Understanding Indonesia Contract Law: Navigating the Essentials

Indonesia Contract Law provides the fundamental legal framework that governs how agreements are formed, interpreted, and enforced within Indonesia’s civil law system. Understanding these principles is essential for assessing the validity of contracts and resolving disputes, particularly when issues of performance or breach arise.

Obligation and Contracts

Article 1233 of the Indonesian Civil Code (“ICC”) stipulates that all obligations arise either from agreements or the law/statutory. Furthermore, Article 1234 of the ICC provides that an obligation is made to provide something, to do something, or not to do something.

The ICC does not specifically define the meaning of an obligation. However, based on jurists’ opinion, obligation is a legal relation between two or more parties which falls within the field of the law of property, establishing to one party the right to get something or have something to be done by the other party, who has the obligation to fulfill such right (R. Setiawan, 1994: 2-3).

Types of obligations under the ICC, including:

Conditional Obligations

A conditional obligation depends on an uncertain future event, whether that event will cause the obligation to become valid or void. This obligation is regulated in Articles 1253 to 1267 of the ICC.

Time-Bound Obligations

A time-bound obligation is an obligation which execution is postponed until a specified time arrives. Article 1270 of the ICC stipulates that a time-bound obligation is always presumed to be made for the benefit of the debtor in the performance of their obligations, unless based on the nature of the obligation itself or the circumstances under which the time-bound obligation was made for the benefit of the creditor. Time-bound obligations are stipulated in Articles 1268 to 1271 of the ICC.

Alternative Obligations

Alternative obligations are stipulated in Articles 1272 to 1277 of the ICC. In this type of obligation, the debtor may choose to fulfill their obligations by performing one of several predetermined acts. Article 1273 of the ICC stipulates that the right to choose which act will be performed lies with the debtor, unless this right is expressly granted to the creditor.

Joint Liability Obligations

A joint liability obligation is an obligation in which two or more persons jointly act as debtors or creditors. In the case where multiple persons act as debtors, each debtor may be required to perform the entire obligation. Conversely, when multiple persons act as creditors, each creditor is entitled to demand payment of the entire debt. Consequently, payment made by one debtor releases the other debtors from their obligations, and likewise, payment made to one creditor discharges the debtor from liability to the other creditors. This type of obligation is stipulated under Articles 1278 to 1295 of the ICC.

Divisible and Indivisible Obligations

In the case of an indivisible obligation, each creditor is entitled to demand full performance of the obligation from each debtor, and each debtor is bound to perform the obligation in its entirety. Conversely, in the case of a divisible obligation, each creditor is entitled to demand only a portion of the performance in proportion to their respective part, and each debtor is likewise bound to fulfill only their respective portion (Subekti, 1990: 10). To avoid confusion between indivisible obligations and joint liability obligations, Subekti explains that indivisibility pertains to the nature of the performance itself, whereas joint liability obligations pertain to the persons involved, which are the creditors or debtors (Subekti, 1990: 10). This type of obligation is stipulated under Articles 1296 to 1303 of the ICC.

Obligations with Threat of Punishment

Obligations with the threat of punishment are stipulated under Articles 1304 to 1312 of the ICC.  It refers to an obligation in which a person is required to perform a certain act as a guarantee for the fulfillment of the principal obligation in the event of non-performance.

As previously mentioned, in addition to agreements, obligations may also arise by law. The fundamental distinction between obligations arising from agreements and those arising from law lies in the basis of the legal duty itself. In contractual obligations, the will of the parties serves as the foundation that gives rise to the legal relationship. Meanwhile, in obligations arising by law, individual consent is not required, as the duty is directly imposed by provisions stipulated by law (Subekti, 1990: 3).

This article provides a brief overview of agreements under the prevailing Indonesian laws. Furthermore, this article does not draw a distinction between the terms “agreement” and “contract.”

Definition

Article 1313 of the ICC defines an agreement as an act whereby one or more persons bind themselves to one or more other persons. Subekti defines an agreement as an event in which one person makes a promise to another person or in which two persons mutually undertake to do something (Subekti, 1990: 2).

Key Principles

Consensualism

Subekti explains the meaning of the principle of consensualism as the notion that, in essence, an agreement comes into existence at the moment the parties reach mutual consent. In other words, a contract is considered valid once the parties have agreed upon the essential terms of the contractual object, and no particular formality is required unless such formality is expressly prescribed by law for certain types of agreements, such as those that must be executed in the form of a notarial deed (Subekti, 1990: 15).

Freedom of Contract

This principle allows the parties to create and determine the contents of their agreement at their own discretion. It is implicitly embodied in Article 1338 paragraph (1) of the ICC, which provides that all legally executed agreements shall apply as law for the parties who have made them. The application of this principle is however not without limitation, an agreement must not contravene statutory provisions, public order, or morality.

Pacta Sunt Servanda

This principle embodies the notion of legal certainty, affirming that a lawfully concluded agreement creates a binding legal obligation and must be complied by the parties who have entered into it. This principle is stipulated under Article 1338 paragraph (1) of the ICC, which provides that all legally executed agreements shall apply as law for the parties who have made them.

Good Faith

Article 1338 paragraph (3) of the ICC explicitly provides that an agreement must be performed in good faith. Based on judicial precedents, J. Satrio concludes that good faith in the performance of a contract is closely related to the principles of propriety and decency (J. Satrio, 1992: 373). Subekti further explains that good faith in the performance of an agreement requires adherence to moral and ethical norms, or in other words, “the performance of the agreement must proceed along the right track” (Subekti, 1990: 41).

Personality

This principle is stipulated in Article 1315 of the ICC, which provides that, in general, a person cannot bind themselves or enter into an agreement except on their own behalf. It is further reaffirmed in Article 1340 of the ICC, which states that an agreement applies only to the parties who have entered into it. There are however exceptions to this principle. Article 1317 of the ICC allows a person to make an agreement for the benefit of a third party under certain specified conditions. Additionally, Article 1318 of the ICC extends the scope of contractual effect not only to the contracting parties themselves but also to their heirs and to those who derive rights from them.

Formation of Contracts

Article 1320 of the ICC provides the general conditions under which a contract is valid. Such conditions concern the subject and the object of the contract. It must comply with 4 (four) conditions, namely:

1. consent between those who bind themselves (the parties);
2. legal capacity of the respective parties;
3. a certain (specific) subject matter; and
4. a lawful cause.

When the conditions mentioned above are fulfilled, a contract is complete and valid. The first two conditions are subjective conditions of the agreement, while the last two conditions are objective conditions.

If the objective conditions are not met, the agreement is null and void. This means that the agreement is deemed to have never been made. If the subjective conditions are not met, either party to the agreement has the right to have the agreement cancelled. Therefore, the agreement that has been made remains binding on the parties, as long as it is not cancelled (by the judge) at the request of the party entitled to request the cancellation of the agreement. The party that may request the cancellation of the agreement is the party who is legally incapable or the party who did not give their consent freely and voluntarily (Subekti, 1990: 20).

When Is a Contract Created?

According to the consensualism principle, an agreement is said to arise when the parties reach a mutual consent regarding the essential terms of the contractual object. Consent refers to the meeting of minds and wills between the parties (Subekti, 1990: 15). In fact, determining the moment of this “meeting of minds and wills” has proved too difficult, so that, in practice, what matters are the actual declarations of the parties (S. Gautama, 2006: 81). In practice, an agreement is deemed to be formed at the moment a legitimate offer has been accepted. Subekti explains a legitimate offer as a statement that may reasonably be regarded as expressing the intention of a person to bind themselves (Subekti, 1990: 27).

A written acceptance is effective upon receipt. A legitimate offer is irrevocable unless a power to revoke has been reserved. If the offer is not accepted during the period of its validity, it terminates automatically at the end of that period. If the offer has no specified duration, it is deemed made for a “reasonable” time, which period varies according to the circumstances (S. Gautama, 2006: 81).

Performance and Breach

The performance of obligations under a contract, commonly referred to as prestasi (performance), is generally classified as set out in Article 1234 of the ICC, namely:

1. to give something;
2. to do something; and
3. not to do something.

The performance encompasses all actions stipulated in the agreement. Furthermore, the parties are bound not only by what is expressly stated in the contract but also by everything that, by the nature of the agreement, is required in accordance with principles of fairness, custom, or law.

As previously discussed, an agreement must be performed in good faith as stipulated in Article 1338 paragraph (3) of the ICC, meaning that the performance of a contract must observe the norms of propriety and morality. Under this provision, the court may, when necessary, reduce or extend the obligations outlined in a contract to ensure the preservation of the principle of good faith. For example, in a 1955 landmark case, the Supreme Court refused to allow land that had been pledged at a price of Rp50 (fifty Rupiah) before the war period to be redeemed at the same price, and instead the Court created its own redemption formula. The Supreme Court held that the risk of currency fluctuation should be borne equally by both parties, even though the contract stipulated a redemption price of Rp50. The calculation was based on the difference in the gold price between the time of the pledge and the time of redemption (during which the gold price had increased thirtyfold). Consequently, the Court ordered the plaintiff to pay 1/2 of 30 x Rp50, amounting to Rp 750, for the redemption of the land (S. Gautama, 2006: 85). Guided by the principle that all agreements must be performed in good faith, the court has the authority to prevent the enforcement of a contractual provision that would violate the sense of justice (Subekti, 1990: 43).

Breach of contract or default (commonly referred to as wanprestasi) occurs when one party fails to fulfil its contractual obligations as outlined in the agreement. A debtor is considered to be in breach of a contract if, after having been formally notified in writing or explicitly demanded to perform their obligation, they still fail to do so (Subekti, 1990: 47). When a debtor commits a breach of contract, the creditor typically issues a formal demand letter or notice by reprimanding that  the debtor has neglected their obligations, as regulated under Article 1238 of the ICC. This notice is commonly known as a somasi letter.

Breaches of contract may occur in four different ways:

1. non-performance, where the debtor does not fulfil its obligations under the contract;
2. partial or incomplete performance, where the debtor performs its duty but not according to the standard of completion required under the agreement;
3. late performance, where fulfilment was done but beyond the deadline; and
4. when the debtor acts in contravention to the contract.

Various remedies are authorized by the ICC to indemnify or otherwise relieve losses resulting from the breach of contract.

Specific Performance

As a general rule, a party to a contract is always free to sue for specific performance of the contract if performance is still possible.

Damages

In addition to performance, or in lieu thereof, the creditor may claim damages. Damages consist of monetary compensation arising from a breach of contract, which generally include three main components:

1. costs, including all expenses and costs actually incurred by the aggrieved party in reliance on the agreement;
2. losses, referring to damage or destruction of the creditor’s property caused by the debtor’s breach, whether involving the contractual object itself or other property affected by the breach; and
3. interests, referring to the loss of profits that the creditor would have otherwise obtained had the breach not occurred.

The ICC imposes certain limitations on the amount of damages that can be claimed:

1. Damages are limited to those losses which were foreseeable at the time of the formation of the agreement and to the injuries which are a direct result of the breach.
2. In the case where performance is to be in the form of a payment of money, the ICC permits the Court to award interest for late or non-payment. Nevertheless, the interest which can be claimed is limited to 6% per year, and is measured, not from the date of the breach, but from the date on which the claim for damages is lodged to the District Court.

Termination of the Agreement

In addition to the claim for the fulfillment of performance, the aggrieved party due to default may also claim the termination of the agreement, along with compensation. In this regard, the aggrieved party may choose between these claims.

Force Majeure

Subekti explains that force majeure, commonly referred to in the Indonesian language as “keadaan memaksa” or “keadaan kahar”, occurs when the debtor can demonstrate that the non-performance of an obligation results from events that were entirely unforeseeable and beyond their control. In other words, the failure or delay in the performance of a contract is not due to the debtor’s negligence. Such a debtor cannot be deemed at fault or in negligence, and a person who is not at fault cannot be subjected to the sanctions prescribed for negligence (Subekti, 1990: 55).

The ICC regulates force majeure under Articles 1244 and 1245, which stipulate that a debtor shall be released from the obligation to pay compensation if the non-performance is caused by force majeure. Several other provisions of the ICC also address force majeure, including Article 1497 and Article 1510 concerning sale and purchase agreements; Article 1545 concerning exchange agreements; Article 1553 concerning lease agreements; and Article 1716 concerning deposit agreements.

A force majeure event must meet the elements of being unforeseeable, unavoidable by the party obligated to perform, and beyond that party’s fault or control.

The types of force majeure include (R. Soemadipradja, 2010: 42):

Due to natural circumstances

This refers to natural disasters. Events that occur naturally, cannot be predicted with certainty, and happen without any human intention or intervention.

Due to emergency situations

These are extraordinary and urgent conditions that could not have been foreseen, such as war, blockades, strikes, epidemics, terrorism, mass riots, and other similar events.

Due to government policies

This occurs when there is a change in government policy, the repeal of an existing regulation, or the issuance of a new one, which directly affects the performance of contractual obligations.

Due to economic conditions

This arises from changing economic circumstances, specific economic policies, or any factors related to the economic sector, for example, an economic crisis.

Due to unforeseen technical circumstances

This results from damage to or malfunction of essential technical or operational equipment necessary for the execution of the contract.

Due to the destruction or loss of the contractual object

This situation renders the contract null and void because the subject matter or object of the contract no longer exists.

Termination of Obligation

Article 1381 of the ICC specifies how an obligation can be terminated, including:

• Performance
  A contract obligation can be discharged by performance. The performance may be executed by a third party with no interest in the agreement, as well as by the debtor, except in the case of obligation to do something where the creditor has a particular interest in seeing the contract is performed by the debtor, rather than by anyone else.

• Performance Offering Plus Deposit
  If the creditor refuses payment from the debtor, the debtor has the right to make an offer of cash payment for the debt through a notary or a court bailiff. If the creditor continues to reject the payment, the debtor may then deposit the payment with the district court (pengadilan negeri) (Subekti, 1990: 69).
  Such an offer of payment followed by a deposit in the district court is considered a valid payment by the debtor and releases the debtor from the debt. The amount deposited in the district court as payment is thereafter deemed to be at the creditor’s risk (Subekti, 1990: 69).

• Novation
  Article 1413 of the ICC stipulates 3 (three) types of novation:

1. Novation of the debt object, which occurs when the debtor and creditor establish a new debt agreement to replace and extinguish the previous one;
2. Novation of the debtor, which occurs when a new debtor is appointed to replace the former debtor, who is released from liability by the creditor; and
3. Novation of the creditor, which occurs when a new creditor is appointed to replace the previous one as a result of a new agreement, in respect of the latter, the debtor is released from its obligation.

• Compensation
  Compensation is a method of extinguishing obligations by offsetting or reconciling mutual debts between the creditor and the debtor, as regulated under Articles 1425–1435 of the ICC.

• Confusion (Merger of Debt)
  A merger of debt, as regulated under Article 1436 of the ICC, occurs when the positions of creditor and debtor are united in the same person, thereby extinguishing the debt. For example, this situation arises when a debtor is appointed as the sole heir of their creditor.

• Remission of Debt
  The release or remission of debt is regulated under Articles 1438 to 1443 of the ICC. A debtor is considered released from their debt only when the creditor explicitly grants such release. Mere inaction or delay in collection by the creditor over an extended period does not constitute a release of debt.

• Destruction of the Property
  If a specific item that constitutes the object of the agreement is destroyed, becomes untradeable, or is lost to the extent that its existence is entirely unknown, the obligation is extinguished, provided that the destruction or loss occurred without the debtor’s fault and before the debtor was in default of delivery.
  Even if the debtor was in default of delivering the item to the creditor, the obligation shall still be extinguished if the debtor can prove that the item would have perished in the same manner even after being delivered to the creditor.

• Null/Nullification
  The nullity or annulment of an obligation, as one of the causes for the extinguishment of obligations, is regulated under Articles 1446 – 1456 of the ICC. These provisions govern the annulment of agreements that may be requested for cancellation, such as agreements made by minors or obligations concluded under duress, mistake, or fraud.

• Applicability of Nullification Requirement
  This relates to conditional obligations as previously discussed. A resolutory condition is a condition which, when fulfilled, extinguishes the obligation and restores everything to its original state, as if the obligation had never existed.

• Expiry
  An expiry is a means of acquiring something or being released from a contract, after the lapse of a specific time period, and pursuant to the requirements stipulated by the law. Furthermore, Article 1967 of the ICC stipulates that all legal claims are extinguished by prescription after 30 (thirty) years. Upon the lapse of this period, the legal obligation ceases to exist, leaving only a natural obligation, meaning that the performance of the obligation may still be accepted voluntarily, but it can no longer be enforced through court (Subekti, 1990: 78).

Other Contract Issues

Validity of MoU as a Contract

Black’s Law Dictionary defines a Memorandum of Understanding (“MoU”) as a written statement outlining the preliminary understanding between parties who intend to enter into a contract or other formal agreement, a non-binding document that does not in itself create any enforceable obligation but serves as a basis for future agreement (Black’s Law Dictionary, 9th Ed., 2009: 988).

The characteristics of an MoU are as follows:

1. its content is concise and limited to essential matters only;
2. it serves as a preliminary document, to be followed by a more detailed agreement;
3. it has a specified period;
4. it usually executed in the form of a private (non-notarial) agreement; and
5. it generally does not impose any binding obligation on the parties to subsequently enter into a more detailed contract after the signing of the MoU (Munir Fuady, 1997: 91-92).

There are two differing opinions regarding the binding legal effect of an MoU (Burhanudin, 2018: 12–13), namely:

• The MoU has binding legal effect equivalent to that of a contract
  Although there are no specific statutory provisions governing MoUs, and their formulation is left to the discretion of the parties, this does not mean that an MoU lacks of legally binding effect. The legal basis for this view lies in Article 1338 of the ICC, which stipulates that all legally made agreements shall apply as law for those who create them. Therefore, if an MoU fulfills the validity requirements of an agreement as prescribed in Article 1320 of the ICC, its position and effect upon the parties can be equated with that of a binding and enforceable contract.

• The MoU does not possess a legally binding effect and therefore cannot be legally enforced by either party
  An MoU is merely a preliminary agreement serving as initial evidence of an understanding that outlines the principal terms to be elaborated upon in a future contract. Despite being rooted in the ICC, its binding effect remains purely moral rather than legal. In other words, an MoU constitutes a gentleman’s agreement that has no legal consequences. Accordingly, if one party fails to perform the MoU, the other party cannot impose any legal sanctions upon them.
  In practice, it is sometimes found that an agreement is titled as a Memorandum of Understanding by the parties, even though the content of the document does not correspond to its name. In such cases, the MoU may in fact possess binding legal effect upon the parties, equivalent to that of a contract.

Languages of Contracts

According to Article 31 of Law No. 24 of 2009 concerning the National Flag, Language, Emblem, and Anthem (“Law No. 24/2009”) jo. Article 26 of Presidential Regulation No. 63 of 2019 concerning the Use of the Indonesian Language, contracts involving Indonesian entities must be drafted in Bahasa Indonesia. If foreign parties are involved, the contract must be available in both Bahasa Indonesia and the national language of the foreign party or English.

Failure to comply with this language requirement may render a contract invalid for failing to satisfy the element of a “lawful cause” as stipulated under Article 1320 of the ICC. Such non-compliance may lead to a contract being deemed null and void. For example, there was a dispute between Nine AM Ltd. (Defendant), a company based in Texas, United States, and PT Bangun Karya Pratama (Plaintiff), an Indonesian company. The Plaintiff argued that their loan agreement was null and void because it violated Article 31 of Law No. 24/2009, as the contract was not written in the Indonesian language. The Panel of Judges granted the Plaintiff’s claim and declared that the loan agreement between PT Bangun Karya Pratama and Nine Am Ltd. was null and void.

At present, there has been a paradigm shift following the issuance of Supreme Court Circular Letter No. 3 of 2023 (“SEMA No. 3/2023”). The Supreme Court introduced a policy stipulating that:

“Indonesian private entities and/or individuals who enter into agreements with foreign parties in a foreign language without an accompanying Indonesian translation cannot use such absence as a ground to annul the agreement, unless bad faith by the parties can be proven”.

To date, however, there have been no known court precedents rejecting a claim for contract annulment on the grounds of a violation of Article 31 of Law No. 24 of 2009, in which the panel of judges explicitly referred to the formulation set forth in SEMA No. 3/2023 as the basis for its consideration.

Notwithstanding the foregoing, prior to the enactment of SEMA No. 3/2023, the Supreme Court had previously rejected a claim for contract annulment based on an alleged violation of Article 31 of Law No. 24 of 2009 through Supreme Court Decision No. 3230 K/PDT/2018. In that decision, although the district court and the high court had declared the contract null and void on the grounds that it constituted an agreement with an unlawful cause and violated the requirement of a lawful cause, the Supreme Court held that the Judex Facti’s view concerning the requirement to use the Indonesian language in contracts as stipulated in Article 31 paragraph (1) of Law No. 24 of 2009 forms part of a “lawful cause” was incorrect.

Furthermore, the Supreme Court clarified that the term “cause” or “lawful cause,” which constitutes an objective requirement of a contract, essentially refers to the content, material, or substantive terms of the agreement, which must not conflict with the law, morality, or public order. Thus, a “lawful cause” does not pertain to the formalities or the form of a contract, but rather refers to the material/substance/content of the agreement itself.

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Reference

Law and Jurisprudence

• Indonesian Civil Code.
• Law No. 24 of 2009 concerning the National Flag, Language, Emblem, and Anthem.
• Presidential Regulation No. 63 of 2019 concerning The Use of The Indonesian Language.
• Supreme Court Decision No. 409K/Sip/1983 dated 25 October 1984.
• Supreme Court Decision No. 601 K/PDT/2015.
• Supreme Court Decision No. 3230 K/PDT/2018.

Literature

• Burhanuddin. 2018. Pedoman Penyusunan Memorandum of Understanding (MoU). Jakarta: Media Pressindo.
• Fuady, Munir. 1997. Hukum Bisnis dalam Teori dan Praktek: Buku Keempat. Bandung: PT Citra Aditya Bakti.
• Gautama, Sudargo. 2006. Indonesian Business Law. Bandung: PT Citra Aditya Bakti.
• J. Satrio. 1992. Hukum Perjanjian. Bandung: PT Citra Aditya Bakti.
• R. Setiawan. 1994. Pokok-Pokok Hukum Perikatan. Bandung: Penerbit Binacipta.
• Soemadipradja, Rahmat. 2010. Penjelasan Hukum tentang Keadaan Memaksa (Syarat-Syarat Pembatalan Perjanjian yang Disebabkan Keadaan Memaksa/Force Majeure). Jakarta: Nasional Legal Reform Program.
• Subekti. 1990. Hukum Perjanjian. Cetakan ke 12. Penerbit PT Internusa.