The Application of "Freedom of Contract" and Applicable Law Clauses Under Indonesian Law in International Contracts
by Mutia Rivayanthi and Christian Teo

The "Freedom of Contract" Principle in Indonesian Law

Indonesia is a civil law jurisdiction in which the basic commercial law is found in the Civil and Commercial Codes initially promulgated during the Dutch colonial era. The concept of free will of the parties under Indonesian law is commonly referred to as the principle of "freedom of contract". This means that the parties are free to enter into any type of contract provided the agreement fulfills the four basic statutory requirements as set out in Article 1320 of the Indonesian Civil Code:

(i) consent of the parties;
(ii) capacity to contract;
(iii) a certain object; and
(iv) a permissible cause.

After fulfilling these four basic elements, a contract will be regarded as law for the signatories, and they will be bound to comply with it.

Issues on Consent

In general, the Indonesian Civil Code does not define when the parties to a contract consent to be bound. Nonetheless, well established doctrines provide that the parties are considered bound when they have reached an agreement, i.e. when one party's offer is accepted by the other party. It is generally held that the contract is formed the exact moment when this acceptance is received by the offerer. In any event, mutual consent of the parties is required to make a contract binding. Contracts are voidable in the event the mutual consent is formed under duress or by mistake.

Issues on Competence

Contracts that are signed by incompetent parties are voidable. Incompetent parties are minors, persons who represent(s) other parties without authority and legal entities that are barred by their Articles of Association from concluding the contract concerned. A minor (i.e. those who are under the age of 17) who has signed a contract may submit a claim (presumably through his guardian) to an Indonesian Court to have the contract declared void. Likewise companies may ask the Court to void contracts signed on their behalf by other parties who have no authority to represent them.

Issues on a Certain Object

Under Indonesian law, contracts that do not have any definite object are null and void. As an example, a sale and purchase contract is null and void if it fails to specify a certain object of the sale and purchase transaction.

Issue on Permissible Cause

A contract shall not contravene the prevailing laws and regulations and principles of public order and morality. Contracts that do not fulfill this requirement are null and void.

Contract Construction Principles

Further, in applying the concept of freedom of contract, it is also important to understand the rules of construction of agreed contractual provisions. The basic underlying principles stated in the Indonesian Civil Code governing the performance of contracts and thus their interpretation are:

(a) Good faith All contracts are to be construed and performed in good faith.

(b) Customary Practice Custom plays an important role in contract interpretation because it is assumed that the language of a contract will not be exhaustive. "Notice", for example, is subject to customary local practice. Lessors wishing to terminate leases are ordinarily required by custom to give 3 months notice, except if the leasehold is a rice field, for example, in which 6 months notice of termination is given. It is customary that the party in default must be given at least one warning before action is taken under a commercial contract.

(c) Basic Fairness In the event the Civil Code and custom are silent on a particular issue, a judge has discretion to rule on the basic fairness of the situation.

(d) Clear Meaning. If the contract language is clear, there is no room for contrary interpretation.

(e) Intent of Parties If an agreement lends itself to various interpretations, the intent of the parties is to be preserved rather than simply adopting the literal meaning of the wording.

(f) Effect to Contract If two interpretations are possible, the one giving effect to the contract, i.e., making it possible for the contract to be performed, shall be chosen.

(g) Contracts as a Whole Contract clauses are to be interpreted in concert with each other and construed as a whole.

(h) Construction against the drafter/requester In case of doubt, contract clauses are to be construed against the party requesting the clause.

(i) Role of experts Experts are sometimes used to clarify disputes between parties, however, a court is not bound to consider the evidence or testimony offered by an expert.

(j) Implied terms Subject to the overriding principle of freedom of contract, a judge is empowered to imply a term into a contract as required by the nature of the contract, the principles of reasonableness, custom and legislation.

Choice of Law

The issue over the choice of law usually arises in matters relating to international commercial agreements between parties from different countries. In addition, it is also possible that two entities located in one country choose a different law from the law in which they are located. This might happen if, for example, the majority shareholder of one party is from a foreign country. The foreign majority shareholder may feel more comfortable if a contract, especially a major contract entered into by its subsidiary, is governed under the law of the foreign shareholders' home country.

The concept of freedom of contract includes the parties' choice of the law to govern a contract. If parties to a contract agree that their contract is governed in accordance with, for example, the laws of the United States of America, the parties are bound by these laws. Nevertheless, in determining the choice of law of a contract, it is important also to consider the enforceability of the contract.

Theoretically, Indonesian Courts should honor the choice of law and adjudicate the case based on the chosen law. It is not impossible to implement a contract governed under foreign law, however, it is also important to understand that Indonesian civil procedure law contains no specific procedures, and there are no court rules for establishing or proving foreign law. The courts may reach different conclusions on a contract governed under foreign law. There are cases where an Indonesian court declined to proceed because the case was governed by foreign law, or applied Indonesian law when the contract expressly provided otherwise. In reviewing a contract governed under foreign law, the Indonesian courts consider whether the merits of the contract contravene Indonesian public policy. One example; a gambling contract between a casino located in a country where gambling is legal and an Indonesian national. The contract is governed under the law of the country where the casino is located. In this case, Indonesian courts generally will apply Indonesian law and decide that this contract is null and void because gambling is prohibited under Indonesian law.

The different rulings that may come from the Indonesian courts are a result of, firstly, as mentioned above, to the absence of specific regulations for establishing or proving foreign law. Secondly, like other civil law countries, Indonesia does not apply the concept of stare decisis or binding precedent as is the case in Common Law jurisdiction. Indonesian courts are not bound to previous court decisions of that court. Even previous decisions of higher courts do not have a definitive binding effect on the lower court. The practice is that courts at any level have the freedom to adjudicate cases and render their own judgment based on the merits of each case.

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If you have any questions on this article or need further assistance, please contact Mutia Rivayanthi (Hadiputranto, Hadinoto & Partners) or Christian Teo (Hadiputranto, Hadinoto & Partners).

Hadiputranto, Hadinoto & Partners
(Associated office of Baker & McKenzie)
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Jakarta 12190, Indonesia

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