The Impact of Corruption on International Commercial Contracts

• May 3, 2022
• Maichael Bessada

1.1   Introduction[1]

Corruption is generally considered one of the greatest enemies of international trade. Where corruption runs rampant, fair players are prevented from accessing the market, and performance and quality are excluded from competition by those who use bribery as a means of acquiring contracts. It is a problem of vast magnitude: according to a frequently quoted World Bank study, an estimated USD1 trillion in bribes are paid each year. Corruption is said to increase the total cost of doing business globally by up to 10 % and the cost of procurement contracts in developing countries by up to 25 %. This means that for the EU alone approximately EUR120 billion, or 1 % of its GDP, is lost to corruption every year.

The international community has therefore undertaken serious efforts to tackle the problem of corruption; the topic has been of the highest priority since the mid-1990s. Countless sets of rules have mushroomed up from this movement, establishing anti-corruption as a new, independent branch of law. At the peak of this complex regime is a series of international treaties, which have since been ratified by many of the world’s leading industrial nations. These conventions are supplemented by domestic anti-bribery legislation, with well-known examples being the US Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act. The legislative landscape is further complemented by several non-governmental initiatives – such as NGOs, professional organizations, or multinational corporations – which use their own rules, recommendations, and codes of conduct to strengthen the fortifications against corruption. Anti-corruption is, therefore, nothing less than a prime example of a transnational legal development in which the rules set at the international, national, and non-governmental levels are constantly intertwined with one another.

So far, criminal law has been the weapon of choice for combating corruption. The majority of the international sets of rules contain the central obligation that the Member States punish the payment of bribes and related crimes. In particular, the territorial scope of domestic criminal law has been expanded by shifting the focus of attention from the country where the corrupt incident occurred to the supply side of corruption, ie the home country of the bribe-giver. The OECD, aiming to create a level playing field in the international business environment, has declared this tenet (whose origins are in the American FCPA) to be the general principle of its anti-bribery convention. However, practical experience has shown that criminal law alone cannot cope with this difficult task; other branches of law must also contribute to achieving this joint objective. Combating corruption has therefore become an en vogue topic in many areas of law such as tax law and employment law, as well as in optimizing public procurement rules, corporate governance, and arbitration.

One branch of the law whose role in tackling corruption has thus far been underestimated in general contract law. Agreements of a contractual nature are present in many different forms of corruption. In light of the immense economic value embodied in international commercial contracts, it is surprising that such little attention has been paid to the legal analysis in this area. Many national reports bemoan the rarity of reported court cases – or even the complete lack thereof – on the civil law aspects of corruption in their respective countries. And yet two questions immediately spring to mind: firstly, the question of using efficient civil law remedies to provide optimal protection to the victims of corruption; and secondly, the broader question of the role of contract law in the prevention of corruption, ie whether and to what extent the contract law regime can deter potential offenders from corruptive behavior.

The consequences of bribery for the contracts concerned are primarily decided by the applicable domestic contract law. There have been few efforts to harmonize this area of law at the international level; the Civil Law Convention on Corruption of the Council of Europe represents the only set of rules so far that has focused entirely on the contractual aspects of corruption. However, for the most part, these rules are limited to a general framework that grants the Member States considerable leeway in their respective transpositions and leaves many of the key questions unanswered.

1.2   Corruption and International Commercial Contracts

1.2.1    On Defining Corruption

The worldwide unanimity when it comes to condemning corruption is deceiving, as there is no uniform understanding of what the term corruption means. There are indeed a nearly infinite number of actions that could in everyday language be branded as “corrupt”; yet, at a legal level, an entirely different analysis may be needed in each instance. Defining its subject matter is thus one of the greatest challenges facing the anti-corruption movement. Each concept of corruption has to overcome different obstacles: firstly, the national borders – what may be unproblematic in one area of the world may trigger severe punishment in others; secondly, inter-disciplinary boundaries – corruption is not just a legal topic but is also heavily researched in other scientific disciplines; finally, the intra-disciplinary boundaries – the perspective varies between the different branches of the law, and a working definition that fits the discussion of the criminal law aspects of corruption may thus be unfit for private law, tax law or public procurement.

Instead of attempting to provide an abstract definition of corruption for specific aspects of private law, we will instead examine which instances of bribery are typically encountered by courts and arbitral tribunals concerning international commercial contracts. The starting point is the following (fictitious) scenario:

Contractor A of country X agrees with intermediary B (“the Commission Agreement”) under which B, for a commission fee of USD1,000,000 would pay, on behalf of A, USD10,000,000 to C, a high-ranking procurement advisor of D, the Minister of Economics and Development of country Y, to induce D to award A the contract for the construction of a new power plant in country Y (“the Main Contract”). B pays C the USD10,000,000 bribe and D awards the main contract to A.

1.2.2    A Basic Model of Corruption

In its simplest form, a typical corrupt exchange can be seen as a triangular relationship between a principal, his agent, and a bribe-giver. The selection of a principal-agent model as a starting point is not by accident but reflects the prominent standing this model has held in the research on corruption since the 1970s. This model is especially suitable for the analysis of the private law side of corruption, as it allows for the clearest depiction of the legal relationships between the different actors. This is because such a triangular structure between principal, agent, and bribe-giver also corresponds to a triangular contractual relationship in private law.

The base of the triangle is formed by the relationship between the principal and his agent. This particular relationship can take many shapes in the modern business world; an agent can be, for instance, an employee in the procurement department, but also the CEO of a large multi-national company. The terms used here are understood in a broad context. In the aforementioned example, C is the agent and the Ministry D (where he is employed and which becomes a party to the contract with bribe-giver A) is his principal. The connecting factor in all situations is that the agent acts for his principal when negotiating with the third party and should therefore decide not to his advantage, but rather in the interest of his principal. The principal-agent relationship is therefore characterized by a strong fiduciary element.

The third-party (A) infringes on this fiduciary relationship by secretly affording the agent with an undue advantage, which need not be in monetary form but can encompass everything that the recipient considers valuable and suitable to cause him to undermine his loyalty: jewelry, invitations to expensive trips, even immaterial assets such as honorary titles or granting sexual favors. In return for such items, the agent breaches his fiduciary duty by ensuring that the bribe-giver receives preferential treatment to the contract with the principal. This preferential treatment can consist of receipt of the tender, which under fair competition would have otherwise been given to another competitor; alternatively, it can also be used in instances in which the bribe-giver would have nonetheless gained the tender, yet the bribe was paid to obtain better conditions.

Under this model, it is, therefore, possible to distinguish between contracts providing for corruption and contracts procured by corruption. For this report, we shall refer to the contract providing for corruption between bribe-giver and bribe-taker as the “bribe agreement”; the contract between the principal and the bribe-giver that has been procured by corruption is referred to as the “main contract”. Although one could say that both contractual relationships are tainted with corruption, they are not necessarily subject to the same legal consequences. The following shall focus particularly on the enforceability of both of these contracts. In contrast, questions of compensation for corruption – though likewise immensely important in practice – must, unfortunately, be left aside.

1.2.3    Advanced Concepts of Corruption in International Commercial Cases

Instances of corruption in practice are often much more complex than can be expressed with a simple three-person framework like the one just introduced. Corruption is a topic that features a multitude of variations and is often connected with additional problems that, although not necessarily present in all instances of bribery, must nevertheless be borne in mind in the abstract search for appropriate legal consequences in the relationship between the parties to a bribe.

1.2.3.1 The Use of Intermediaries

The first additional problem concerns the manner and form in which the bribe is paid. In international trade, it is likely that the relevant parties will not know each other personally and will therefore not be sure whether they can trust one another. The bribe-giver cannot openly approach his business partner’s agent and offer him a bribe. Rather, the illegality of these activities requires that the bribe results from a careful and subtle approach. Accordingly, negotiations concerning bribery often feature intermediaries (like B in the example) to ease the transaction. Such middlemen often appear as “consultants” or “brokers” for their employer. Consulting services are common in international trade and can be a sensible approach, for instance to the political or economic situation in the target country or regional customs and practices. However, amongst the herd of consultants are black sheep whose main or sole activity consists of funneling bribes to influential people. These people have at their disposal both the political contacts as well as the know-how for such covert transactions.

The legal structure of this exchange often follows the same pattern: A hires B to initiate the conclusion of a contract with D. The precise activities expected of him are described only very superficially in the consultancy agreement. The intermediary usually receives a generous contingency fee for his services – it is an open secret between the parties that parts of this fee will be forwarded as bribes to influential persons on the opposite side. The contracting company will often not want to know the details to be able to claim plausible deniability and thereby protect itself from prosecution.

1.2.3.2 The Victims of Corruption

Furthermore, it is to be noted that, contrary to a widespread cynical view, corruption is by no means a “victimless crime”. Quite in contrast, many bear the brunt of its consequences. The direct effect is felt first by the principal, who often pays an inflated price for the contract with the bribe-giver. In the aforementioned example, A would not resort to bribery if he could not gain an advantage that would be at least equal to the payment of the bribe to C. In practice, the resulting loss is probably even much greater than the amount paid as a bribe.

However, the financial loss to the principal is typically not the end of the story: corruption also has indirect negative effects on further parties. If (as in the example) D is a state or a government contractor, it has to cover its additional costs resulting from the inflated price through tax increases or by deducting the amount from other important infrastructure projects. On the other hand, where the victim is a private business, the additional costs will usually fall within the principal’s price calculation and will thereby be passed on to its customers; the price of the products will increase. In both cases, the costs of corruption will thus ultimately be borne by everyone.

A further group of victims can be said to be the competitors of the bribe-giver who, due to the illicit payment made by their rival, have lost the chance to acquire the main contract with the principal for themselves. Market survival depends on at least occasional success in acquiring contracts, as otherwise one quickly loses a position on the market. If there is no chance for bidders to acquire contracts through honest competition, they are then left with the choice between just two undesirable alternatives: either to voluntarily retreat from the market or to enter the competition for the highest bribe. This dilemma forms the basis for why particular sectors have such great problems in containing widespread corruption after it has initially occurred.

Because of this situation, it is to be expected that the competitors observe with particular criticism the question of the enforceability of a contract that has been purchased via bribes. If the law does not punish the bribe-giver but instead allows him to retain the contract, it sends a devastating signal to all other market participants to equally resort in the future to such illegal methods. The situation is further complicated by the lack of sufficient protection in the form of damages claims for competitors; there are practically no court decisions in which a competitor has successfully claimed compensation from his corrupt rival.

1.2.3.3 Shareholder Lawsuits

Ultimately, corruption can also create considerable harm on the bribe giver’s side. It is easy to overlook that a bribe-giver is not necessarily an economic unity, but, as in the case of a multinational enterprise, can encompass several different interest groups. A possible example is that, despite explicit company policy to the contrary, an overambitious manager pays a bribe to secure a contract; then the company and its shareholders are also victims of this corruption if, after the crime has been discovered, the affected contract falls through and the prosecution leads to a severe fine. This internal conflict of interests forms the background for the current boom of anti-corruption compliance, which aims at reducing the risk of liability through organizational measures.

[1] – The Impact of Corruption on International Commercial Contracts, Michael Joachim Bonell • Olaf Meyer, Chapter 1: The Impact of Corruption on International Commercial Contracts – General Report