Judgment of the Federal Supreme Court of 19 April 2022
Case Reference : 4A_29/2022

Facts

An individual (the Seller) entered into a sale agreement with two buyers (the Buyers) concerning the sale of several plots of land (including a house, barn and pastureland).

The notarized agreement was executed in October 2019, but provided for a deferred transfer of title, which was meant to take place in March 2020.

In a text message dated February 2020, the Seller unexpectedly informed the Buyers that she wished to “cancel” the sale. In a follow-up letter from her lawyer, the Seller contended that she was the victim of a “fundamental mistake” when concluding the sale and therefore did not consider the contract to be valid and binding.

The Buyers sued for transfer of title, which was awarded by the first-instance court. The judgment was later upheld on appeal by both the Zurich cantonal court and the Federal Supreme Court.

Throughout the proceedings, the Seller argued that due to her physical disability, she had previously intended to convert her barn into a residential building with a lift but was unable to do so due to the agricultural zoning rules in place. In 2016, an employee from the relevant authority informed her that she would be unable to secure a land conversion permit due to ever-more stringent regulations. Yet, in January 2020, shortly after the agreement had been signed, the Seller learned that the local building regulations would soon be reformed, allowing for land conversion in her area. The Seller argued that had she known this at the time of concluding the sale, she would not have entered into the agreement with the Buyers.

Issue

The Federal Supreme Court had to determine whether the Seller could, in good faith, allege a fundamental mistake within the meaning of Art. 24 para. 1 (4) of the Swiss Code of Obligations (SCO) in order to refuse to transfer title to the Buyers.

Decision

First, the Federal Supreme Court recalled that a contract is not binding for the party who was labouring under a fundamental mistake at the time of concluding the contract (Art. 23 SCO).

A mistake is deemed fundamental namely when a party is mistaken about certain facts that it considered in good faith to be a necessary basis for the contract (Art. 24 para. 1 (4) SCO). In addition to the mistaken party relying subjectively on these facts as an indispensable prerequisite for concluding the contract, these facts must also appear objectively necessary to the parties’ agreement (i.e. from the standpoint of fair business dealings). The circumstances at the time of the conclusion of the contract are key.

Second, the Federal Supreme Court recalled that a fundamental mistake may be the result of fault or negligence on the part of the mistaken party. Art. 26 para. 1 SCO provides that a mistaken party who invokes its mistake to avoid a contract and whose mistake is attributed to its own fault or negligence, is liable for the damage resulting from the nullity of the contract, unless the other party knew or should have known of the mistake. Thus, while the negligent party may have to pay damages to the other party under Art. 26 SCO, its negligence would not, as such, prevent the mistaken party from relying on its mistake to avoid the contract or to refuse its performance.

This must be distinguished from the case where a fundamental mistake is relied upon in breach of good faith. Art. 25 para. 1 SCO provides that a person may not invoke a mistake in a manner contrary to good faith. In this respect, the lack of good faith would impede the mistaken party from invoking its mistake. Thus, for example, if a party fails to raise a fact or a question it considers important when concluding the contract, the other party may legitimately conclude that its contracting partner did not consider it a necessary basis for the contract. In this scenario, the mistaken party would be barred from relying on its mistake, since an attempt to do so would be contrary to good faith.

In the case at hand, the cantonal court considered the Seller’s mistake fundamental within the meaning of Art. 24 SCO. Despite this, it found that the Seller had invoked its mistake in breach of good faith.

While the Federal Supreme Court saw no reason to overturn these findings, it did add that the Seller’s mistake was due to its own negligence. In fact, the last steps undertaken by the Seller to clarify the zoning rules dated back three years prior to the conclusion of the contract. As a “fair, honest and conscientious contracting party”, she should have sought updated information before the sale, especially since legal norms are known to evolve. All in all, the Federal Supreme Court found that the Seller’s failure to seek up-to-date information, which would be fundamental to her, was negligent within the meaning of Art. 26 SCO.

Beyond this finding of negligence on the Seller’s part, the Federal Supreme Court ultimately confirmed that the Seller’s attempt to rely on its negligent conduct was contrary to good faith within the meaning of Art. 25 SCO. In fact:

• the Seller failed to raise the issue of land zoning during the negotiations with the Buyers; in particular, she did not mention that the lack of prospects for land conversion was the underlying reason for the sale;
• the Seller’s conduct did not otherwise demonstrate, in any recognizable way, that her decision to sell was based on her mistaken belief regarding the prospects of land conversion; and
• therefore, the Buyers could not have recognized the importance of this fact to the Seller. Rather, the Buyers could, in good faith, assume that the Seller had carried out the clarifications that were essential to her – especially since this was not an everyday transaction and the sale was not executed under strict time constraints.

Given the above facts, the Federal Supreme Court considered that the Buyers’ legitimate expectations should be protected. It thus upheld the decision of the cantonal court to deny the Seller the possibility to refuse performance of the contract on the basis of a fundamental mistake.

Key takeaway

This case illustrates the distinction between negligence (which relates to the cause of a mistake) and the breach of good faith (which relates primarily to the manner in which said mistake is invoked).

As a general rule, negligence is not an obstacle to invoking a fundamental mistake. Thus, a party who operates under a mistaken belief due to its own fault or negligence is still entitled to avoid the contract or to refuse its performance, but may be found liable to pay damages to the other party under Art. 26 SCO.

However, negligent conduct can become problematic if relying on the resulting mistake can be perceived as a breach of good faith. Notably, a party cannot claim to be the victim of a fundamental mistake when it failed to undertake any necessary clarifications prior to concluding a contract. In this scenario, and by application of Art. 25 para. 1 SCO, the mistaken party would be unable to avoid the contract or to refuse its performance on these grounds.

Comments

This decision confirms previous case-law on the notion of good faith in relation to fundamental mistakes. Indeed, the Federal Supreme Court had previously found that if a party negligently fails (or does not bother) to clarify a certain question when concluding a contract, even though it may be an obvious matter of fact, the other party may reasonably conclude that this question is not a “necessary basis for the contract”. Thus, negligent conduct may – in certain circumstances – entitle the other party to consider in good faith that the point in question is not fundamental to the deal (see case reference ATF 117 II 218, para. 4b).

While the Federal Supreme Court chose to deny the Seller’s defence in application of Art. 25 SCO in this case, it is interesting to note that the principle of good faith is also embedded in Art. 24 para. 1 (4) SCO itself (which relates to the very definition of fundamental mistake). Indeed, for a mistake to be deemed fundamental under Art. 24 para. 1 (4) SCO, it must be recognized or recognizable as such to the contracting party, as per the rules of good faith and fair business dealings. In this sense, the failure of a party to clarify a question prior to a transaction and to signal its importance to the other party may be regarded as relevant under both legal provisions.

Other sources presenting the case

Chernaya Viktoriya / Galli Dario / Vischer Markus, Fahrlässiger Irrtum und Verstoss gegen Treu und Glauben, in: dRSK, published on October 2022, available at: https://www.walderwyss.com/user_assets/publications/Fahrlassiger-Irrtum-und-Verstoss-gegen-Treu-und-Glauben.pdf

Judgment of the Federal Supreme Court of February 2020
Case Reference : 4A_341/2021

Facts

On September 2, 2014, two companies had entered into a real estate sale agreement (“the Sale Agreement”), whereby under the terms of the Sale Agreement, the Seller had agreed to transfer the ownership of two parcels of land to the Buyer in exchange for the payment of the sale price. In addition, the Seller would undertake to pay all costs of soil decontamination, if any such practice were to be ordered by the competent authorities in subsequent years.

When concluding the Sale Agreement, the Seller was represented by C., who was given an ad hoc power of attorney for this purpose. In fact, C. was not registered in the commercial register as having signatory power on behalf of the Seller.

As early as October 2016, the presence of soil contaminants was detected in the two parcels of land. Upon receiving confirmation by a testing laboratory that the soil in the parcels contained arsenic, a meeting was held on January 19, 2017 between C., the architectural firm overseeing the site, the testing laboratory, and representatives of the Buyer. Following this meeting, one of the architect representatives appointed by the Buyer (“the Architect”) sent a letter to C. asking him to return it after having signed it. This letter stipulated that the Seller had agreed not to intervene in the decontamination process, but accepted to cover the costs of the whole operation. On January 30, 2017, C. signed the letter and returned it to the Architect.

Subsequently, a specialized company proceeded to decontaminate the site. As the work progressed, the company sent its invoices to the Seller. After receiving the first invoice, the Seller argued that it had never ordered the decontamination work and refused to pay said invoice.

In order to discuss the emerging dispute, a meeting was held on May 2, 2017 in the presence of the Architect, C. and I., the latter being a development manager in a company related to the Seller.

After receiving further invoices and reminders from the Architect, the Seller argued that neither C. nor I. had made any commitment in its name to pay for the decontamination costs. According to the Seller, the commitment it had made in the context of the Sale Agreement was only valid in the event of remediation of the site (“assainissement”) and not in the event of a simple decontamination procedure (“dépollution”). Furthermore, the work undertaken did not constitute a remediation. The Seller also added that it could only validly commit itself via the collective signature of two persons duly authorized according to the commercial register and that no specific power of attorney had been established to authorize C. to individually represent the Seller in relation to the costs of the decontamination process.

In view of the Seller’s refusal to pay the invoices related to the decontamination of the site, the Buyer initiated civil proceedings. The claim was rejected by the First and Second Instance Courts. The Buyer, therefore, lodged an appeal with the Federal Supreme Court.

Issue

The main issue to be decided by the Federal Supreme Court was whether the Seller had validly agreed – through its representatives – to bear the costs of the decontamination process.

Decision

The Federal Supreme Court recalled the conditions under which an agent can conclude a contract in the name of a principal.

Under Swiss law, when an agent who enters into a contract claims to act on behalf of a principal, the principal is bound in three cases: i) if the principal has conferred the necessary power on the agent (internal power of attorney, Art. 32 para. 1 of the Swiss Code of Obligations [SCO]); ii) in the absence of an internal power of attorney conferred on the agent by the principal, where the third party could infer the existence of such power from the behavior of the principal (apparent power of attorney, Art. 33 para. 3 SCO); and iii) also in the absence of an internal power of attorney conferred on the agent by the principal, where the latter has ratified the contract (Art. 38 para. 1 CO).

The principal is normally bound – in the first scenario, governed by Art. 32 para. 1 SCO – when the agent has declared that he or she is acting on behalf of the principal and has the internal power of representation. Art. 32 para. 1 SCO thus essentially protects the interests of the principal. However – in the second scenario, governed by Art. 33 para. 3 SCO – in the absence of an internal power of attorney, the contracting third party is exceptionally protected when the principal has (expressly or tacitly) brought to his or her attention an (external) power of attorney which goes beyond the power which he or she has actually conferred on the agent (internal power of attorney) and, relying on this communication, the third party has believed in good faith in the existence of the agent’s power. It is no longer a question of protecting the interests of the principal, but of protecting the interests of the third party contracting with him or her, and hence the security of the transaction. In this case, representation is subject to two conditions: i) the principal must have informed the third party of an external power of attorney that goes beyond the internal power of attorney (this communication may be tacit) and ii) the third party must be acting in good faith (according to Art. 3 para. 2 of the Swiss Civil Code (SCC), the third party cannot rely on his/her own good faith if he or she has failed to exercise the diligence required by the circumstances).

In the present case, it was not disputed that no internal power of attorney had been granted to C. to agree that the Buyer shall bear the decontamination costs. Therefore, the Seller could not be validly bound under the rule of Art. 32 para. 1 SCO (first scenario). The Federal Supreme Court had therefore to determine whether the Seller could nevertheless be bound by an external power of attorney and the good faith of the Buyer (second scenario). However, as the previous courts had also observed, the good faith of the Buyer was clearly lacking here, for the following reasons:

1) the Buyer, who was a real estate professional, knew that C.’s power of attorney was limited in time and that it was also limited to the conclusion of the Sale Agreement; 2) according to the commercial register C. was not authorized to represent the Seller; 3) if the Buyer wanted to change the remediation costs-clause of the Sale Agreement, it had to ensure that C. had a special power of attorney to do so; and 4) that the Sale Agreement stipulated that the coverage of the remediation costs by the Seller based on a decision of a competent authority, and that such a decision had not been undertaken in this case.

Thus, since the Buyer could not rely on its good faith, it could not be admitted that the Seller had been validly represented by C.

Key takeaway

This decision adds to Federal Supreme Court’s case law rendered in representation matters. It once again highlights the risks for parties who do not pay (enough) attention to the circumstances in ensuring that a business party is duly bound by the actions of third parties. It would be wise for parties who interact with corporations to bear in mind the following lesson: always check the powers of attorney of the people you are dealing with, and, when in doubt, carry out a thorough investigation.

Comments

The conclusion reached by the Federal Supreme Court (and the First and Second Instance Courts before it) is convincing. The general rule of representation is that the principal is only bound by the acts of an agent if he or she has validly conferred an (internal) power of attorney on the agent. In the absence of such an internal power of attorney, the principal shall only exceptionally be bound by an external power of attorney (i.e. the appearance of a power of attorney), which he or she contributed to creating by their actions or inactivity.

In the present case, however, no action or inaction can be reproached to the principal: indeed, the Seller had never communicated to the Buyer special powers of attorney in favor of C., neither expressly nor tacitly by way of an (hypothetical) ambiguous behavior. A diligent person cannot be bound by the acts of a purported agent who has no power of attorney.

The initial reaction of the Buyer may be understandable: upon discovering the pollution of the site, it naturally wanted to contact the Seller through its main contact person, C. This first instinctive reaction, as natural as it may be, is however not entirely excusable. The rules of corporate representation in Switzerland are well known, especially by parties acting in a professional capacity. The commercial register, with the list of authorized representatives of a company, is easily accessible online. If there were any doubts about C.’s powers of representation it would have been easy for the Buyer to obtain clarification directly from the Seller. One can only conclude that the Buyer had shown a certain amount of carelessness in relying solely on the impression created by an outdated power of attorney.

In the absence of a contractual claim against the Seller, one might wonder whether the Buyer could not try to sue C. for wrongfully acting as a representative under Art. 39 SCO. Indeed, this provision gives to the third party a claim for damages against the person who pretended to act as an agent, i.e. the falsus procurator. However, this claim is subject to a good faith test: if the third party knew or should have known that the falsus procurator lacked the proper authority, then the third party will not be able to claim damages. Alas, in the present case it would be difficult for the Buyer to rely on its good faith, as it would have been easy for it to verify C.’s powers of representation by consulting the commercial register or to confirm a possible ad hoc power of attorney. Even if case law has considerably limited the scope of the good faith requirement, recognizing that it is only a factor in reducing – and not excluding – compensation (ATF 116 II 689), it is likely that the Buyer’s conduct would be assessed severely by a judge and would lead to a significant reduction of potential damages.

A second option would be for the Buyer to sue the Seller on the basis of pre-contractual liability for associates (so called culpa in contrahendo in connection with Art. 101 SCO, cf. Chappuis Christine, in Thévenoz Luc/Werro Franz, Commentaire romand du Code des obligations I, Art. 39 SCO N 2). However, since the judgment did not provide sufficient information about C.’s relationship with the Seller, it’s very hard to assess the outcome of this approach.

Judgment of the Federal Supreme Court of 19 March 2020

Case Reference : 4A_313/2019

Facts

The case concerned a hairdresser, tenant of a commercial lease, who had decided to hand over his business. Various merchants were interested, among them a chocolatier who wanted to open a new shop.

The hairdresser and the chocolatier had started negotiating the handover of the business. During the negotiations, the chocolatier had agreed to offer the hairdresser the sum of CHF 50,000, subject to the landlord’s acceptance of the change of tenant.

The hairdresser had two choices: 1) to transfer the commercial lease directly to the chocolatier, by remaining jointly and severally liable for the rent for two years (Art. 263 of the Swiss Code of Obligations [SCO]); or 2) to terminate his lease contract and have the chocolatier conclude a new lease contract with the landlord. Given that the hairdresser was not satisfied with the first option, the parties decided they would meet with the landlord to sign, in writing, both the business sale (between the hairdresser and the chocolatier) and the new commercial lease (between the chocolatier and the landlord). Shortly thereafter, however, the hairdresser asked the chocolatier to sign the business sale agreement the day before the tripartite meeting was scheduled to take place.

Without any news from the chocolatier – who suddenly disappeared – the hairdresser opted to break off negotiations with him. Later on, he discovered that the chocolatier had come to an agreement directly with the landlord to conclude a lease agreement and rent the premises previously held by the hairdresser, thereby avoiding to pay the sum of CHF 50,000.

The hairdresser put the chocolatier on notice to pay the price of the business sale discussed among them, i.e. the expected CHF 50,000.

Issue

The Federal Supreme Court had to clarify the scope of the duty to negotiate in good faith: was the chocolatier entitled, after negotiating the business handover agreement with the hairdresser, to enter into a lease agreement directly with the landlord and to get the premises without paying the agreed fee to the hairdresser?

Decision

1. The Federal Supreme Court explained the legal framework for contractual negotiations. The main principle is contractual freedom: everyone is free to enter into, or interrupt a negotiation whenever they want, even without justification.

However, the possibility to interrupt negotiations is subject to good faith (cf. Art. 2 para. 1 of the Swiss Civil Code [SCC]), generally known, in this context, as the culpa in contrahendo.

The culpa in contrahendo is a basis for liability for persons negotiating a contract. It is based on the idea that talks by their very nature create a form of legal relationship between the negotiating parties and impose on them reciprocal duties, in particular the obligation of negotiating seriously and in accordance with their true intentions. The purpose is to make a party liable for having, through behavior which does not align with its true intentions, given rise to the illusory hope that a deal would be concluded and thus leading the other party to make arrangements or incur expenses in view of this deal. It is contrary to the rules of good faith to agree in principle to the conclusion of a formal contract and to refuse in extremis, without reason, to translate it into the required form.

In practice, culpa in contrahendo for breach of contract is only accepted in exceptional situations, especially when the type of contact is subject by law to a written form. Neither long negotiations nor the knowledge that the other party has made investments are sufficient. Indeed, incurring costs before the conclusion of the contract has, in principle, to be carried out at one’s own risk. The conduct contrary to the rules of good faith does not consist so much in having broken off the negotiations as in having kept the other party in the belief that the contract would certainly be concluded or in not having dispelled this belief in time. In practical terms, failed negotiations will not, in principle, give rise to liability, unless specific elements such as an oral or written commitment give rise to a legitimate expectation that the contract will certainly be concluded.

2. In this case, the Federal Supreme Court clarified that legitimate expectations (that the contract would be concluded) were excluded from the outset – and therefore the pre-contractual liability of the other party would not come into play – when the allegedly injured party knew or should have known that the negotiations would not be successful.

3. In the case at hand, the Federal Supreme Court found that there was no evidence of any agreement that would have been entered into between the chocolatier and the landlord before the hairdresser broke off the negotiations with the chocolatier. Besides, it is rather the attitude of the hairdresser that was at the origin of the misunderstanding that affected the last phase of the negotiations: after having fixed a meeting to sign the business sale and the lease agreement simultaneously, the hairdresser demanded that prior to that meeting the chocolatier sign the business sale contract. This conflicting behavior created an unclear situation for the chocolatier, who was legitimately reluctant to enter into the business transfer agreement without the guarantee of obtaining the commercial lease. The chocolatier’s silence obviously did not help the parties find a solution, but he simply refused to sign the business sale since the initial plan was to sign the new lease agreement at the same time.

4. The pre-contractual liability of the chocolatier could not be triggered.

Key takeaway

When the tenant of a commercial lease wants to sell his business, there is a risk that the would-be transferee will come to an agreement directly with the landlord of the premises without the transferor being involved. In order to avoid direct negotiations between the would-be transferee and the landlord, it is in the business interest of the seller to obtain the landlord’s consent in advance or, alternatively, to proceed with a transfer of the lease in accordance with Art. 263 SCO, even if it means remaining jointly and severally liable for two years. Last option: draft a letter of intention preventing the buyer from negotiating directly with the landlord.

Comments

Unlike other laws (specifically French law), Swiss law does not, strictly speaking, recognize the concept of “fonds de commerce” (sale of a business) nor does it provide for a specific legal framework. Under these conditions, the transfer of a business must be carried out according to several legal rules, specific to each of the components of the business (lease, furniture, clientele, etc.). In the same way, Swiss law does not recognize the French concept of “droit au bail” (right to the lease), which authorizes a business owner to transfer his lease to another business owner without the landlord being able to oppose it.

Art. 263 SCO does limit the landlord’s right to oppose the transfer of the lease under justified reasons; but, in exchange, the first tenant remains liable, jointly with the new tenant, for a period of up to two years. When the tenant has not obtained the prior agreement of the landlord to transfer his lease to any other merchant, he is in an unfavorable position if he wants to sell his business. Indeed, the lease contract is an essential element of the transfer of a business and it is unlikely (as the case commented here shows) that anyone will buy a business without the relevant lease agreement for the premises where the business will be carried out. Case law shows that the absence of a specific legal regime for the transfer of business gives significant power to commercial lessors to the detriment of lessees (cf. recently 4A_30/2020).

In this case, the hairdresser, being in an unfavorable position, acted improperly. He sought to transfer his business at all costs without considering that the chocolatier would not be satisfied with a transfer of the business without assurance that he will take over the lease. Although the attitude of the chocolatier may seem to lack transparency and be unfair since he stopped the negotiation with the hairdresser and began negotiations directly and separately with the landlord, the Federal Supreme Court did not sanction this behavior.

Good faith is the underlying principle of the liability for culpa in contrahendo. Since such liability is based on the protection of the legitimate expectations that one negotiating party holds over the other, it is subject to a fairly subjective assessment by the courts, who put themselves in the shoes of both negotiating parties and rule according to the behavior they find most appropriate.

In short, since pre-contractual liability is only rarely admitted, there is a requirement for the party claiming fault on his counterparty to show irreproachable conduct. If his behavior was not impeccable, it would have been difficult for him to accuse the other party of violating the rules of good faith by refusing to enter into the contract. However, in this case, the hairdresser changed his strategy and pushed for an unrealistic agreement since it cannot usually be expected that the other party would accept this in good faith.

Other sources presenting the case

Blaise Carron, in Droit du bail, 2020 p. 15.

Judgment of the Federal Supreme Court of 10 July 2020
Case Reference : 4A_562/2019

Facts

A general contractor (the Principal) subcontracted a part of the construction work it has been entrusted with to another company (the Third Party).

When the Third Party’s director signed the contract for work and services, he added a handwritten statement (the Handwritten Statement) stating that an employee of the Principal called F. (Employee F.) was authorized to sign for the Principal, i.e. for its employer (original text [in German]: “Hr. F. ist unterschriftberechtigt für den Bauherrn + GU [which stands for Generalunternehmer]”, translation: “Sir F. is authorized to sign for the building contractor + the general contractor”). The Principal, who had already signed the contract, received a copy of the contract countersigned by the Third Party with the Handwritten Statement and did not object nor react the Handwritten Statement.

Employee F. monitored and coordinated the construction work, and acted as primary contact of the Principal to the Third Party. The Principal did not object that the construction work be managed by Employee F. Later on, Employee F. declared that he was unsure as to whether he had the authority to sign on behalf of the Principal.

Once the construction work had been carried out by the Third Party, Employee F. signed off on the work and sent the final statement to the Third Party for signature (with the amount due by the Principal to the Third Party). On the same day Employee F. sent the final statement to the Third Party, the Principal terminated the agreement with Employee F. (which was not disclosed to the Third Party). A couple of months later, the Principal claimed that Employee F. had not been authorized to legally act and submit documents on its behalf. When the Third Party sent the invoice to the Principal, the latter only paid half of the amount requested.

The Third Party claimed payment of the outstanding amount by the Principal. Both the court of first instance and the cantonal court of appeal in the canton of Valais ruled in favor of the Third Party. The Principal appealed to the Federal Supreme Court.

The Principal argued that at the time it had signed the contract, the Handwritten Statement made by the Third Party stating that Employee F. was authorized to sign for the Principal had not yet been added. As a result, the Principal had not granted Employee F. the authority to act on its behalf. The Principal also invoked a breach of Art. 33 para. 3 of the Swiss Code of Obligations [SCO], stating that the Third Party had acted in bad faith by not informing the Principal of the Handwritten Statement which had been added to the contract.

Issue

The Federal Supreme Court had to determine whether the Principal was bound by the acts of Employee F. towards the Third Party since it would have given the impression that it had granted to Employee F. the authority to act on its behalf.

Decision

The Federal Supreme Court set the legal framework on agency rules (Art. 32 ff. SCO) by recalling the three situations in which a person (the represented person) may be bound by the rights and obligations arising from a contract made on its behalf by another person (the agent):

• If the represented person had granted the agent the required authority to act on its behalf (“internal relationship”) ( 32 para. 1 SCO which provides that “[t]he rights and obligations arising from a contract made by an agent in the name of another person accrue to the person represented, and not to the agent”);
• In the absence of authority conferred by the represented person to the agent, if the third party could infer the existence of such authority from the behavior of the represented person (“external relationship”) ( 33 para. 3 SCO which provides that “[w]here a principal grants such authority to a third party and informs the latter thereof, the scope of the authority conferred on the third party is determined according to the wording of the communication made to him”);
• In the absence of authority conferred by the represented person to the agent, if the represented person has ratified the contract ( 38 para. 1 SCO which provides that “[w]here a person without authority enters into a contract on behalf of a third party, rights and obligations do not accrue to the latter unless he ratifies the contract”).

In the first case (see 1) above), the Federal Supreme Court underlined that Art. 32 para. 1 SCO requires a power of attorney conferred by the represented person to the agent (so-called internal power of attorney). From that perspective, the Handwritten Statement could not have been regarded as an internal communication of authority that would have been made by the Principal to Employee F. Therefore, the question of whether or not the contract had been signed by the Principal’s director before or after the addition of the Handwritten Statement was deemed irrelevant. Moreover, given that Employee F. was unsure as to whether he had the authority to sign on behalf of the Principal, the Federal Supreme Court considered that Employee F. had not been granted the required authority to act on behalf of the Principal, and therefore excluded the application of Art. 32 para. 1 SCO.

With regards to the second case (see 2) above), the Federal Supreme Court recalled that, even in the absence of authority conferred to the agent, the represented person may nevertheless be bound if it has communicated to the third party the existence of a power of attorney in favor of the agent (see Art. 33 para. 3 SCO, so-called external power of attorney). The Federal Supreme Court pointed out that such communication may be implied and may be inferred from the behavior of the represented person if such behavior leads the third party to think that the person has granted authority to another person. What is decisive is whether the behavior of the represented person can objectively be understood in good faith as being a communication to the third party of powers, irrespective of the subjective perception or willingness of the represented person. Art. 33 para. 3 SCO further requires the third party’s good faith (which is legally presumed to exist pursuant to Art. 3 para. 2 of the Swiss Civil Code [SCC]).

In this case, due to the Principal’s lack of reaction to the Handwritten Statement (i.e. the Principal did not challenge the statement of the Third Party according to which Employee F. had the power to act for the Principal) and the day-to-day management by Employee F., the Federal Supreme Court considered that the Third Party could validly believe that the Principal had granted a power of attorney in favor of Employee F. It also held that the Principal failed to prove that the Third Party had acted in bad faith. The fact that the Principal had terminated the agreement with Employee F. on the same date that Employee F. had sent the final account to the Third Party was dismissed (given that the Third Party had not been informed about this).

In conclusion, the Federal Supreme Court found that, in accordance with Art. 33 para. 3 SCO, the Principal was bound by the Handwritten Statement added in the contract by the director of the Third Party and that, as a result, it was obliged to settle the final invoice corresponding to the amount that Employee F. had notified to the Third Party.

Key takeaway

As a general rule, an act of representation (a relationship of agency) is not valid in the absence of authority conferred by the represented person (the principal) to the agent. Swiss law, however, provides for an exception to this principle when the behavior of the principal leads the other party to think that the principal has granted authority to another person (such as an employee) to act on its behalf (Art. 33 para. 3 SCO). Art. 33 para. 3 SCO provides in this respect that “[w]here a principal grants such authority to a third party and informs the latter thereof, the scope of the authority conferred on the third party is determined according to the wording of the communication made to him”. Art. 33 para. 3 SCO consequently presupposes that the principal communicates this to the third party, whereby “the scope of the authority conferred on the third party is determined according to the wording of the communication made to him”. Based on its wording, this provision presupposes a communication made to the third party. What is interesting in this judgment handed down by the Swiss Federal Supreme Court is that the power of representation was admitted on the basis of a communication that was not made to the third party but rather by the third party (i.e. the Handwritten Statement). The good faith of the Third Party in believing that the Employee F. had the power to act for the Principal was upheld because of the Handwritten Statement that was added on the contract by the Third Party at the time of signing of the contract. This constitutes a very broad application of Art. 33 para. 3 SCO.

In the context of commercial contracts, especially between corporate entities, many individuals may intervene in the process (whether during negotiations or for the purpose of performing the contractual obligations). Therefore, companies must stay alert and pay careful attention to the content of the contractual documentation and to the management of contracts – particularly in the process of signing the contract. This case law serves as a lesson of contractual diligence during the conclusion of a contract. By not reacting to a handwritten statement made by the other party on the signature page of the contract, the company was held liable for the acts of one of its employees to which it had not given a power of representation. Companies must consequently be aware of the risks of giving the impression that they would have granted a power of attorney to one of their employees.

In terms of contractual risk management, a response to a handwritten statement added to a contract when signing the contract implies a diligent contract management process. As the number of contracts in business transactions continue to grow, companies can no longer shove a contract signed in a drawer: it is imperative to manage and avoid risks (such as the risk of an unwanted power of representation) by identifying and keeping an eye on any potential last-minute amendment to a contract. In an era of growing automation of (AI-based) contract management and even contract conclusion mechanisms, one can wonder whether a totally automatic (i.e. without any human oversight) contract management system, in which the contract in question in this case would have been automatically digitally registered and stored by the Principal, would have identified the potential legal risk resulting from the addition of the Handwritten Statement that was made by the Third Party.

Comments

This judgement is a case book illustration of the reasoning that the Swiss Federal Supreme Court adopts in order to analyze whether there is a relationship of agency: is the represented person bound by the acts of the agent as a result of an internal power of attorney (Art. 32 para. 1 SCO)? If not and alternatively, is it bound as a result of an external “apparent” power of attorney (Art. 33 para. 3 SCO)? Or lastly because of a ratification of the contract by the represented person (Art. 38 para. 1 SCO)?

Quite interestingly, this case gives a concrete example of an agency which does not result from an active and direct “communication” of the powers that would have been made by the represented person. In this case, the agency results rather from the silence and thus from a lack of response from the represented person to the addition of a handwritten statement made by the third party at the time of signing the contract. Although silence does not generally mean acceptance, the detailed reasoning of the Federal Supreme Court reveals in this case the necessity for the represented person (i.e. the Principal) to respond in order to avoid giving the impression of a relationship of agency.

The case also outlines the key distinction between the internal power of attorney pursuant to Art. 32 para. 1 SCO and the so-called external power of attorney pursuant to Art. 33 para. 3 SCO. While the former generally derives from a unilateral communication of authority by the represented person to the agent, the latter, on the contrary, depends on the behavior of the represented person (in this case the Principal) which leads the third party (in this case the Third Party) to believe, in good faith, that a power of attorney was granted by the represented person to the agent.

Judgment of the Federal Supreme Court of 3 September 2020
Case Reference : 4A_45/2020

Facts

The dispute arose in respect to the tax consequences resulting from a real estate sale. On December 16, 2008, the seller sold the buyer two apartments located in the canton of Valais, Switzerland, for the price of CHF 1,300,000 by public deed. According to Clause 6 of the sale agreement, all costs relating to the sale were to be borne by the buyer and any taxes on real estate capital gains would be paid by the buyer, in full discharge of the seller.

In order to settle tax matters related to the acquisition of the apartments, in particular real estate capital gains taxes, the buyer initially appointed the trustee X SA, a subsidiary of the international group ABC. The buyer was a member of the management team of the group ABC. The cantonal tax office in Valais notified the seller of a tax decision fixing the amount of tax related to the real estate capital gains at CHF 111,590.40, against which the seller filed a complaint. The cantonal tax office reversed the decision and agreed to tax the real estate capital gains resulting from the sale of the real estate as ordinary income tax.

The trustee X SA terminated its contractual relationship with the seller on the grounds that it has not been able to obtain the necessary information to process the tax return. As a result, the seller hired a second trustee, which asked the cantonal tax office to reconsider its decision and to qualify the capital gain as private assets, subject to real estate capital gains taxes. As a result, a new tax decision was issued fixing the amount of tax relating to the real estate capital gains at CHF 141,273.90. Pursuant to the sale agreement, the seller sent the invoice to the buyer, who refused to pay it.

On September 19, 2019, the seller filed a claim against the buyer for the payment of the full amount of the tax (CHF 141,273.90) with interest. The court of first instance ruled in favor of the seller and the buyer’s appeal was rejected by the court of appeal.

The buyer’s main argument was that he had only accepted the terms stated in Clause 6 of the sale agreement because he had a good faith expectation that the seller would use the trustee X SA, which was a subsidiary of the international group ABC of which the buyer was a member of the management team, to administer taxes related to the sale of the apartments. The buyer considered that the seller had a duty to collaborate with his trustee and a duty to take all necessary actions to reduce the tax burden. The buyer considered that the seller failed to fulfil its obligations, resulting in the tax authorities levying a capital gains tax on the property that was higher than the amount that they had initially taxed the buyer.

Issue

The Federal Supreme Court was required to determine whether the principle of good faith gave rise to an ancillary obligation requiring the seller to act against his own interests by entrusting the administration of his tax interests to the trustee X SA, which was a subsidiary of the international group ABC of which the buyer was a member of the management team, and to take all necessary actions to reduce or discharge the capital gains tax on the property (borne by the buyer), in favor of an income tax (borne by the seller).

Decision

An ancillary obligation is generally defined as an obligation arising from the contractual relationship of trust between contracting parties. Pursuant to the general principle of good faith under Swiss law (art. 2 para. 1 of the Swiss Civil Code [SCC]), the debtor must do all that is necessary for the proper performance of its principal contractual obligation. Ancillary obligations can be obligations to monitor or protect. For instance, when the performance of a contract creates a dangerous situation, the principal obligation of the contracting party creating the dangerous situation can be coupled with an ancillary obligation to ensure the safety of the contracting party. A principal contractual obligation can also be complemented by an obligation to supply or disclose information. For example, if one party produces an ambiguous legal situation, that party should draw the attention of its contractual partner to this issue.

In this case, the issue was whether the seller had an ancillary obligation to prevent the buyer from needing to pay tax on the sale of the real estate. The buyer challenged the tax strategy of the seller and the trustee Z SA. The buyer was in fact expecting the tax authorities to subject the capital gain from the sale to ordinary income tax (borne by the seller), which would discharge the real estate capital gains tax (borne by the buyer). The buyer assumed that the seller had the obligation to comply with this strategy.

However, the seller could only implement this strategy if the sale of the apartments were allocated to the business assets of the seller. According to tax law rules in the canton of Valais, in order to tax real estate as business assets, it is necessary to carry out a self-employed activity. The existence of such activity is determined on the basis of various indications, which are lacking in this case. According to the trustee Z SA, the seller had never been active in the real estate business and the real estate owned by the seller had always been classified as private assets for tax purposes. In addition, the Federal Supreme Court stated that, given that the seller had not been automatically taxed, he collaborated and provided the tax authorities with the necessary elements to determine the taxable real estate capital gains.

On this basis, the Federal Supreme Court held that the seller did not have an ancillary obligation arising from the principle of good faith to give a partial representation of the facts to the cantonal tax office with the sole aim of preventing the buyer from needing to pay tax on the sale of the real estate. In addition, if the buyer’s tax strategy had been successful, this could have had the consequence of discharging the real estate capital gains tax, but could have resulted in the tax authorities levying an income tax, payable by the seller.

The Federal Supreme Court concluded that there was no ancillary obligation for the seller to entrust the administration of his taxes to the trustee X SA (as desired by the buyer) and that it was unconscionable for the principle of good faith to impose an ancillary obligation on the seller to act against his or her own interests.

Key takeaway

A contracting party cannot have an ancillary obligation based on the principle of good faith to act in its disadvantage and even to submit false or incomplete information to the tax authorities, even if this could have improved the other party’s financial position (in this case the avoidance of taxes). The duty to act in good faith cannot lead one party to act against its own interests.

Parties are advised to specify clearly in the agreement the terms related to any potential ancillary obligation.

Comments

This decision confirms previous decisions of the Federal Supreme Court where the existence of an ancillary obligation arising from the principle of good faith was denied. In particular, the Federal Supreme Court held there was no ancillary obligation for a credit card organization to report all card losses to the affiliated company, even if the losses could cause damage to the merchant (ATF 113 II 174, c. 1b). In another decision, the Federal Supreme Court held that a telecommunications service provider did not have a duty to warn – based on the principle of good faith – when the fees for a given connection exceeded a certain amount during the current month (ATF 129 III 604, c. 4.2.2).

On the other hand, the Federal Supreme Court held that there was a duty to protect, not only when the life or health of the contractual partner may be jeopardized, but also when financial interests were at stake. In particular, the Court held that a doctor has a contractual duty to provide information to the patient when a treatment, an intervention or his fees might not be covered by health insurances (ATF 119 II 456, c. 2). Contrary to the above-mentioned decisions, where the existence of an ancillary obligation arising from the principle of good faith was denied, the parties entered into a mandate agreement (art. 394 ss of the Swiss Code of Obligations [SCO]) for which the parties rely on a relationship of trust for the execution of the agreement. Such relationship of trust does not arise from the real estate sale agreement itself.

The existence of an ancillary obligation arising from the principle of good faith might therefore depend on the qualification of the contract, in particular the existence of a relationship of trust between the parties.

Other source presenting the case

Leandro Schafer/Dario Galli/Markus Vischer, Nebenpflichten aus Treu und Glauben bei Drittansprüchen, in: dRSK, published on December 8, 2020