147–8 generally, 147–50 German legal system, in, 147–9 interpretive guideline, as, 147

limited interpretation of obligations, 149 obligations, modification of approach, 148 uncertainty, dealing with, 148, 150 other distinct concepts— abuse of rights see abuse of rights above corporate law insights see corporate law insights above fiduciary logic, 152 objective good faith see objective good faith above restraint of trade see restraint of trade below private law theory, conceptualisation under, 146 restraint of trade— generally, 151–2 interpretive guideline, unsuitable as, 151–2 negative nature, 151 purpose, 151 rationale of doctrine, 151 useful, where, 151 sectors in network, distinguishing, 145 sincere cooperation, 144–7 Teubner’s analysis, 144, 145, 156 types, 149 uncertainty, problems flowing from, 145 Managing internal coordination braiding theory— claims made by, 120 court’s role under, 120, 121, 122 entropy, 121 expectation damages, 120, 122 generally, 116, 119 low-powered enforcement— adequacy, 122 objections to, 121 support for, 120 preliminary agreements, negotiation in good faith, 120–1 red-faced violations, and, 120 reliance interest, 120 remedies under, 120 spillovers, 121 textualism and contextualism, rejection, 119–20 Brazilian law— autopoietic theory, and, 125 Civil Code, enactment, 123 connected contracts, 124

Index  259 foreign doctrines, referencing, 123 franchiser dominating network, 126 generally, 123–6 lack of rules on networks, 123 linked contracts, 123–5 little exploration of networks, 126 low-powered enforcement see under low-powered enforcement below relational contracts, 124–5 typical contracts, 125 conflict resolution see legal doctrine below European private law, 122–3 generally, 115–18 legal doctrine— braiding theory see braiding theory above Brazilian law see Brazilian law above courts, whether having a role, 117–18 difficulties, 118–19 enforceability of contract, determining, 118–19 European private law, 122–3 expectation damages, 116–17 generally, 116, 118–19, 236–7 incentive structure established by, 117 low-powered enforcement see low-powered enforcement below modulation, 236 relational contract in English law see under Relational contract reliance damages, 117 sanctions, 116 specific performance, inadequacy, 116, 122 low-powered enforcement— adequacy, 116, 118, 119 Brazilian law, in— cancelled negotiations, 133 cooperation, duty, 132–4 generally, 132–4 good faith, duty, 132–4 implied terms, court enforcement, 133 incomplete contract, 133 intermediate environment, 133 pre-contractual phase, 133 reliance damages, 134 enforceability indicated in agreement, 128 English law, in— best efforts to obtain permission, 130 charges and shipping schedule, failure to specify, 129 contractual construction, 128

cooperation, duty— generally, 128, 129, 131 matters for consideration, 131 generally, 128–32 good faith— behaviour violating expected conduct, 130–1 case law, 129–31 clause to negotiate in, 129 distribution contract, in, 130 generally, 128–9, 131 honesty and fidelity, 130 oral joint venture, 130 negotiation for specified period of time, 130 obligations of means, 131–2 reliance damages, 128, 132 specific performance, exclusion, 131, 132 express clauses, lacking precision, 127 generally, 236 see also braiding theory above uncertain projects, 115 voluntary cooperation, need for, 115 Mass production clothing company, 34 effect, 17 global economy, changing nature— consequences, 18 generally, 17 limitations, methods to overcome, 17 regulation of networks, different approaches to, 17–18 requirements for economic growth, 17 saturation of world markets by, 16–17 Neoclassical Economics approach, 20 Non-discrimination duty see Duty of non-discrimination Partnerships joint venture initiatives, and, 35 Production practices inaccessibility, 1 Productive network aim, need for, 44 bundling of resources, 44 companies, need for, 43–4 competition between parties, 44 coordination of activities, 44 economic interdependence in joint project, 44

260 Index features, 43–5 legal constructs— business networks, 49–50 connected contracts, 45–6 contrats-alliance, 46–7 Contratti Di Rete, 47–8 generally, 45 no contradiction of legal system, 45 non-profit organisation, exclusion, 43 partial economic independence, exchange for gain, 44 plurality of participants, 43 voluntary participation, 44–5 Profit sharing analysis, approach to, 200 balancing act, 198 Brazilian law— co-creation relationships, lack, 208 contract, division of profits in, 209–10 cooperation through approximation, 207 cooperation through intermediation, 207–8 courts’ role see court’s role below del credere clause, barring, 208 duty of loyalty— criteria, application through, 211 effect, 209 generally, 207–10 impoverishment, whether resulting, 209 lack of discussion, 207 objective good faith, effect of principle, 208–9 pre-competitive relationships, 208 quasi-organisational ventures, 208 restitution, rules on, 209 risk allocation as defence to unjust enrichment, 210 unjust enrichment, 209–10 case law, 200–3 contractual mechanisms— clauses— case law, 202 examples, 199 generally, 198–9 coordination tools, 199 courts’ role— contractual provisions, whether prevailing, 210 exceptional cases for intervention, 211 generally, 210–11 matters for initial consideration, 210 transparency as to risks, 210

uncertainty, effect, 210, 211 vertical integration, where, 210 English law— analogies from case law, 203–7 case law— foreign, 205–7 lack, 203, 207 contract, importance, 207 duty of loyalty as contractual guideline, 207, 211, 236 generally, 203–7 partnerships, 203 unjust enrichment see unjust enrichment below ex ante division, difficulties, 199 failure of usual approaches, 200 franchising disputes— English law, lack of authority, 207 German case law, 200–3 Privy Council decision, 206 South African case law, 205–6 US case law, 206–7 generally, 197–200 governance mechanisms— generally, 211–13 incentive structure, building, 213 mutual equity participation, where, 213 open-book management, 213, 236 profit-sharing agreements, 211–12 proportional valuation of profits, 211 relational incentives, 211–12 reward on meeting target or milestone, 211–12 target costing— generally, 212–13 open-book management policy, where, 212 high uncertainty— effect, 199, 210 hypothetical example, 202–3 implied duty, 200 initial dilemma, 198 investments of member, need to protect, 211 lack of legal rules and case law, 199 monetary resources, pooling, 198 organisational integration, dependent on, 211 partnerships, 199, 203 patrimonial funds, use, 198 proportional valuation of profits, 211 risk allocation, 200

Index  261 statutory regulation, lack, 199 unjust enrichment— applicability, 199 bilateral relationships, 204 contract as defence against, 205 disgorgement of profits, 205 foreign case law, 205–6 generally, 204 multiparty relationships, 204 partnerships, 203 relevant situations, 204–5 tax law context, 204 Relational contract Brazil, in, 124–5 classical contract law, and, 38 contractual networks classified as, 39 criteria establishing, 141–2 English law, in— changing nature of contract law, 135 commercial cases, development of concept in, 139–42 consequences of classification as, 142–3 contextualism, growing importance, 135–8 cooperation duty, 142, 143 criteria for existence of, 141–2 enforceability, 134 established concept, as, 141 example of relational contract, 140 features of legal concept, 142 formalist nature, 135 generalist approach, 134 generally, 134–43 good faith, relevance, 135–6, 139–40, 141 historical background, 138–9 Horizon computerised system, 141 ideological ramifications, 135 Lord Hoffmann’s approach, 136–7 loyalty to network see Loyalty to network neo-formalism, 137 no such contract existing, 140–1 reliance and reasonable expectations, 135 solidarity in market economy, rise, 135 trust and confidence, importance, 139, 140 factors encouraging, 38 features, 38, 39 flexible and differentiated intervention by courts, 37 generally, 37–40 good faith, and, 124

governance mechanisms, and, 78–81 informal mechanisms, use, 68 interpretations, 37–8 loyalty to network see Loyalty to network Macneil’s theory, 37–9, 138, 139 neoclassical contract law, emergence etc, 38–9 non-interventionist law, support for, 37 objections to, 39–40 trust relationships, development, 124 Restraint of trade see under Loyalty to network Scientific workforce Brazil, in— Institute for Science and Technology, 112 location, 111–12 developed countries, in, 112 Social relations crucial nature of networks, 21 Granovetter’s approach, 20–21 Neoclassical Economists’ approach, 20 New Institutional Economics, and, 20 over socialised view, 20 trust see Trust under socialised conception, 20 State role, need to re-conceptualise, 18 Symbiotic contract experimentalism, deterring, 43 features, 42 generally, 42–3 Schanze’s analysis, 42 Termination anti-copying clause, breach, 218 braiding theory, 217 Brazilian law— absolute impossibility of performance, 226 Civil Code, 224 damages, request for, 224 forced continuation, drawback, 225 fundamental or absolute default, 224, 225, 226, 227, 228 generally, 224–9 indeterminate duration, contract with, 224–5 information exchange regime, as interpretive tool, 227 nature of most contracts, 225 positive violation, 225–6

262 Index radical change of circumstances, 226 remedies, 224 revision of terms by court, 226–7 right to request termination, 224 specific performance, restriction on right to, 224 substantial performance, 226 usefulness of performance, analysis, 227 breach warranting— fundamental, whether— Brazilian law, 224, 225, 226, 227, 228 English law, 228 essence, 228 identifying, 214 competent firm, third party business delays, 228 continued cooperation, imposition, 217 contractual interpretation, need for, 214 courts’ role, 215 criteria of interpretation and governance, 228–9 delays— English law see English law below third party, by, 228 distinctiveness in collaborative networks, 213–15 duties, problems determining, 214 English law— anti-copying clause, breach, 218 case law, 218–19 condition— breach, 221 criteria for identifying, 221 consequences, relevance, 219–20 contractual condition, violation as, 217–19 delays— case example, 219 justification for, 219 minor, 218, 221–2, 223 remedy for, 219 fairness etc in contract, no need for, 217 forms of designing clauses, 217–20 fundamental breach, 228 freedom to terminate at any time— excluded, 223–4 generally, 223 generally, 217–24 hypothetical case example, 219–20 information exchange regime, as interpretive tool, 227

innominate term— breach, 221, 222 factors for consideration, 222 presumption as to, 222 insufficiency of rules, 217 material breach see material breach below minor violation, 220, 221 nature of breach, importance, 221 no need for legal reform, 224 notice, termination with, 223 past breaches, failure to admit to, 218–19 precedents, 221 remedies, 217, 221 repeated breaches, 223 repudiatory breach, 220 validity of termination clauses, 217 warranty, breach, 221 ex ante obligations, difficulties determining, 215 experimental innovative relationship, material breach in, 215–17 expertise etc of departing party, 214 fundamental breach in incomplete contract, determining, 214 governance mechanisms, use, 215, 217 hypothetical case, joint research and development etc, 215–17 informal incentives to avoid, 215 lawful, whether, 215 material breach— anti-copying clause, 218 assessment according to consequences, 219–20 case law, 218–19 compliance with governance procedures, 220 failure to cooperate, 220 hypothetical case, in, 222–3 meaning, 218–19 non-trivial, 219 past breaches, failure to admit to, 218–19 procedural character of contract, importance, 219 reasonable justification for, 219 repudiatory breach, 220 uncertain and experimental project, where, 219 milestones, where contract fashioned in, 228–9

Index  263 minor violation not justifying, 220 model clauses, variation, 214–15 not an issue, where, 215 opportunistic use, 214 past breaches, failure to admit to, 218–19 preliminary investments, protection, 214 reliance damages, 217 repudiatory breach, 220 specific performance, 217 uncertainty, response to, 229 underperforming company deterring innovative partner, 228 Transaction costs Coase’s analysis, 18–19 economising on, 19 importance, 18–19 Williamson’s analysis, 19 Trust see also Social relations contracts designed to favour, 69 exogenous to contracts, 68

governance mechanisms, and, 72, 76, 77 loss, 22 meaning, 21 outcome of contract, as, 111 uncertainty’s effect on, 21–2 Uncertainty abuse of rights, 151 comparative contract governance— Brazil, in, 94–5 England, in, 100 continuing, 119 disclosure of information, 175 generally, 232–3 governance mechanism— effect, 73 relevance, 111 inherent, as to future events, 57 management see Managing internal coordination objective good faith, dealing with, 148, 150

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