When concluding transactions, each party wants the outcome of the transaction to satisfy both parties. Although the need to carefully and responsibly prepare and analyze transaction documents before concluding a contract is repeatedly emphasized and warned about, in practice there are clear examples of contracting parties not paying sufficient attention to the content of the contract.
What does the term “contractual gaps” mean? What are the most common “contractual gaps”? How do courts/arbitration tribunals hearing disputes between parties interpret “contractual gaps”?
When concluding transactions, each party strives to ensure that the outcome of the transaction is satisfactory to both parties. Despite repeated reminders and warnings about the need to approach the preparation and analysis of transaction documents carefully and responsibly before concluding a contract, in practice there are clear examples of the parties to a contract not paying sufficient attention to the content of the contract.
Loopholes in a contract are a shortcoming that arises when the parties have not agreed on certain issues that are essential for the successful performance of the contract, and there are no legal provisions in the mandatory or dispositive norms of the law to remedy this incompleteness. If a court/arbitration tribunal finds a defect in the contract, it fills it by further interpreting the contract, taking into account the hypothetical will of the parties, i.e., by determining what content of the contract provisions the parties could reasonably have agreed upon if they had been aware of the existence of this gap. However, if the final answer to unresolved issues in the contract can be found in the mandatory or dispositive provisions of the law, it can be argued that there is no gap in the contract and no additional interpretation is required.
Mandatory rules are rules that must be applied or implemented and cannot be changed by anyone except the institution that created them or a higher authority.
A dispositive provision is a provision that is not mandatory; it applies when the parties to the contract have not independently determined their rights and obligations or settled their relations.
The most common shortcomings of a contract (contractual gaps) are mainly related to the following:
1. Incorrect wording of penalties
In judicial/arbitration practice, contracts in which the penalties included and established for delay in the performance of the contract do not have an unambiguous interpretation are very often the subject of dispute. In particular, when drafting the contract, its author included terms that are not defined in the law, such as penalty interest and late payment penalties. The law defines and specifically names three types of penalties: contractual penalties, contractual interest for late payment, and statutory interest for late payment. This means that if the parties have specified other terms in the contract, the court/arbitration court will interpret these terms in such a way that they are less detrimental to the interests of the less protected party, i.e., the defendant. For example, if your cooperation agreement states that a penalty of 1% applies for breach of obligations, the court/arbitration tribunal will consider this as a contractual penalty, which cannot exceed 10% of the total amount of the principal debt. In judicial practice, there are cases where contracts often include all possible types of penalties, namely, when concluding, for example, loan agreements, not only contractual penalties are included, but also interest for late payment, interest on capital gains, and interest for using the loan. Of course, you have the right to ensure the fulfillment of obligations by specifying penalties in the contract, but at the same time, you should assess their size and proportionality so that not only the parties to the contract, but also the court/arbitration court, understand when and in what amount the penalties are applied!
2. Joint and several liability and suretyship
In commercial transactions, it is very common to encounter contracts in which one of the parties wishes to strengthen its rights so that, in the event of a breach of contractual obligations, the performance of these obligations can be demanded simultaneously from the main party to the transaction and the guarantor, or in this case, the joint and several debtor. Without understanding the difference between a joint debtor and a guarantor, a clause with a guarantee is included in the contract, which is often formulated incorrectly and is not fully understood by the parties, namely: the party that guarantees the performance of the contract does not always fully understand that it is assuming responsibility as a joint debtor.
When assessing the wording of the contract regarding the guarantor’s liability, the court/arbitration court will be guided by the provisions of the law that distinguish joint and several liability from suretyship, and if the wording of the contract is unclear, the court/arbitration court will interpret it based on the provisions of the law and after hearing the guarantor’s explanations. If you want to reinforce obligations with a guarantee in contracts, be sure to choose the correct and clear wording of the liability to be borne by the person who will be the guarantor for the performance of the obligations — whether it is a guarantor (with the right to first apply to the debtor and, if it is impossible to collect the debt, to the guarantor) or a joint and several debtor (with the right to simultaneously turn to the debtor and the guarantor as joint and several debtors)!
3. Determination of jurisdiction over the dispute
In judicial practice, there are still cases where the parties to a contract do not consider it necessary to determine the place of dispute resolution, as they believe that disputes will not arise. Or, conversely, they include a clause on dispute resolution in contracts only formally, without delving into whether it is correctly formulated. If one of the parties to the transaction is unscrupulous, it is this clause of the contract that helps them to evade their obligations for a long time. We would like to draw your attention to the fact that 89% of contracts contain the abbreviation “in accordance with the legislation of the LR”. Did you know that this abbreviation actually means “Republic of Liberia”? To use the abbreviation “Republic of Latvia,” the abbreviation LVR should be used correctly. If both parties in court/arbitration do not object, silence is taken as the parties’ consent to Latvian law, but as soon as one of the parties objects, the issue is considered in more detail. Similarly, contracts do not pay enough attention to the correct translation of bilingual contracts. For example, contracts use the English translation “Arbitration court in Riga,” which the party referring to in the contract meant as the Riga Arbitration Court, but the literal translation would be “Arbitration Court in Riga.” Given that there is both a Riga Arbitration Court and a Riga Arbitration Court in Riga, it is not entirely clear which arbitration court the parties agreed upon. In this case, even the fact that the Latvian text refers to the Riga Arbitration Court will not resolve the situation if one of the parties to the contract is a person who does not speak Latvian. Recommendation: provide accurate information and correct details—registration number, address—if you use abbreviations, specify in advance in the contract what you mean by this abbreviation so that the parties to the transaction and the court/arbitration court have no doubts about the clear agreement and consent of the parties to a specific dispute resolution.
4. Incomplete contact information
In court/arbitration practice, there are cases when one of the parties to the transaction has to prove the identity of the party to the contract. In particular, the party concluding the contract (most often representatives of legal entities — managers, client consultants) carelessly checks (or does not check at all) the contact information of the legal entity or the data of the individual. It is precisely such cases that are exploited by unscrupulous individuals who deliberately provide incorrect information, such as a surname, identification number, or address. Representatives of legal entities are not always authorized to conclude contracts. The creditor applies to the court/arbitration court, and there is an additional need to prove that it was this person who signed and was authorized to sign the contract. It is not enough to specify a specific person, as they can refute the transaction! All agreements stipulated in the contract will be invalid if you cannot prove that the person was authorized to sign the contract and assume contractual obligations on behalf of the principal!
5. General terms and conditions that do not contain specific actions
In the rush to prepare the contract, the parties do not discuss or specify the specific terms of the contract that must be fulfilled. In particular, sometimes the parties tacitly express their intention or understand the specified in their own way, and when a result is necessary and expected, it does not always correspond to what one party had in mind and the other understood. For example, the parties enter into a lease agreement, which additionally stipulates the need to renovate the building located on the territory. The lessor meant the demolition of this building and the construction of a new one, while the lessee (a legal entity whose activities are not related to construction) understood that it was necessary to restore the building, for example, to strengthen it, to put it in order so that it would be safe for use if necessary. Contracts must specify clearly and precisely what the landlord means by the word “restore” so that the parties do not have any disagreements when performing their contractual obligations.
Interpretation of gaps in contracts in courts/arbitration tribunals
The rules for interpreting legal transactions contained in the Civil Code (Articles 1504-1510 of the Civil Code) include both subjective and objective criteria for interpretation. The legislator has limited the objective interpretation of a transaction by establishing that if the parties to the transaction have agreed on a different meaning of the words used in it, that meaning shall prevail. In particular, Articles 1504 and 1505 of the Civil Code state that when interpreting a transaction, the court must determine the objective meaning of the words used in the transaction (in a broader sense, the provisions of the transaction), if the parties have not reached a consensus on a different meaning of the words used during the court proceedings or if it has not been proven that the parties agreed to use these words in a different meaning.
The provisions of the Civil Code on the interpretation of legal transactions (Articles 1504-1510 of the Civil Code) are not intended to fill gaps in the contract, but to translate vaguely worded provisions of a legal transaction.
As a result of interpretation, the content of the transaction will not always be what all parties to the transaction would like it to be, i.e., the result of the translation is often more favorable to one party to the legal act but does not satisfy the other. However, this does not relieve the court or arbitral tribunal of its obligation to interpret the transaction in accordance with the requirements of the law.
In accordance with Article 1504 of the Civil Code, when interpreting a transaction, it is necessary to evaluate and consider the meaning of the words used in the transaction, and if they do not have a double meaning, they should be strictly adhered to, unless it is proven that they do not correspond to the will of the parties. Article 1505 of the Civil Code provides that in case of doubt as to the meaning of words, their meaning and the clearly expressed or otherwise manifested intention of the parties to the transaction shall be taken as a guide.
Article 1508 of the Civil Code provides that preference is given to the more favorable interpretation, and on this basis, preference is given to the one that least binds the debtor. In accordance with Article 1509 of the Civil Code, bilateral transactions that impose certain obligations on both parties, in case of doubt, are interpreted to the detriment of the party who is the creditor in this case and who therefore should have expressed themselves more clearly and precisely.
Case law and legal doctrine indicate that there are two main methods of interpreting declarations of intent and legal transactions in civil law:
- subjective interpretation, which aims to ascertain the true intent of the parties to the transaction by examining and clarifying each party’s subjective understanding of the content of their declaration of intent;
- objective interpretation, the purpose of which is to interpret the expressions of will contained in the transaction as they would be understood by a reasonable and impartial person familiar with the circumstances of the transaction. In this case, the content of the transaction is determined in accordance with its objectively acceptable meaning.
The parties to the contract and the court/arbitration tribunal in its decision should not rewrite the rules of law, as they must be complied with by the parties directly on the basis of the law, namely, in addition to the provisions of the contract, the parties must comply with the mandatory rules of law in the performance of the contract, and unless the provisions of the contract provide otherwise, with the dispositive rules as well.
When concluding contracts, both parties must carefully review and discuss the clauses of the contract and, if there are any deficiencies in the contract, remedy them in a timely manner so that in the event of a dispute, the court/arbitration court can clearly see and understand the will of the parties!
The article was published on April 8, 2025, on the iTiesības portal.
Author of the article: Ilga Neretniece, Administrative Director of the Riga Arbitration Court.