Judgment of the Federal Supreme Court of 28 April 2025
Case Reference : 4A_526/2024

Facts

Aa., Inc. (the “Client“) is a US company incorporated under the laws of the State of Delaware, USA. It is part of the A. group (the “Client Group“). B. GmbH (the “Supplier“) is a German company.

Until 2015, both companies manufactured and distributed hearing-aid batteries. In 2014, the Client decided to focus exclusively on distributing hearing-aid batteries. The Client sold its means of battery manufacturing and packaging to the Supplier.

On October 5, 2015, the Client and the Supplier entered into a master supply agreement regarding the sale and delivery of hearing-aid batteries (the “MSA“). On October 19, 2015, the parties revised the MSA by entering into an amended and restated master supply agreement (the “ARMSA“).

On January 16, 2018, the parent company of the Client Group announced that it was to acquire the battery business of the US conglomerate C. Holdings, Inc. (the “Battery Business“), including its hearing-aid battery business (the “Acquisition“).

On December 21, 2018, in preparation for the Acquisition, the Client and the Supplier entered into an amendment to the ARMSA (the “Amendment“), which modified some provisions of the MSA and subjected it to Swiss law (to the exclusion of the United Nations Convention on Contracts for the International Sale of Goods (CISG) and other international treaties). The Amendment included, inter alia, the following provisions (in original English):

“[Section 1.h] Designation as Exclusive Supplier: In exchange for Sections 1.f and 1.g, [Client] designates [Supplier] as [Client]’s (and, for clarification, as all [Client]’s subsidiaries and affiliates, excluding the entities acquired in connection with the Acquisition) exclusive Supplier of Products.”

“[Section 1.j] In the event that [Supplier] alleges that [Client] breaches Section 1.h., [Supplier] shall so notify [Client] in writing without undue delay setting out details of the alleged breach, and, if requested, provide to [Client] reasonable documentation to support its allegation, and [Client] shall, without undue delay, evaluate the allegation; [Client] shall, without undue delay, review and respond to [Supplier]’s allegation. After such evaluation, [Client] will discuss in good faith with [Supplier] the appropriate remedial action to be taken, in particular the purchase of the Products in question. If the parties, even after involvement of the top-level management, do not reach an agreement on the appropriate remedial action within a reasonable period, and if [Client] breaches Section 1.h., [Client] shall pay to [Supplier] the Liquidated Damages. The parties intend that the Liquidated Damages constitute compensation, and not a penalty. The parties acknowledge and agree that [Supplier]’s harm caused by such a breach by [Client] would be impossible or very difficult to accurately estimate as of the Effective Date, and that the Liquidated Damages are a reasonable estimate of the anticipated or actual harm that might arise from such a breach. [Client]’s payment of the Liquidated Damages is [Client]’s sole liability and entire obligation and [Supplier]’s exclusive remedy for such breach. However, in the event [Client] breaches Section 1.h and [Client] shall pay to [Supplier] the Liquidated Damages as set forth above, the following applies: [Client] may take up to a maximum of thirty (30) days to review and respond to [Supplier]’s allegation.”

“[Section 1.i] [‘Liquidated Damages’ means] an amount equal to two (2) times the amount paid by [Client] to [Supplier] in the prior twelve (12) month period provided, that if the Agreement term has not extended for 12 months, the amount shall be equal to the average amount paid by [Client] over the most recent three (3) months period multiplied by 24 […].”

In addition, pursuant to Section 5.c ARMSA, the means of hearing-aid battery manufacturing and packaging sold by the Client to the Supplier, were to be used by the Supplier exclusively for the benefit of the Client. The Client also enjoyed the right to be offered Supplier’s products with a technological edge on the same terms as other clients.

The Acquisition was completed on January 2, 2019. The contractual relationship between the Parties continued normally until June 2020, when the Client began purchasing hearing-aid batteries from the newly acquired Battery Business. The Client gradually reduced the volume of its purchases from the Supplier and, in November 2020, ceased all purchases.

On November 24, 2021, the Supplier filed a claim before the Handelsgericht des Kantons Zürich (the “Cantonal Court“). The Supplier claimed that by ceasing to purchase its hearing-aid batteries, the Client has breached the exclusive supply relationship between the parties, set out in Section 1.h of the Amendment, and consequently sought payment of liquidated damages (USD 14,885,536.86 plus interest) in accordance with Section 1.j of the Amendment.

On August 27, 2024, the Cantonal Court partially upheld the claim and ordered the Client to pay the Supplier USD 10,963,160.12 with interest. The Client appealed to the Federal Supreme Court.

Issue

The Federal Supreme Court addressed whether the Cantonal Court correctly held that (i) the Client breached the exclusivity obligation by ceasing to purchase hearing-aid batteries from the Supplier and instead sourcing them from related companies during the initial term, and (ii) the Supplier had incurred damages giving rise to the payment of contractually agreed liquidated damages.

Decision

1. Breach of contract by the Client

According to the Cantonal Court, under the amended ARMSA (the “Contract“), the Client was not permitted to permanently reduce its orders to zero and purchase hearing-aid batteries from related companies. This constituted a breach of contract.

The Cantonal Court based its reasoning on an objective interpretation of the Contract in accordance with the principle of trust (Vertrauensprinzip, principe de la confiance), pursuant to which declarations of intent must be interpreted as they could and should have been understood in good faith based on their wording and context, as well as the overall circumstances. This interpretation can be substantially summarized as follows:

• The Cantonal Court first noted that the parties agreed on the Supplier being the “Exclusive Supplier” of the Client, but that it could not clearly infer from this designation that the Client was prohibited from purchasing hearing-aid batteries from related companies.
• Second, the Cantonal Court examined the purpose of the Contract. The Cantonal Court noted that the Contract was designed as a reciprocal cooperation: the Client fully transferred its manufacturing and packaging capacity to the Supplier, but was guaranteed the supply of hearing-aid batteries from the Supplier, which committed to using the transferred capacity exclusively for the Client. The Client was further granted the right to be offered the Supplier’s products with a technological edge on the same terms as other clients. In addition, the Supplier could not sell ‘as is’ the hearing-aid batteries manufactured for the Client to third parties. Compliance with said obligations was further guaranteed by liquidated damages that had to be paid by the Client in case of breach.
• Third, the Cantonal Court examined the interests at stake and noted that although no minimum purchase quantities has been agreed, a permanent reduction in the order quantity to zero during the contractual term would be equivalent to a premature withdrawal from the Contract by the Client. This would ultimately lead to a unilateral shift of interests in favor of the Client.
• Fourth, the Cantonal Court examined the background of the Contract, and noted that, despite the Acquisition, the Contract was extended for 5 years up to September 30, 2025, indicating an expectation that the Client wanted to continue to be supplied with hearing-aid batteries at least until the term of the Contract. The Supplier’s rights were also newly secured by liquidated damages in case of breach.
• Finally, the Cantonal Court considered accompanying circumstances, and noted that the forecast dated June 2020 submitted by the Client projected unchanged demand for hearing-aid batteries until January 2021, and that the Client only notified the Supplier of reductions in July 2020, indicating that the drop in demand was driven solely by internal business reasons.

The Federal Supreme Court largely upheld the reasoning of the Cantonal Court, except for the consideration of the parties’ conduct after the conclusion of the Amendment, which was not relevant to objective interpretation.

In particular, the Federal Supreme Court noted that the Cantonal Court rightly assumed that even if the parties had not agreed on minimum purchase quantities (and thus also no fix quantities), this does not mean that the Client was entitled to permanently suspend its orders and thus effectively withdraw from the Contract. The Client was required to continue purchasing hearing-aid batteries from the Supplier during the term of the Contract. Further, whether the Client was entitled to manufacture hearing-aid batteries ‘in-house’ was irrelevant, as the Battery Business had been acquired by the parent company of the Client Group, and not the Client itself.

2. Damages suffered by the Supplier

The Cantonal Court held that the Supplier had suffered damages. The Federal Supreme Court examined whether this finding was justified.

The Federal Supreme Court noted that liquidated damages (Schadenspauschalierung, fixation forfaitaire du dommage) are not explicitly regulated by the Swiss Code of Obligations (“SCO“), but it is recognized in practice that parties to a contract may predetermine the amount of damages by agreeing on liquidated damages. Pursuant to such an agreement, if a specific liability event occurs, the predetermined amount is payable as compensation for damages incurred. Such an agreement releases the creditor from proving the quantification of the damages, but, in principle, not from proving their occurrence, unlike contractual penalties (Konventionalstrafe, peine conventionnelle) within the meaning of Art. 160 et seq. SCO.

Whether stipulation of liquidated damages also releases the creditor from proving the occurrence of damages is disputed among legal scholars. Three views can be distinguished: (i) the liquidated damages clause affects the burden of proof only with respect to the quantification of damages, while the creditor must still prove that damages occurred; (ii) the liquidated damages clause relieves the creditor from proving both the occurrence and the quantification of damages; and (iii) the liquidated damages clause relieves the creditor from proving the damages, but the creditor must still substantiate, but must not prove, the damages.

The Federal Supreme Court took the view that a liquidated damages clause per se neither releases the creditor from proving that damages have occurred, nor obliges the creditor to prove such occurrence. Rather, the parties to a contract are free to allocate the burden of proof and factual allegation within the scope of their contractual freedom. Accordingly, the parties may agree, within the framework of a liquidated damages clause, to release the creditor from proving damages provided that the debtor retains the opportunity to prove the absence of damage. Otherwise, the clause would qualify as a contractual penalty.

On this basis, the Federal Supreme Court assessed whether the liquidated damages clause in the case at hand entailed a shift in the burden of proof as to the occurrence of damages. The Federal Supreme Court noted that, although the wording of the Contract did not explicitly indicate such a shift, it can be inferred from the wording that the will of the parties was to release the Supplier not only from proving the amount of damages, but also from proving that damages had occurred, while preserving the Client’s opportunity to demonstrate the absence of damage.

This intent was reflected in the contractual framework: in the event of a breach of Section 1.h of the Contract by the Client, the parties intended that the Client would be required to pay liquidated damages to the Supplier after completion of the stipulated formal escalation process. Furthermore, the liquidated damages were intended to cover both actual damages and expected losses that might arise from the breach of contract. Finally, the parties agreed that the liquidated damages are intended to constitute compensation rather than a penalty, noting that the damages caused to the Supplier by a breach of contract were impossible or difficult to quantify at the time the ARMSA was concluded.

Accordingly, the Cantonal Court correctly held that the Supplier suffered damages, as it was irrelevant whether the Supplier had sufficiently alleged or proved the damages in the case at hand. The Client was obliged to pay liquidated damages because it breached the Contract and the Supplier complied with the stipulated formal escalation process. Furthermore, the Client failed to prove that the Supplier had suffered no damage.

In view of the above, the Federal Supreme Court upheld the judgment handed down by the Cantonal Court, and thus rejected the appeal brought forward by the Client.

Key takeaway

Notwithstanding the absence of minimum purchase obligations or fixed purchase quantities, a client bound by an exclusive supply agreement may not reduce purchases to zero and source from group companies instead of the exclusive supplier.

Contractual clauses setting out liquidated damages (Schadenspauschalierung, fixation forfaitaire du dommage) per se neither relieve the creditor from proving that damages have occurred, nor impose on the creditor an obligation to prove such occurrence. The scope and effect of a liquidated damages clause must be determined in accordance with the rules governing contract interpretation.

Comments

This case is of particular relevance to two issues that often give rise to disputes in the context of exclusive supply agreements, namely minimum purchase obligations and in-house manufacturing. In addition, it further sheds light on the enforcement of liquidated damages in this contractual context.

Often, it is unclear whether a client that has undertaken to source exclusively from a supplier may reduce purchase quantity and if it is permitted to manufacture the relevant products in-house or to purchase them from group companies.

1. Minimum Purchase Obligations

Regarding the first issue, the Federal Supreme Court held that, although the parties had not agreed on minimum purchase obligations or fixed quantities, this did not entitle the Client to indefinitely suspend its orders, which constitutes a de facto withdrawal from the Contract. The Client was required to continue purchasing hearing-aid batteries from the Supplier during the term of the Contract.

Although this outcome was upheld in the case at hand, it is doubtful that it can be applied to exclusive supply agreements (or comparable arrangements) in general. The Federal Supreme Court’s reasoning rests heavily on the particular factual matrix, notably the existence of a specific reciprocal cooperation. In particular, the Supplier’s manufacturing capacity was dedicated exclusively to the Client, and the parties had legitimate expectations regarding the continued placement and acceptance of purchase orders by the Client. More importantly, even after the Client Group acquired companies capable of manufacturing hearing-aid batteries, the parties elected to extend the exclusive supply agreement for an additional five years. Moreover, the Supplier’s position was further strengthened by the introduction of liquidated damages provisions in the event of breach.

Undeniably, parties to an (exclusive) supply agreement share an interest in ensuring that each assumes obligation to purchase and supply, respectively. In practice, however, contracting parties often refrain from stipulating minimum or fixed quantities to preserve commercial flexibility. On the one hand, the client seeks to avoid being tied to excessive commitments that might exceed market demand, while on the other hand the supplier retains the ability to allocate production capacity to other clients. Rather than prohibiting what amounted to a permanent reduction of purchase volumes (which was found by the Federal Supreme Court in this case), parties may opt to protect their respective interests by resorting to alternative contractual mechanisms. One common approach is the use of forecasts, which, once binding within defined lead times prior to manufacturing, provide the client with assurance of supply while simultaneously allowing the supplier to secure sufficient demand and plan capacity allocation.

The solution adopted by the Federal Supreme Court raises a further question: what volume must be purchased in order to remain compliant with an exclusive supply agreement when no minimum purchase obligations are stipulated?

2. In-House Manufacturing

Regarding the second issue, the Federal Supreme Court did not definitively decide whether in-house manufacturing is permissible under the exclusive supply agreement in the case at hand. The Federal Supreme Court nevertheless appeared to recognize a breach of contract in the Client sourcing products from group companies. However, the breach was grounded primarily in the Client’s permanent reduction of orders to zero, thereby effectively withdrawing from the Contract (as discussed above), rather than sourcing products covered by the exclusive supply agreement from group companies.

In our view, the concept of ‘in-house’ manufacturing could legitimately extend to manufacturing carried out by group companies, although this should ultimately depend on the will of the parties in a case-by-case basis. Within corporate groups, operational functions are often distributed across multiple entities, frequently across different jurisdictions, with certain entities focusing on manufacturing while others assume responsibility for distribution, marketing, or other business activities. Imposing a rigid distinction between an internal department and an affiliated company (particularly when wholly-owned) would fail to reflect the economic and operational realities of how corporate groups function.

Whether a reduction in the quantities to be purchased by a client, or in-house or intragroup manufacturing, is permissible ultimately depends on the interpretation of a contract in the context of the specific circumstances of the case. To mitigate the risk of contractual ambiguity, contracting parties may consider expressly reserving the client’s right to refrain from placing orders and to engage in in-house manufacturing, including, where applicable, manufacturing by group companies.

3. Liquidated Damages

As for the issue of liquidated damages, the Federal Supreme Court highlighted the distinction between liquidated damages (Schadenspauschalierung, fixation forfaitaire du dommage), which are not expressly regulated by the SCO, and contractual penalties (Konventionalstrafe, peine conventionnelle) within the meaning of Art. 160 et seq. SCO. It also clarified the scope and effect of liquidated damages clauses.

By way of reminder, a contractual penalty clause requires the debtor to pay a lump sum to the creditor in the event of a breach of contract, irrespective of whether the conditions of contractual liability are met, whereas a liquidated damages clause predetermines the amount of damages recoverable under rules governing contractual liability.[1]

The scope and effect of liquidated damages clause are disputed among legal scholars. The Federal Supreme Court noted three views: (i) the liquidated damages clause affects the burden of proof only with respect to the quantification of damages, while the creditor must still prove that damages occurred; (ii) the liquidated damages clause relieves the creditor from proving both the occurrence and the quantification of the damages; and (iii) the liquidated damages clause relieves the creditor from proving the damages, but they must still substantiate the damages.

The Federal Supreme Court did not endorse any of the above-mentioned views. Instead, it emphasized that, as a matter of principle, a liquidated damages clause neither per se relieves the creditor from proving that damages have occurred, nor does it impose on the creditor an obligation to do so. The parties to a contract are free to allocate the burden of proof and factual allegation within the scope of their contractual freedom. Accordingly, the scope and effect of a liquidated damages clause must be determined through contract interpretation.

In the case at hand, the Federal Supreme Court held that the parties intended to release the Supplier not only from proving the amount of damage, but also from proving that any damage had occurred, while preserving the Client’s right to demonstrate that no damage was incurred. This conclusion followed from the parties’ agreement that the Client would be required to pay liquidated damages to the Supplier after completion of the stipulated formal escalation process. The parties further specified that the liquidated damages were intended to cover both actual damages and expected losses, which were impossible or difficult to quantify, and that such liquidated damages were intended to serve as compensation rather than a penalty.

The scope and effect of a liquidated damages clause or a contractual penalty clause ultimately depends on the parties’ agreement. When drafting an agreement, it is essential to clearly specify whether a clause is intended to be a liquidated damages clause or a contractual penalty clause. While both types of clauses concern the enforcement of monetary obligations that may arise from a debtor’s breach of contract or other liability events, their purposes differ fundamentally.

A liquidated damages clause has a compensatory function. By stipulating such a clause, the parties predetermine the amount that the debtor shall pay to compensate for damages arising from a specific liability event. In order for the creditor to obtain payment under a liquidated damages clause, the conditions of contractual liability must be met: the debtor must have committed a wrongful breach of contract that caused damage to the creditor, and the breach and damage must be linked by a natural and adequate causal relationship.

The burden of proof can be allocated freely by the parties in their contract. It is important to state expressly whether the clause relieves the creditor from proving both the occurrence and the amount of damage, while preserving the debtor’s right to prove the absence of damage. Particular care must be taken to avoid any confusion between liquidated damages clauses and contractual penalty clauses. As noted by the Federal Supreme Court, if the debtor’s right to prove the absence of damage is excluded, the clause qualifies as a contractual penalty.

By contrast, a contractual penalty clause has a punitive purpose. It entitles the creditor to claim the stipulated amount upon occurrence of a specified event (such as a breach of contract), irrespective of whether the conditions of contractual liability are met. In particular, the creditor may enforce the penalty even without having suffered any damage, and the debtor cannot be released by proving the absence of damage.[2]

In both cases, the creditor may, as a rule, still claim additional damages if the actual loss exceeds the agreed amount provided for in the liquidated damages or contractual penalty clause.[3] Moreover, the court (or arbitral tribunal, as applicable) may reduce any such amount if it is deemed excessive in relation to the actual damages suffered by the creditor.[4]

When stipulating a contractual penalty, the parties are well advised to specify clearly whether the penalty clause is (i) alternative, allowing the creditor to claim either performance of the secured obligation or payment of the penalty, (ii) cumulative, allowing the creditor to claim both performance of the secured obligation and payment of the penalty, or (iii) exclusive, whereby the creditor may claim only payment of the penalty, to the exclusion of performance.[5]

Other comments on this judgment

Borel & Barbey, Swiss Supreme Court clarifies the burden of proof in the context of liquidated damages clauses, https://www.borel-barbey.ch/en/swiss-supreme-court-clarifies-the-burden-of-proof-in-the-context-of-liquidated-damages-clauses/

Gaspard Couchepin, Simon Waeber, Tribunal fédéral, 1^re Cour de droit civil, arrêt 4A_526/2024 du 28 avril 2025, Aa. Inc. contre Ba. GmbH, dommages-intérêts forfaitaires, in : Pratique Juridique Actuelle (PJA) 2025, p. 1144 ss.

Philipp H. Haberbeck, Linkedin Post https://www.linkedin.com/posts/philipphaberbeck_sft-4a5262024-activity-7339277566148554754–WTi

Patrick Ostendorf, LinkedIn Post https://www.linkedin.com/posts/patrick-ostendorf-3a92a05_schweizer-bundesgericht-auslegung-liquidated-activity-7341028588885876736-9Wn1

Sébastien Picard, La preuve des dommages-intérêts forfaitaires (liquidated damages) en droit suisse, https://lawinside.ch/1615/

Raphael Riedo, BGer-Urteil 4A_526/2024 vom 28. April 2025 zu vertraglich pauschalisierten Schadenersatzansprüchen, in : bratschi zivilprozessrecht blog, Oktober 2025, https://www.bratschi.ch/publikationen/zivilprozessrecht-blog-bger-urteil-4a-526-2024-vom-28-april-2025-zu-vertraglich-pauschalisierten-schadenersatzanspruechen

Wenger Plattner, Wenger Plattner klagt erfolgreich Liquidated Damages vor Handelsgericht Zürich ein und wehrt danach auch Beschwerde vor Bundesgericht ab, https://wenger-plattner.ch/de/news-insights/wenger-plattner-klagt-erfolgreich-liquidated-damages-vor-handelsgericht-zurich-ein-und-wehrt-danach-auch-beschwerde-vor-bundesgericht-ab/

 

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[1] See Sylvain Marchand, Clauses contractuelles, Du bon usage de la liberté contractuelle, Basel (Helbing Lichtenhahn) 2008, pp. 214 et seq.; Alborz Tolou, La forfaitisation du dommage, Thèse, Zurich (Schulthess) 2017, N 107 et seq. and 208 et seq.

[2] See Tolou, op. cit., N 172.

[3] See Tolou, op. cit., N 173.

[4] See Judgment of the Federal Supreme Court of 19 April 2016, 4A_601/2015, reason 2.3.3.

[5] On those notions, see Marchand, op. cit., pp. 213 et seq.; Tolou, op. cit., N 166 et seq.

Judgment of the Federal Supreme Court of 24 September 2024

Case Reference : 4A_202/2024, 4A_212/2024

Facts

B. (the “Plaintiff”) is a company specializing in human resources, management, strategy and planning. It operates under multiple brands, including “Construction21”.

On December 11, 2020, the Plaintiff and A. (the “Defendant”), Chairman of the Board of Directors of the newly founded Arkadium company, together (the “Parties”), jointly notified the clients of Construction21 that Arkadium would assume responsibility for all employees and ongoing recruitment processes previously managed by Construction21.

A week later, on December 18, 2020, the Parties entered into a share purchase agreement that included a non-competition clause. This clause prohibited the Defendant and all affiliated entities from using the name components “Prime”, “GetTemp”, “Construction”, “Care” and “21” to compete with the Plaintiff. A contractual penalty of CHF 100,000. per breach was stipulated.

On January 11, 2021, the Defendant sent a letter to all Construction21’s experts (workers that are to be placed in construction industry companies) informing them that Arkadium had taken over Construction21’s operational activities as well as all current employment contracts. The letter featured “CONSTRUCTION21” logo in the header and included the Plaintiff’s name next to the defendant’s signature.

Claiming this communication violated the non-competition clause, the Plaintiff filed a claim in the Court of first instance seeking CHF 100,000 as a penalty. The initial claim was dismissed. However, on appeal, the Cantonal Court partially granted the Plaintiff’s claim and awarded CHF 10,000. Both Parties appealed to the Federal Supreme Court: the Defendant sought either complete dismissal or a reduction to CHF 1,000, while the Plaintiff sought full payment of the CHF 100,000.

Issue

Two issues had to be addressed by the Federal Supreme Court:

1. Whether the Defendant’s letter to the experts constitutes a breach of the non-competition clause; and
2. If so, what were the legal consequences of said breach.

Decision

The Federal Supreme Court found the language in the Defendant’s letter , specifically its reference to a “retroactive takeover of Construction21’s operational business”[1] problematic regarding the non-competition clause. The earlier letter to clients mentioned a “retroactive takeover of placement processes of Construction21 candidates”,[2] and there was no legitimate reason to change that phrasing in the second letter regardless of the fact that the two statements are equally correct.

The Federal Supreme Court interpreted the wording change as an attempt by the Defendant and Arkadium to distance themselves distinguish themselves from both the Plaintiff and Construction21, thereby violating the non-competition clause. Mentioning the takeover of Construction21’s business twice in the letter was unnecessary, and it would have been enough to simply inform the candidates that they would now need to contact Arkadium due to organizational changes. In that context, the Defendant was also not allowed to use the “CONSTRUCTION21” logo in the letterhead or to place the name of the Plaintiff below his signature.

A further breach of the non-competition clause was found in the letter, when Arkadium stated that “as a leading headhunter in the construction & property sector, [Arkadium] acts as a source of information for the experts” and “Arkadium specializes in the construction and property sector and focuses exclusively on the following sectors: architecture, civil engineering, construction logistics, building services engineering, energy sector, property, asset and real estate management, lean construction and digitalization”. Both these statements were clearly advertisement (the Defendant did not deny it) and using them alongside the Construction21 trademark only shed more light on the breach of the non-competition clause.

The Federal Supreme Court then had to analyze the consequences of said breach. Under Swiss law, and according to art. 163 paras. 1 and 3 of the Swiss Code of Obligations (SCO), parties may freely stipulate the amount of a penalty, however, the courts are authorized to reduce it if it is manifestly excessive. Importantly, the penalty remains payable even if no if no financial loss has occurred (art. 161 para. 1 SCO). If the judge considers that a reduction is necessary, restraint must be shown as to not infringe too much on contractual freedom. Such a reduction is justified in particular if there is a blatant disproportion between the amount agreed upon and the loss suffered from the contractual breach.

Such a blatant disproportion existed in the case at hand, according to the Federal Supreme Court. It considered the violations of the non-competition clause to be extremely minor, and took into account the fact that the Plaintiff did not suffer any quantifiable loss from them. On that basis, it upheld the lower court’s decision to reduce the penalty from CHF 100,000 to CHF 10,000.

Key Takeaway

Interpretation and scope of the non-competition clause in a share purchase agreement

Art. 18 para. 1 SCO establishes that the contract must be interpreted according to the real and common intention of the parties rather than being limited to the wording used. This principle, which is essential in contract law, can be broken down into two stages: subjective interpretation and objective interpretation.

Application and reduction of the penalty clause (art. 163 SCO)

While penalty clauses are permitted, art. 163 para. 3 SCO allows the court to reduce an excessive penalty clause when there is a clear imbalance between the agreed sum and the actual harm.

When a court reduces a penalty clause, restraint is required in order to respect the principle of contractual fidelity and freedom of contract (art. 163 para. 1 SCO).

In this judgment, the Federal Supreme Court upheld the reduction of the penalty clause.

Comment

The Federal Supreme Court’s decisions 4A_202/2024, 4A_212/2024 concern a non-competition clause contained in a share purchase agreement concluded between two companies.

The parties were bound by a contract (business-to-business contract). They never challenged its conclusion (art. 1 seq. SCO) or its validity (art. 11 seq. of the Swiss Civil Code (SCC), arts. 11-16 SCO, arts. 19-20 SCO, art. 21 and arts. 23-24 SCO). Instead, the parties were disputing the interpretation and enforcement of a specific contractual clause and the proportionality of the associated penalties.

The primary issue was whether the defendant had actually breached the non-competition clause in the contract.

In addition, the contract contained a penalty clause applicable in case of such a breach, which could be reduced if the amount was deemed excessive. While the Federal Supreme Court confirmed that the clause had been breached, it ruled that the contractual penalty was excessive and upheld its reduction under art. 163 para. 3 CO.

This commentary will analyze three core themes:

1. Freedom of contract and the general principles of contract law (arts. 19 and 20 SCO).
2. Contractual interpretation and the will of the parties (art. 18 para. 1 SCO).
3. The application and judicial reduction of the penalty clause (art. 163 paras. 1 and 3 SCO).

1. General principles of contract law: freedom of contract

A. Foundations and scope of freedom of contract

Although this Federal Supreme Court’s decision does not call into question the validity of the contractual clause, it is nonetheless important to recall the legal framework that such a clause must respect before analyzing its scope.

The fundamental principle of Swiss contract law is based on freedom of contract, enshrined in art. 19 para. 1 SCO, which allows the parties to freely determine whether or not to enter into a contract, with whom, and under what terms and conditions. This principle is a corollary of respect for private autonomy, which is supported in several constitutional and legal guarantees.[3]

While freedom of contract is a fundamental principle, it is not absolute. Art. 19 para. 2 SCO imposes general restrictions, specifying that contractual clauses must not be unlawful, immoral or contrary to public policy. Furthermore, Art. 20 para. 1 SCO provides for the nullity of contracts that relate to an impossible, illicit or immoral object.

However, additional limitations may apply to specific contracts. For example, art. 340 et seq. SCO imposes strict limitations on non-competition clauses included in an employment contract, particularly with regard to their duration, geographical and material scope, in order to protect the employee’s economic freedom.

B. Application to non-competition clauses in a share purchase agreement

Non-competition clauses in share purchase agreements are not governed by any specific provision of the SCO and are subject to the general principles of the law of obligations. Unlike non-competition clauses in an employment contract (art. 340 et seq. SCO), they are assessed exclusively according to arts. 19 and 20 SCO.

The main question put to the Federal Supreme Court here concerns the interpretation of the scope of the non-competition clause and enforceability of the agreed sanction.

Accordingly, the Federal Supreme Court’s analysis initially focused on the contractual interpretation of the non-competition clause in order to determine its scope (art. 18 SCO) and whether the alleged conduct constituted a breach .

2. Contractual interpretation and the intention of the parties

A. Interpretation of the contract

Art. 18 para. 1 SCO establishes that the interpretation of a contract must be done according to the true and common intent of the parties rather than merely limiting it to the wording used. This principle, which is essential in contract law, can be broken down into two stages:

1. Subjective interpretation: The court seeks to establish the true and common intent of the parties by relying on contextual elements such as previous negotiations or the parties’ post-contractual behavior (ATF 144 III 93, para. 5.2.2).
2. Objective interpretation: If the parties’ common will cannot be ascertained, the court must resort to normative (or objective) interpretation, i.e. seek out their presumed will by determining the meaning that, according to the rules of good faith, each of them could and should reasonably attribute to the declarations of will of the other. This is an interpretation in accordance with the principle of trust, itself deduced from art. 2 para. 1 CC. The determination of the objective will of the parties, according to the principle of trust, is a question of law, which the Federal Supreme Court examines freely; to decide it, however, it is necessary to base oneself on the content of the expressions of will and on the circumstances, which are a matter of fact (ATF 144 III 93, para. 5.2.3).

B. Interpretation means and maxims

When interpreting a clause, the court uses various means of interpretation. The text of the contractual clause is the primary means of interpretation (ATF 148 III 57, para. 2.2.1). However, others include but are not limited to contextual (ATF 148 V 70, para. 5.1.1), historical (ATF 77 II 154 para. 4), teleological (ATF 144 V 84 para. 6.2.1), commercial usages (ATF 132 III 460, para. 4.3).

With regard to maxims of interpretation, some legal authors, with whom we agree, consider that the wording of a clause does not take precedence over other means of interpretation.[4] Consequently, the wording of the disputed clause is merely an indication of the parties’ intentions, in the same way as the other means of interpretation. For the Federal Court, this lack of primacy of the text applies both to subjective interpretation (4A_290/2017, para. 5.4) and to objective interpretation (4C.94/2000, para. 2c).

In this decision, the Federal Supreme Court largely relied on the literal wording of the non-competition clause in order to determine its scope. On this basis, it found that the defendant had breached the non-competition clause (4A_202/2024, 4A_212/2024, paras. 4.2.1 – 4.2.5).

As one might expect, this practice is not necessarily contrary to the practice of the Federal Court, in its ATF 136 III 186 para. 3.2.1, the Federal Supreme Court points out that ‘there is no reason, however, to depart from the literal meaning of the text adopted by the parties when there is no serious reason to believe that it does not correspond to their wishes.’[5] Furthermore, although the Federal Supreme Court does not express this directly in its ruling, the weight of the contractual clause may be reinforced by the fact that the contracting parties are professionals (business-to-business contract).

3. Application and reduction of the penalty clause (art. 163 SCO)

A. Nature and function of the penalty clause

The parties are free to determine the amount of the penalty clause. However, if said amount is found to be excessive, the court may reduce it as it sees fit (art. 163 paras. 1 and 3 SCO). The penalty is due even if the creditor suffered no actual damage (art. 161 para. 1 SCO).

A penalty clause is an accessory contractual undertaking that sanctions the non-performance or breach of an obligation.[6]

It fulfils two functions:

1. Repressive: It deters the obligated party from breaching its contractual obligation; and
2. Compensatory, restorative: It compensates for the loss suffered in the event of a breach without the creditor needing to prove any damage.

In the case under review, the penalty clause served to guarantee the effectiveness of the non-competition clause by imposing a financial penalty in the event of a breach.

Excessive penalty clauses must be reduced by the courts. However, this does not mean that the court must intervene ex officio. The burden of proof lies with the debtor, who bears the consequences of failing to allege the conditions justifying a reduction, and of failing to prove them. However, the allegation need not be formulated in a particularly rigorous manner. The debtor need not explicitly request a reduction in the contractual penalty: it is sufficient for him/her to conclude, by way of exception, that the action has been dismissed in its entirety and to invoke facts, whether established or contested, that justify a reduction. The creditor may be required to indicate their loss and to contest with supporting reasons the allegation that the loss is non-existent or insignificant; they are not, however, required to prove their interest with supporting figures.[7]

B. Legal grounds for judicial reduction of excessive penalties

Art. 163 para. 3 SCO allows the court to reduce an excessive penalty clause if it clearly exceeds the damage suffered.

When a court reduces a penalty clause, restraint is required in order to respect the principle of contractual fidelity and freedom of contract (art. 163 para. 1 SCO). Judicial intervention in the contract is only justified where the agreed penalty exceeds the reasonable threshold compatible with law and equity (ATF 133 III 201, para. 5.2 ; ATF 133 III 43, para. 3.3.1).

A reduction in the penalty clause is particularly justified where there is a clear disproportion between the agreed amount and the creditor’s interest at the time of the breach of contract. This assessment must be based on the specific circumstances of each individual case.

Factors to be taken into account include: the nature and duration of the contract; the seriousness of the fault and breach of contract; the creditor’s interest in compliance with the clause; and the economic situation of the parties, particularly that of the debtor of the obligation.

Other relevant factors include any dependencies arising from the contractual relationship and the commercial experience of the parties. A reduction is more easily justified when an economically weaker party is involved, rather than in a contract concluded between partners of equal economic strength and experience in business (ATF 133 III 201, para. 5.2 ; ATF 133 III 43, para. 3.3.2)

In this judgment, the Federal Supreme Court upheld the reduction of the penalty clause for several reasons:

• The minor nature of the breach;
• The absence of proven or potential damage;
• The previous court had already reduced the penalty clause to CHF 10,000 on the grounds that the initial amount was disproportionate.

The Federal Supreme Court upheld this reduction, considering that this sum constituted an adequate penalty that is both proportionate and dissuasive.

This ruling illustrates the rigorous approach of the Federal Supreme Court to apply the principles of contractual interpretation in commercial matters, as well as its measured use of judicial discretion in reducing penalty clauses. It underscores the importance of contractual clarity in a business-to-business context and shows that the Swiss courts will intervene sparingly to modify a penalty clause, except in cases of manifest disproportion.

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[1] The letter reads as follow in the original German version: “Rückwirkenden Übernahme des operativen Geschäfts der Construction21”.

[2] The letter reads as follow in the original German version: “Rückwirkende Übernahme Vermittlungsprozesse von Kandidaten der Construction21”.

[3] Guillod Olivier/Steffen Gabrielle, art. 19-20, no. 1-5, in: Thévenoz Luc/Werro Franz (éd.), Commentaire romand du Code des obligations I, 3 éd., Bâle (Helbing Lichtenhahn) 2021, (hereinafter: CR-CO-I-Auteur).

[4] D. Oppliger, Interprétation contractuelle – Poids du texte du contrat et clause d’intégralité, in Aktuelle Juristische Praxis – Pratique Juridique Actuelle (AJP/PJA), 2022, p. 1054 ss.

[5] In French : « Il n’y a cependant pas lieu de s’écarter du sens littéral du texte adopté par les intéressés lorsqu’il n’existe aucune raison sérieuse de penser qu’il ne correspond pas à leur volonté » (ATF 136 III 186 para. 3.2.1).

[6] CR-CO-I-Mooser, art. 163, no. 4.

[7] CR-CO-I-Mooser, art. 163, no. 6.