Common law and civil law systems affect how business is conducted within a country’s specific jurisdiction. Such systems of law also affect how international business is supervised in terms of compliance issues and taxation laws. The goal of this article is to outline some of the differences between the two legal systems. The source material for this blog is the legal framework assessment section of the World Bank resource website for public-private partnerships.
To begin with, the origins of the two types of legal systems need to be defined. Countries following a common law system are typically those that were former British colonies or protectorates, including the United States. Countries following a civil law system are typically those that were former French, Dutch, German, Spanish or Portuguese colonies or protectorates. Given the history of colonization, this includes much of Central and South America. The majority of Central and Eastern Europe have a civil law system. In addition, in light of the shifts in the world economy, it’s important to note that most East Asian countries (including China and Japan) follow a civil law structure.
Overall, a common law system is less prescriptive than a civil law system. There is an extensive freedom of contract when setting up a contractual relationship between two parties. Few provisions are implied into the contract by law, although safeguards often are implied to protect private consumers. As a direct result, ALL the terms that govern the relationship between the parties need to be clearly defined in the contract itself. Such necessities often result in a contract being longer than one in a civil law country.
In general, when it comes to common law contracts, almost everything is permitted that is not expressly prohibited by law. If there is a question of legality, it tends to be decided by the courts with such rulings becoming universally recognized. In a common law system, judicial decisions are binding. Decisions by the highest court can only be overturned by that same court or, in certain cases, but not all, through legislation.
In contrast to common law, the civil law system is a codified system of law that dates all the way back to the Roman legal system. A civil law system is generally more prescriptive than a common law system. There is definitely less freedom of contract than in a common law system. Many provisions are implied into a contract by law and parties cannot contract out of certain provisions. As a direct result, less importance is placed on setting out ALL the terms governing the relationship between the parties to a contract. Rather than be defined in the contract itself, such inadequacies or ambiguities tend to be remedied or resolved by operation of law. This will often result in a contract being shorter than one in a common law country.
In a civil law system, administrative laws tend to be less codified, and only legislative enactments are considered binding for all. There is not a lot of toleration for judge-made law in civil, criminal and commercial courts. Legal decisions are not necessarily binding on third parties, although judges tend to respect precedence. In certain civil law systems, like in Germany, writings of legal scholars have significant influence on the courts. In contrast, in common law systems, the writings of legal scholars have little importance when it comes to actual legal precedence.
In a civil law jurisdiction, unless the contract specifies that the parties have agreed to arbitration, administrative courts will enforce the contract. Unlike common law jurisdictions, arbitration is not a choice unless previously agreed upon, but the rules are quite ambiguous. For example, legal issues about restoring the “financial equilibrium” of the contract are far from clear. This lack of clarity is because the definition of “financial equilibrium” often changes from case to case.
The contracting authority under civil law, like in France, may have the right to modify aspects of a contract unilaterally when it deems the change to be in the public interest. The contracting authority does not have the right to change the contract’s financial provisions or its fundamental nature, but it can change such aspects as the specification of the service to be provided. Still, the operator is protected in certain circumstances by the right to have the “financial equilibrium” of the contract preserved. A unilateral modification is not supposed to be financially damaging to the other party.
In terms of bankruptcy, common law jurisdictions, such as England and the US, the emphasis when a business gets into financial trouble is on seeking reorganization. Liquidation is avoided in most cases in order to keep a company in business as a viable entity. In civil law jurisdictions, the bankruptcy process almost always focuses on liquidation. As a result, bankruptcy tends to offer greater flexibility in a common law system.
Common law systems also have greater flexibility in granting different types of security over assets. They have the concept of trusts that enable security interests to be held by a trustee for lenders in a syndicated loan situation. Such a trust can be executed without the need for formal transfer or re-registering of security interests in names of new lenders. Traditionally, civil law does not have such a concept, and security interests generally are required to be re-registered in the name of the new lender.
The international tax team at LSL CPAs understands that this is only an introduction to the complexities of doing business under common law and civil law legal systems. Given the challenges at hand, it is important to have an experienced financial professional in your corner when it comes to international business and contractual obligations.
With over twenty years of experience in private and public accounting, Yana has extensive knowledge in many areas of taxation. She is serving clients in manufacturing, healthcare and real estate industries providing them with entity planning support, transaction structuring, practice entry and exit strategies, cross-border transactions and other important financial matters.