Transfer of a commercial lease to a third party (Art. 263 SCO): refusal for good cause

Nathalie Adank (as Guest contributor)

In this case, the Federal Supreme Court confirmed the mandatory nature of Art. 263 SCO: parties to a lease agreement cannot agree on more stringent conditions for a commercial lease transfer than those provided by the law.

Judgment of the Federal Supreme Court of 29 August 2023

Case Reference: 4A_453/2022

Facts

Since July 1, 1986, B. and C. (the “Lessees”) have been renting commercial premises of approximately 55 m2 (hereinafter referred to as the “Premises”) located in Geneva. The lessees fully equipped and maintained the premises as a hair salon.

Article 6 of the rental agreement provides that ‘[…] [t]he transfer of the lease shall only be authorized for good cause and only if the transferee exercises the same business activity as the lessee and possesses the moral, professional and financial capacity to ensure that the business continues to operate normally. The tenant may request documentation of the assignment terms.[1] The lease expires on March 31, 2013, with tacit renewal every five years. The annual rent amounts to CHF 13,220, excluding ancillary fees.

On September 27, 2019, the Lessees requested from A. (the “Tenant”) the authorization to transfer their lease to D. (the “Transferee”) with effect as of November 1, 2019. The request included the business transfer agreement signed that same day between lessee B. and the Transferee. This agreement specified a purchase price of CHF 40,000. The Lessees submitted additional documentation regarding the Transferee. These documents showed that the Transferee was a Swiss national with a net monthly income exceeding CHF 7,500 and assets of more than CHF 60,000. The documents also confirmed that no legal proceedings or deeds of default had been instituted against him. The Lessees further confirmed to the property management company that they had intentionally reduced their business operations due to their age, which should be taken into account when calculating their turnover.

The Tenant refused the transfer of the lease, arguing that the amounts quoted did not correspond to the bookkeeping records of the business and claiming that the amount of CHF 40,000 should be understood as key money (‘pas-de-porte’), rather than compensation for the residual value of the business and goodwill. The Lessees then had an inventory drawn up by E., detailing the market value of each piece of furniture in the hair salon, totalling CHF 56,530. They shared it with the Tenant and set him a deadline to accept the transfer of the lease. The Tenant reiterated her refusal, adding that the Transferee had never worked as a hairdresser and was forecasting an excessive turnover in comparison to the results achieved by the Lessees. She argued that the price at which the business was sold was directly related to the very low rent for the premises.

The Lessees filed a petition before the Geneva Tribunal des baux et loyers,[2] seeking a court ruling confirming the reasons given by the Tenant to refuse the transfer of the lease were not justified and authorizing the transfer of the lease. They submitted a new estimate of the value of the furniture in the hair salon, drawn up by another third party. The Geneva Tribunal des baux et loyers authorized the transfer of the lease. The Geneva Court of Justice dismissed the Tenant’s appeal. In essence, it ruled that the Tenant had not demonstrated the existence of good cause for refusing to consent to the transfer of the lease.

The Tenant appealed the judgment before the Federal Supreme Court, which also upheld the decision to dismiss the appeal.

Issue

The Federal Supreme Court had to determine whether the Tenant could claim the existence of good cause to withhold her consent to the transfer of the commercial lease within the meaning of Art. 263 SCO.

Decision

The Federal Supreme Court started by addressing the question of the right to evidence (Art. 8 SCC), confirming that the previous instance could (i) refuse the Tenant’s request for a judicial expertise to set the fair market value of the business and (ii) make an anticipated assessment of the facts on the basis of the two inventories drawn up by third parties without this being constitutive of arbitrary. Moreover, the Federal Supreme Court confirmed that it was not unusual for the inventory to be drawn up after the Tenant refused the transfer of the lease.

On the merits, the Federal Supreme Court reviewed the conditions for the transfer of the lease within the meaning of Art. 263 SCO, pointing out in particular that these rules are absolutely mandatory.

When the conditions set forth by Art. 263 SCO are met, the original lessee has a subjective right to transfer their commercial lease to the transferee. The tenant may object to the transfer only on good cause. Some circumstances in particular are considered to constitute good cause, such as the insolvency of a transferee or an agreement on a key money payment between a former lessee and a  transferee, i.e. a payment compensating the mere transfer of the right to use the premises. The tenant’s freedom of contract is thus limited, based on the interest of the lessee to impose a specific transferee in cases where the lessee has an opportunity to transfer assets it created itself on the leased property (e.g. a customer base) or stocks of goods on terms which are favorable because the sale happens under the transfer of the lease. As a counterpart for the tenant’s inability to freely chose its new contractual partner, the former lessee is jointly and severally liable with the lessee taking over for a specified period (Art. 263 para. 4 SCO).

In this case, the Tenant unsuccessfully argued that the consideration for the takeover should be considered key money and that contractual obligations relating to the personal operation of the business were breached.

First, the Federal Supreme Court confirmed – relying on third parties inventories and valuations – that the amount paid by the Transferee was commensurate with the property on offer: the hair salon did in fact have a customer base and other valuable intangible assets, such as a ‘brand’ and a telephone number, which were the subject of the business takeover, and the lower turnover from the past years could be explained by the Lessees’ intentional decision to reduce their workload in light of their age and health conditions. The Tenant had failed to demonstrate the contrary.

Second, the Federal Supreme Court dismissed the Tenant’s argument pertaining to the fact that the Transferee, who had no experience as a hairdresser, would not be operating the business himself, as foreseen in the lease’s provision about any transfer and that this would constitute good cause to refuse the transfer. The court relied on the fact that the profession did not require official authorization and on the fact that the Transferee had shown his intention to surround himself with qualified people, since he had the entrepreneurial skills required to manage the salon. Importantly, the Federal Supreme Court ruled that the requirements of the lease agreement could not be more stringent than the legislation in force, which is mandatory in nature.

Based on the above, the Federal Supreme Court excluded the existence of good cause to refuse the transfer of the lease and dismissed the Tenant’s appeal.

Key takeaway

Parties to a commercial lease agreement may not agree validly on conditions for a transfer of the lease which would be more stringent than those set forth in Art. 263 SCO.

Comments

The question of the transfer of a commercial lease often comes up in practice, particularly when a tenant is handing over their business, and a transfer of leases is, as a matter of principle, commonly used. In this context, a distinction must be made between the application of Art. 263 SCO, which allows the tenant to impose a transferee, and that of Art. 264 SCO, which only aims to release tenants from their contractual obligations in advance, without however obliging the tenant to take on the proposed candidate. The choice between these two options will depend primarily on whether the outgoing tenant transfers their lease in the broader context of a business transfer (in which case they will opt for Art. 263 SCO).

This decision by the Federal Supreme Court reiterates an important point in this regard, namely that Art. 263 SCO is mandatory and that the parties are therefore not at liberty to agree that the tenant may object to the transfer outside of the conditions set out in this provision. It points out that this is the result of a deliberate choice by the legislator, who deliberately limited tenants’ contractual freedom (they may be forced to take on a lessee they had not chosen) in favor of the lessee’s interest in being able to transfer their lease to a specific third party, with whom they may agree on special conditions such as a takeover price for equipment or goodwill.

The classification of the takeover price often raises questions, insofar as it is sometimes difficult to distinguish between a real consideration and a key money payment. In this case, the Federal Supreme Court did not need to specifically examine this issue, as it was able to dismiss the appeal due to insufficient arguments against the lower court’s decision and based on the rules of evidence. f. In any event, the transferring tenant should be cautious, as the Federal Supreme Court confirmed the prohibition on key money, such type of payments being constitutive of good cause to refuse the transfer.

In the view of the Federal Supreme Court, Art. 263 SCO is absolutely mandatory (with the exception of para. 4, which is not relevant here, cf. 4A_30/2020). Consequently, no derogation to the detriment of the tenant is possible. The nature of this provision has long been a matter of discussion among scholars and the absolute mandatory nature could also be questioned as a matter of policy, keeping in mind that the legislator wanted to facilitate business transfers. It also appears debatable in circumstances where lease agreements would provide for more flexible conditions for intra-group transfers, which are provisions frequently requested by commercial tenants of a certain size when group reorganisations are required.

This decision by the Federal Supreme Court confirms established case law on the mandatory nature of Art. 263 SCO. In practice, tenants also address the issue of lease assignments by other means, in particular by provisions cancelling tenants’ renewal options when the lease has been transferred to a third party, which – without allowing them to oppose a transfer even if they consider that the interest in taking over the lease is based primarily on favorable rent conditions (as the tenant argued in the case at hand) – opens up the possibility of renegotiating a new lease upon expiry as the transferee does not have an option to extend the lease.

Other comments on this judgment

Eron Gjukaj / Dario Galli/Markus Vischer, Übertragung des Mietverhältnisses im Rahmen eines Betriebskaufs, in: digitaler Rechtsprechungs-Kommentar (dRSK), published on August 27, 2024

[1] The original provision in French reads as follows: “[…] [l]a cession du bail ne sera autorisée que pour de justes motifs et seulement si le cessionnaire exerce la même activité que le locataire, et s’il possède les capacités morales, professionnelles et financières pour assurer la marche normale de l’entreprise. Le bailleur peut exiger la production des conditions de la cession.” 

[2] A specialized court that deals specifically with disputes concerning lease contracts.

Reproduction authorized with the following reference: Nathalie Adank , "Transfer of a commercial lease to a third party (Art. 263 SCO): refusal for good cause", published on: Swiss Contract Law, January 16, 2025, https://scl.cultureweb.ch/36/



Unilateral termination of a long-term IT contract: when is good cause not good enough?

The existence of good cause denied in unilateral termination of a long-term IT contract, despite claims of outdated equipment, repeated technical issues and poor maintenance services.

Judgment of the Federal Supreme Court of 11 October 2021

Case Reference : 4A_573/2020, 4A_575/2020

Facts

In 2010, a company running a 5-star hotel in Geneva (the Hotel) and an IT company (the IT Company) entered into an 84-month-long contract (the Contract), relating to the provision of an IT system (the IT System) for in-room entertainment and information services (e.g. on-demand TV, video, music and internet access).

Under the Contract, the IT Company provided equipment (e.g. television screens), delivered software with user licenses, installed the equipment and software in the Hotel, and offered maintenance service in the form of a call center and on–site visits by technical staff. In return, the Hotel paid a fixed monthly sum of CHF 135 per room.

In 2013, the IT Company’s call center was relocated to India. That same year, the IT System experienced its first major breakdown.

A second major breakdown occurred in May 2014. In a letter to the IT Company dated June 2014, the Hotel complained of the breakdowns as well as the relocation of the call center, which was now only available during office hours. The Hotel also claimed the technical equipment was outdated and too expensive, and demanded the IT Company disclose its financial investments in the Hotel.

In December 2014, the Hotel informed of its intention to terminate the contract, citing advances in technology and customer habits, which rendered the IT System less profitable. Contrary to the letter of June 2014, no mention was made of the technical problems experienced by the Hotel.

A third breakdown occurred in January 2015. The Hotel immediately informed the IT Company that it completely lost trust in their services.

Following over two months of fruitless negotiations, the Hotel terminated the contract for July 31, 2015 by letter dated April 10, 2015. It cited numerous technical malfunctions and the lack of responsiveness of the technical support staff, whose level of competence it deemed unsatisfactory.

The IT Company responded to the notice of termination by claiming the “Early Termination Fee” provided for in the Contract, which the Hotel paid in part, the remainder being claimed by the IT Company in debt enforcement and judicial proceedings.

Throughout the legal proceedings, the Hotel referred to a table listing 5,353 technical issues recorded over a period of four years. The problems and their importance were not always specified. Moreover, the IT Company claimed to have issued only 388 tickets during this period (of which 110 concerned the same room) and disputed the relevance and severity of the remaining issues. It namely claimed that the majority of the listed issues were not technical in nature but arose in cases where the hotel guests did not know how to use the IT System and its equipment (e.g. remote controls, cables, etc.).

Issue

For the purposes of this commentary, the key issue dealt with by the Federal Supreme Court was whether the grounds raised by the Hotel for terminating the Contract constituted good cause and therefore justified termination.

Decision

To begin with, the Federal Supreme Court briefly examined the legal qualification of the Contract. It held that the notion of “IT contract” refers in fact to the underlying technology and can thus encompass a large array of services. In the case at hand, it found that the parties were bound by a long-term contract of a mixed nature, insofar as it included elements of a lease, a license agreement, a contract for work and services, and a maintenance contract.

Next, the Federal Supreme Court had to determine whether the grounds raised by the Hotel for terminating the Contract constituted good cause.

It recalled that the right of immediate termination for good cause flows from a general principle applicable to long-term contracts and that it forms an exception to the principle of contractual loyalty. A party may terminate for good cause only where – due to a change in circumstances – it can no longer be required to pursue the contract until its term, whether this is due to a serious breach of contract or repeated breaches committed despite notices/warnings.

In the present case, the Federal Supreme Court denied the existence of good cause on the following grounds:

  • First, it held that the technical problems relating to the IT System did not exceed what was tolerable in the performance of a long-term contract of such nature. Moreover, it was held that the Hotel had failed to properly document and to demonstrate the severity of the technical issues that it relied upon as the primary ground for termination.
  • Second, despite the technical issues raised by the Hotel, the real reason for termination was deemed to be economic in nature. This finding relied on exchanges between the parties, in which the Hotel complained that the equipment was outdated and too expensive, and that the IT System had become less profitable due to advances in technology and customer habits. In this regard, the Federal Supreme Court noted that (i) the IT Company was not to be held liable for the change in habits of the Hotel customers; and (ii) in entering into a long-term contract, the parties had accepted the risk that the equipment supplied could become outdated.
  • Finally, the previous instance also found that the Hotel had failed to terminate without delay, as required by the relevant case law, but had instead (i) endured the maintenance and technical issues for several years; (ii) let several months lapse after the last major breakdown before resorting to termination; and (iii) terminated without immediate effect (i.e. termination announced in April for the end of July). Furthermore, the fact that the parties held negotiations from January to March showed that the current Contract was not in fact intolerable for the Hotel, subject to certain adjustments. These latter points seem not to have been challenged before the Federal Supreme Court, who abstained from commenting thereon.

Ultimately, the Federal Supreme Court denied the existence of good cause and held that the Hotel must pay the “Early Termination Fee” provided for in the Contract (i.e. a fixed sum multiplied by the number of months remaining until the expiry of the initial term of the Contract). Indeed, it held that while the parties did not explicitly provide for this fee to be due in case of termination without good cause, the relevant contract provision (entitled “Consequences of termination”) must be interpreted coherently so as to also cover this scenario.

Key takeaway

Swiss case law has developed stringent rules governing termination for good cause, which the party terminating must abide by if it wishes to avoid paying damages (or a contractual fee/penalty). As regards IT contracts in particular, parties should endeavor to properly document all technical issues and to react appropriately (and quickly) in order to safeguard their right to immediate termination. Moreover, absent specific contractual mechanisms (some of which are briefly discussed below), the assessment of the level of service provided, of the technical issues encountered and of the outdated nature of the equipment supplied will be left to the discretion of the courts.

Comments

This decision calls for two key comments:

(1) First, as regards the reasoning of the Federal Supreme Court, it is worth noting that the General Terms applicable to the Contract provided for the possibility of early termination in the event of a “material breach” of the Contract. Curiously, however, neither the previous instances, nor the Federal Supreme Court, seemed willing to examine whether any such “material breach” had been committed in the case at hand. Instead, the grounds for termination were examined exclusively in light of the notion of good cause and of its requirements under Swiss case law.

It is also worth noting that while the Federal Supreme Court denied the existence of good cause, it did not explicitly examine whether this affected the efficacy of the termination itself. In other words, did the notice of termination – which proved unjustified – still effectively trigger termination? This issue is the subject of much uncertainty (and even controversy) for innominate contracts. In the case at hand, the courts derived the effects of the unjustified termination exclusively from an interpretation of the Contract, which was in fact silent on the issue. This begs the question of whether contract interpretation alone was enough or whether the application by analogy of other provisions of the Swiss Code of Obligations (such as art. 264 of the Swiss Code of Obligations [SCO]) should have stepped in to fill the gap in the Contract and to reach the result achieved in this case – a result that is otherwise to be saluted.

(2) Second, the courts have looked past the apparent reasons invoked by the Hotel (i.e. repeated technical issues and unsatisfactory maintenance services) and identified the true ground for termination as being economic in nature (i.e. potential loss of profits due to outdated equipment). In essence, the terminating party wanted an out from a long-term commitment that proved to be less profitable than expected.

From a practical perspective, this case shows that clients relying on outsourced technological solutions for their business should be cautious when entering into long-term commitments. Due to rapid technological advances and evolving customer preferences, long-term IT contracts may expose the client to risks of outdated software and/or equipment.

One way to address this issue is through Update/Upgrade Clauses, which allow the client to ensure that the technology supplied is up-to-date and competitive (whether it’s at no additional cost or for a separate fee). The parties may also add a benchmark mechanism, allowing them to periodically assess (namely with the help of a third party) the level of service provided and to compare the quality and price offered to those of other providers on the market.

Furthermore, parties to an IT contract may wish to incorporate a Service Level Agreement (SLA), in which they may specify the level of service that the service provider must meet and set a service performance level below which the client may be entitled to terminate the contract. In doing so, the parties may also define certain services as essential (e.g. a Help Desk or Call Center service with 8/5, 24/5 or 24/7 availability). Depending on the agreed level of service, the restriction, outsourcing or relocation of these maintenance services may be deemed a breach of the agreement.

Reproduction authorized with the following reference : , "Transfer of a commercial lease to a third party (Art. 263 SCO): refusal for good cause", published on: Swiss Contract Law, January 16, 2025, https://scl.cultureweb.ch/36/