Judgment of the Federal Supreme Court of 9 November 2022

Case Reference : 4A_480/2021

Facts

When contemplating to purchase the shares of a company (“the Target Company”), a prospective purchaser (“the Purchaser”) requested an accounting firm (“the Agent”) submit a financial audit report of the Target Company’s accounts as at December 31, 2010 (“the Report”). In the Report, the Agent confirmed that the audit had not revealed any factors that might call into question the accounting methods used to prepare the provisional financial statements of the Target Company as at December 31, 2010. A few weeks later, the Purchaser offered a price of EUR 4,000,000 to the shareholder of the Target Company (“the Seller”), instead of the sale price of EUR 4,500,000 set by the Seller, stating the risks inherent to the Target Company’s activity, particularly at a geopolitical level.

It subsequently became apparent that the Target Company’s financial situation was significantly less positive and as a result required a significant adjustment, with a difference in equity of approximately CHF 2,000,000. After negotiation, the Target Company accepted to pay back CHF 1,500,000 to the Purchaser in full and final settlement, without admission of liability. Arguing that the Agent had failed to identify several accounting errors which led the Purchaser to pay an inflated acquisition price of the Target Company, it sued the Agent before the Geneva First Instance Court, claiming the payment of around CHF 2,400,000 (whereby the proceedings also involved other parties, specifically a third party company that had worked together with the Agent on the Report).

A judicial expertise concluded that the Agent had failed to exercise due diligence while establishing the Report and that the Purchaser suffered damage resulting from an excessive acquisition price that was due to accounting errors in the Report. Despite the findings of the Report, both the First Instance Court and the Court of Appeal rejected the claim of the Purchaser.

Issue

The Federal Supreme Court had to determine whether the Purchaser had validly established the damage that it had allegedly suffered as a result of the inflated purchase price paid for the acquisition of the shares of the Target Company based on the Report.

Decision

An agent is liable to the principal for the diligent and faithful performance of the business entrusted to him or her (Art. 398 para. 2 SCO). In the context of a judicial action, the principal has to allege and prove a violation of the duty of care, a fault, a damage and a (causal and adequate) link between the violation of the duty of care and the damage. In this context, the damage suffered corresponds to the difference between the current state of assets and the hypothetical state that the assets would have had without the harmful event (so-called “Difference Theory”).

According to the reasoning of the Court of Appeal, which was upheld by the Federal Supreme Court, the Purchaser had sufficiently alleged the current amount of its assets, but had not alleged the amount of the latter in the event that the harmful event had not occurred. In order to do so, it would have had to indicate what decisions it would have taken if the harmful event had not occurred, i.e. if it had known the correct financial situation of the Target Company for the 2010 accounting year. In other words, the Purchaser would have had to establish whether it would have purchased the shares of the Target Company for a lower amount or whether it would have renounced the acquisition. On this basis, the Purchaser could have alleged its damage in a manner consistent with the legal concept of damage. The judicial expertise, which was based on the plaintiff’s allegations, only stated the acquisition value of the company, the actual value of the company as at December 31, 2010, and the difference between these two values.

In this case, instead of alleging and proving these elements in accordance with Art. 55 SCPC and Art. 8 SCC, the Purchaser focused on establishing its own current asset value and the actual value of the Target Company as at December 31, 2010. However, the latter parameter, which does not allow for the establishment of the hypothetical state of assets of the Purchaser that would have existed without the harmful event (i.e. without the acquisition of the Target Company at the inflated price), is irrelevant in the context of the Difference Theory. For the same reasons, the argumentation of the Purchaser in relation to the payment of an inflated price instead of the actual price was deemed irrelevant, as these concepts do not shed light on what the parties would have actually agreed.

Under these circumstances, the Federal Supreme Court found that the Purchaser had failed to allege and prove the damage resulting from the purchase of the Target Company. It also held that the judicial expertise tended to prove an irrelevant fact (i.e. the actual value of the Target Company), thus its findings were legitimately disregarded by the lower courts.

Key takeaway

According to the difference theory, the damage incurred by a principal due to a violation of duty of care by the agent corresponds to the difference between the principal’s current state of assets and this state of assets had the harmful event not occurred. In the context of inaccurate financial audit reports prepared in view of the acquisition of a company, purchasers should notably allege and prove the decisions they would have made if they were aware of the correct financial situation of the target company.

Comments

This decision is another example of the well-established “difference theory”, this time in the context of a corporate acquisition. It is also a good reminder of the burden of allegation and proof on the principal seeking compensation, especially as regards the damage suffered. From a procedural perspective, the corresponding allegations should be made and offered to prove in the briefs filed with the court, that is to say at the very beginning of the proceedings. As the decision at hand makes clear, a judicial expertise concluding the existence of a damage is of no use if it is based on irrelevant allegations. This highlights the importance for parties (and particularly for the party claiming to have suffered damages) to make sure that their allegations and the judicial expertise cover all issues that are legally relevant.

Even if it was not further developed by the Federal Supreme Court, it would appear from the decisions handed down by the lower jurisdictions that the link between the violation of duty of care and damage was also subject to debate. For such link to be admitted in the case at hand, the price of the acquisition of the target company should have been influenced by the inaccurate financial audit report. The first instance court rejected this hypothesis, on the ground that the price had been set based on considerations unrelated to the financial audit report (e.g. the geopolitical situation on a relevant market for the business of the target company). By contrast, the court of appeal admitted the influence of the financial audit report on the price of the acquisition, given that the price had been calculated in relation to the company profits.

Other sources presenting the case

David F. Braun, Tribunal fédéral 4A_480/2021 (https://publications-droit.ch/files/arrets/rcassurances/12-23-fevrier-4a-480-2021.pdf).

Dario Galli / Markus Vischer, Schadensberechnung beim Unternehmenskauf in RSDA 2023, p. 256 ff.

Markus Vischer / Dario Galli, Unrichtige Due Diligence-Berichte und ihre Folgen bei einem Unternehmenskauf in dRSK Weblaw, published on May 5, 2023 (https://www.walderwyss.com/user_assets/publications/Unrichtige-Due-Diligence-Berichte-und-ihre-Folgen-bei-einem-Unternehmenskauf.pdf).

Judgment of the Federal Supreme Court of 5 May 2021
Case Reference : 4A_229/2020

Facts

The dispute concerns the following (summarised) facts:

The owner of an apartment (also known as the Owner or the Principal in a brokerage contract) had contacted a broker (hereafter the Broker) who introduced her to a buyer (hereafter the Buyer).

The Buyer had put in an offer to purchase the Owner’s apartment for CHF 2,100,000 through the Broker, which the Owner had accepted immediately. However, the Broker did not disclose the acceptance to the Buyer.

At the same time, the Buyer had planned to buy another (more expensive) apartment, however the Broker later learned that he could not follow through with this plan because he had not been able to obtain the required financing. Nonetheless, the Broker did not inform the Buyer that it was still possible to acquire the Owner’s apartment (knowing that the Broker had not previously informed the Buyer that the Owner had accepted the purchase offer).

Given that the Owner had not found an interested buyer for the desired price of CHF 2,100,000 (even though the Buyer had in fact made an offer at this price), she agreed to reduce the sale price of the apartment to CHF 2,000,000.

Through another broker, the Buyer ultimately bought the Owner’s apartment for CHF 2,000,000.

Following a first legal proceeding, the Owner was ordered to pay the Broker CHF 20,000 for having provided the Owner with the name of the Buyer who ultimately bought the apartment. In this first trial, the Broker’s fees were reduced by CHF 10,000.

The Owner sued the Broker for breach of the brokerage contract and for the damage suffered as a result of failing – on the part of the Broker – to sell the apartment for CHF 2,100,000 (the price the Buyer was initially willing to pay), which the Owner calculated at CHF 87,000.

Issue

The issue in this case is whether the Broker broke its contractual obligations and, if so, what are the damages that the Broker should pay the Principal.

Decision

1. The definition of brokerage contract and the Broker’s contractual liability

The Federal Supreme Court first reviewed the definition of brokerage contract and the Broker’s contractual liability.

According to Art. 412 para. 1 of the Swiss Code of Obligations (SCO), a brokerage contract is a contract whereby the Broker is instructed to alert the Principal to an opportunity to conclude a contract (indication brokerage) or to facilitate the conclusion of a contract in exchange for a fee (negotiation brokerage).

As a matter of principle, the broker has no obligation to be active (and can thus remain inactive). However, once the broker becomes active, the broker is liable for the proper and faithful execution of the contract (Art. 398 para. 2 SCO applicable by reference from Art. 412 para. 2 SCO). Art. 398 para. 1 SCO refers to the rules governing the liability of the worker in the employment relationship, that is to say to Art. 321e SCO. It follows that the liability of the Broker presupposes that four cumulative conditions are met: (1) a breach of a duty of care, (2) a damage, (3) a relationship of causality (natural and adequate) between the culpable breach of the duty of care and the damage that has occurred, and (4) a fault. The onus is on the Principal to provide proof of the facts showing that each of these conditions has been met (Art. 8 of the Swiss Civil Code [SCC]), except for the alleged fault (Art. 97 para. 1 SCO).

In this case, the Federal Supreme Court found that the parties were bound by an indication and negotiation brokerage contract. It also held that all four conditions of the contractual liability of the Broker had been fulfilled and that the cantonal court had not erred in arbitrariness when stating the facts.

2. Loss of an opportunity theory

The Federal Supreme Court analysed the loss of an opportunity theory on which the Broker relied in an attempt to deny his contractual liability. The Broker claimed that the Principal had not suffered any damage on the grounds that the Principal would have merely lost an opportunity to sell her apartment at the price of CHF 2,100,000, knowing that the loss of an opportunity does not lead to damage claims under Swiss law. The Federal Supreme Court recalled that, based on the loss of an opportunity theory, the repairable damage consists of the loss of a measurable chance of an actual gain or of avoiding harm. It thus corresponds to the probability for the injured party obtaining this profit or not suffering any harm. The value of the lost opportunity is in principle the value of the total stake multiplied by the probability of obtaining it. The reasoning behind this method is to limit compensation to the damage that corresponds to the degree of probability of damage caused by the liable party.

However, the Federal Supreme Court noted that, in addition to the fact that the loss of an opportunity theory is not applicable under Swiss law, the Broker had wrongly invoked it. In fact, the Principal had not been deprived of an opportunity to a gain, but the fact that the Broker had violated its obligations of due diligence had directly deprived the Principal of the gain in question (i.e. the gain resulting from the sale of the apartment at a higher price, keeping in mind that the Principal had accepted the offer made by the Buyer and that the Broker had failed to notify the Buyer of the Owner’s acceptance).

3. No reduction of the damage claim

The Federal Supreme Court also had to decide whether the damage claim raised by the Principal should be reduced on the grounds that the Principal would have caused her own damage by reducing the sale price of her apartment (as claimed by the Broker) by application of Art. 44 SCO thus challenging the establishment of a causal link between the breach of contract committed by the Broker and the damage suffered by the Principal. The Federal Supreme Court ultimately established a causal link between the breach of contract committed by the Broker (i.e. failure to disclose information) and the damages suffered by the Principal, and dismissed the claim brought forth by the Broker based on Art. 44 SCO.

4. The amount of the damage

Lastly, the Federal Supreme Court had to determine the amount of damages to award to the Principal as a result of the breach of contract committed by the Broker. The Broker claimed in this respect that the Principal could not claim full damages (i.e. CHF 87,000) given that the other legal proceedings had reduced the Broker’s fees by CHF 10,000. The Federal Supreme Court had to determine whether it is possible to combine the Principal’s right to compensation for the damage caused by the improper performance of contractual obligations (Art. 398 para. 1-2 SCO applicable by reference from Art. 412 para. 2 SCO) and the Principal’s right to a reduction of the Broker’s fees (Art. 394 para. 3 SCO applicable by reference from Art. 412 para. 2 SCO) in the event of a breach of the brokerage contract. The Federal Supreme Court stated (in line with its case law) that the compensation for the damage shall not allow the Principal to obtain a second compensation for the same purpose, that is to say compensation by reduction of fees and in addition to compensation for damages. In application by analogy of Art. 397 para. 2 SCO, case law has thus admitted that if the broker has already remedied the damage that he/she had caused, it can be considered as if he/she had correctly performed the brokerage contract and thus be entitled to full fees.

In this case, the Federal Supreme Court decided that the Principal was not entitled to receive a second compensation for damages, in view of what had already been awarded to her in the other case (i.e. a reduction of the Broker’s fees of CHF 10,000). Consequently, the Broker, whose fees were reduced in the first proceedings, was entitled to either the reduction of CHF 10,000 or owed the amount to be allocated in the second trial. The Federal Supreme Court admitted part of this claim and set the Principal’s damage at CHF 77,000 by taking into account the reduction of CHF 10,000 in fees which had been obtained in the related case concerning the amount of Broker fees.

In conclusion, the Federal Supreme Court granted the appeal and ordered the Broker to pay CHF 77,000 (plus interest).

Key takeaway

This case constitutes an important reminder of the conditions related to the broker’s contractual liability and of the risks that a broker faces if the broker does not disclose relevant information that may lead to the conclusion of a contract for his/her client.

Comments

The judgment prompts three comments.

1) This judgment is interesting because it shows that, even though as a matter of principle, a broker has no obligation to be active (and can thus remain inactive). Once a broker becomes active, he/she becomes liable for the proper and faithful execution of the contract (Art. 398 para. 2 SCO). In this case, this meant that the Broker had to actively disclose the relevant information with its client in order to facilitate the sale of the apartment: the Broker’s silence triggered its contractual liability. Consequently, once the Broker became active, it had to remain active and to actively disclose any information. In this context, the Federal Supreme Court rightly did not apply Art. 321e para. 2 SCO (the extent of the duty of care) to the Broker’s contractual liability even if Art. 412 para. 2 and Art. 398 para. 1 SCO refer to the rules of the employment contract regarding the liability of the employees and thus to Art. 321e SCO. According to Art. 321e para. 2 SCO, “the extent of the duty of care owed by the employee is determined by the individual employment contract, taking due account of the occupational risk, level of training and technical knowledge associated with the work as well as the employee’s aptitudes and skills of which the employer was or should have been aware.” As mentioned in our PhD thesis (Kaveh Mirfakhraei, Les indemnités de fin de contrat dans le contrat d’agence et le contrat de distribution exclusive, Basel/Zurich/Geneva 2014, p. 135-136, N 449), Art. 321e para. 2 SCO (the extent of the duty of care) is specific to the employment contract.

2) Instead of dismissing the loss of an opportunity theory from the outset, the Federal Supreme Court examined it before determining that it was inadmissible under Swiss law and that the appellant had wrongly invoked it. We believe that by doing so, the Federal Supreme Court left the door open to the possibility of admitting the loss of an opportunity theory in future cases.

3) The Federal Supreme Court confirmed its previous case law whereby a Principal who suffers a loss resulting from a contractual breach committed by the Agent cannot cumulatively claim full damages and a reduction of the fees due to the Agent. The Federal Supreme Court decided that, in application of Art. 397 para. 2 SCO, if the Agent has remedied the damage caused, the it can be considered that the Agent had correctly performed the mandate and consequently be entitled to full fees. One should, however, note that this issue is controversial and is still a subject of debate in legal literature (see e.g. Franz Werro, Le mandat et ses effets, thesis Fribourg 1993, N 1069; see also the doctrinal sources cited in the Judgment of the Federal Supreme Court of 5 March 2014, case reference 4A_364/2013).