Judgment of the Federal Supreme Court of 4 March 2022

Case Reference: 4A_488/2021

Facts

The case concerned a public company listed on the stock exchange. A conflict had arisen among the shareholders, which led to the non-re-election of three out of six directors. A new chairman of the board was appointed, as well as a new CEO (who was not a board member). Later on, a member of the board resigned, leaving henceforth two members on the board: the chairman and another director.

An employment and mandate agreement had been drafted by the company and the chairman. This agreement had been signed by the second director and the newly appointed CEO on behalf of the company. To this end, a power of attorney had been specifically granted to the new CEO by the chairman and the second director. The agreement provided for two types of remuneration: a fixed monthly salary under the employment contract and a fixed annual fee as a member of the board of directors. In addition, a termination notice period of six months was provided for.

A few months later, a new board of directors was elected. It had decided to freeze the remuneration of the chairman and to dismiss him with immediate effect. The latter filed a claim in court for more than CHF 500,000 to cover salary remuneration, administrative fees, participation in profit-sharing plan, unused PTO, reimbursement of expenses and compensation for unjust dismissal.

The lower courts held that the employment and mandate agreement was void. Given that the board of directors consisted of only two members and that one of them was caught in a conflict of interests (i.e. the chairman), the board could not grant a power of attorney to the CEO. Since the chairman had to be aware that he was orchestrating the signing of a contract contrary to the law and the company’s articles of association[1], he was acting in bad faith and could therefore not rely on the void contract.

Issue

The issue was whether the employment and mandate agreement had been validly concluded or whether it was null and void due to the prohibition of concluding a contract with oneself. In the case of the latter, the question of a fictional application of the employment contract due to the services rendered (de facto contract theory) also arose.

Decision

I. Is the contract void because of the prohibition of self-contracting? (para. 5)

The Federal Supreme Court explained that a contract concluded with oneself corresponds to a situation whereby the same person is a party to the legal act in two different capacities: on the one hand on his or her own behalf, and on the other hand as the representative of another person. This situation, like dual representation, entails a risk of conflict of interest. For this reason, a contract concluded with oneself is not permissible and therefore invalid, subject to two exceptions: (i) the nature of the transaction itself precludes any risk of harm to the principal (this is particularly the case where the agreement is concluded on market terms); and (ii) the principal has consented in advance or ratified the agreement.

These principles also apply to the legal representation of a legal person by its bodies. The legal person is presumed to tacitly exclude the power of representation for any act that may create a conflict of interest between its own interests and those of its representative. The consent or ratification to such an act must originate from a body occupying the same rank as the body having signed the act or higher.

In the case at hand, it was found that the parties involved had devised a scheme to circumvent the rules prohibiting self-contracting by granting the CEO a power of attorney authorizing it to sign the employment agreement with the chairman. The Court also found that because of its subordinate position, the CEO did not meet the requirement of an independent body of the same rank and was, therefore, not qualified to approve or ratify the conclusion of the employment agreement. Furthermore, it had not been proven that the remuneration terms of the employment agreement were actually in line with the market.

Thus, the contract was deemed void on the grounds of the prohibition of self-contracting.

II. Should the contract, despite its invalidity, still be applied in a fictitious way because of the work performed? (para. 6)

Under labor law, when a pseudo-employee has entered into an employment contract which is subsequently found to be null and void, the employee may claim the application of a de facto contractual relationship in order to be remunerated for the work it has performed, unless it knew that the contract was null and void (Art. 320 para. 3 of the Swiss Code of Obligations [SCO]).

The Federal Supreme Court held that it could be inferred from the circumstances of the present case (i.e. granting a subordinate manager special power to sign an employment and mandate agreement on behalf of the company) that the chairman was aware that such a contract may not be valid, and had accepted such an outcome in the event that it be proven true.

Since the chairman was aware of the deficiency in the contract, he could not rely on Art. 320 para. 3 SCO and the existence of a de facto contractual relationship.

Key takeaway

In the event that a company is in a delicate situation due to a dispute among shareholders that has led to a nonfunctional board of directors, it is advisable to wait until the dispute has been settled and the composition of the board of directors has been reconstituted, before entering into contracts with members of the board. It is further advisable for companies to implement rules, bylaws or internal regulations explicitly dealing with conflicts of interests.

Comments

This judgment highlights two sets of rules under the general law of obligations:

I. Contracts concluded with oneself

The principle of the prohibition of self-contracting is well established under Swiss law. The risk of such contracts for a company is well known, since the people who run a company can take advantage of their position in order to obtain undue benefits. In this view, it is less a question of a prohibition on self-dealing than of a prohibition on using the company to obtain an undue personal advantage.

As there are several ways of bypassing this prohibition, scholars have proposed to extend the prohibition to situations in which a director – who has a conflict of interest – empowers another person to sign a contract in which the former has a personal interest. This mechanism does not formally violate the prohibition against contracting with oneself, but it pursues the same goal by allowing the director involved to grant itself a personal advantage through the influence, or even the pressure, that he or she exerts on another person.

Such test had been carried out by the Federal Supreme Court in the case at hand, leading to the conclusion that the chairman managed to get the contract signed by another person, but to his own advantage. The circumstances of the case appear to be decisive, in particular the fact that the CEO was given a unique and specific power to co-sign the agreement with the chairman.

However, this is an after-the-fact analysis. It is questionable whether the company could not enter a contract with the chairman until all the other members of the board had been appointed. This situation could have extended over a longer period of time and the company had to continue to be managed in the meantime. There is little doubt that a prolonged blockage situation would have had negative consequences for the company as well as for the various stakeholders. One may ask whether it would have been advisable to balance (purely internal) quorum requirements against the company’s legitimate interest in having an effective governing body.

Furthermore, the Federal Supreme Court had been quick to dismiss the question of whether the remuneration conditions were in line with the market. However, one may wonder whether this criterion should not have been the most important in this particular case, where formally, the contract had not been concluded by the chairman himself. In any event, it is surprising that the employee (in this case, the chairman) should have to bear the consequences of the absence of proof of a remuneration in line with the market. Given the difficulties in providing evidence on directors’ remuneration – fact acknowledged by the Federal Supreme Court itself –, it seems to us that the evidentiary requirements in this respect should not be too high, so as not to unduly penalize the employee.

II. De facto contractual relationship in case of an invalid contract

The legal text (Art. 320 para. 3 SCO “[w]here an employee performs work in good faith for the employer under a contract which is subsequently found to be invalid, both parties must discharge their obligations under the employment relationship as if the contract had been valid until such time as one party terminates the relationship on grounds of the invalidity of the contract”) provides for a de facto contractual relationship in the case where an employment agreement turns out to be null and void, in order to prevent the worker from providing unpaid work. The exception of bad faith is intended to punish the person who has entered into a contract for which he or she was aware of the fact it was not valid. It is an extremely harsh penalty given that the contractual partner is enriched by the work of the other party without having to pay any salary.

From this point of view, the requirement that the (limited) validity of the employment contract be subject to the good faith of the employee is objectionable in itself: the question that should be answered here instead is whether or not the employee deserved to be paid for the service he or she had provided (cf. Hartmann Stephan, Rückabwiclung und “faktisches Vertragsverhältnis” bei ungültigen Arbeitsverträgen – Bemerkungen zu BGE 132 III 242 ff., in ZBJV 2007, p. 277 ff., in particular p. 286 f.). The good faith of the employee is not relevant to answer this question. Besides, it is interesting to note that the Federal Supreme Court had already recognized that the requirement of good faith may lead to unfair results, which is why it had advocated for a restrictive interpretation of the notion of good faith in this context (cf. ATF 132 III 242).

Regardless of the question of good faith, the conclusion reached by the Federal Supreme Court in this judgment does not seem entirely convincing. In particular, by denying the existence of a de facto employment contract, the Federal Supreme Court has opened the door to other pressing questions which remain unanswered. Indeed, as the Federal Supreme Court indicated, due to the absence of a valid contract the involved parties could assert claims for unjust enrichment against each other. Specifically, the company is enriched by the work performed by the chairman, while the chairman is enriched by the salary paid by the company. To the extent that these two claims are of equal value, they would be extinguished by set-off. This outcome would thus lead to a situation comparable to a de facto contract.

However, the same would not be true if the chairman’s work were to be considered a case of “forced enrichment” (“aufgedrängte Bereicherung”, cf. Hahn Anne-Catherine, in Furrer Andreas/Schnyder Anton K., Handkommentar zum Schweizer Privatrecht, Zurich 2016, Art. 64 SCO N 8). Since the company could not validly accept the work performed due to the lack of quorum of its board of directors, this work was in a way “forced” on the company. If this analysis were to be retained, the chairman alone would be deemed enriched, and therefore only he would be required to return the salary received. Conversely, the company would not be required to compensate him, or, if so, only according to the rules of business management. Then, could the chairman possibly assert a salary claim on the basis of an agency without authority relationship under Art. 419 et seq. SCO? It is difficult to answer this question without knowing the precise circumstances surrounding the chairman’s work. Moreover, the very possibility to assert such a claim under agency principles is a matter for debate among legal scholars (cf. Héritier Lachat Anne/Chappuis Christine, in Thévenoz Luc/Werro Franz, Commentaire romand du Code des obligations I, Basel 2021, Art. 422 SCO N 17).

One key consideration remains: is it fair for a person who has worked, knowing that the employment agreement is null and void, to not be entitled to remuneration? A negative answer does not seem to be reconcilable with the system of the law of obligations. Either a person has provided a service to another and the latter is thereby enriched, whether the contract is null or valid, or the person has caused damage to another and must be liable under the rules of tort. Derogations from this fundamental principle should only be admitted to a limited extent.

The Federal Supreme Court seems – at least in an intuitive sense – to agree with the above reasoning, since it felt obliged to specify that in the case at hand the rules on unjust enrichment were not invoked by the chairman and that “financial benefits” had nevertheless been paid to him in exchange for his activity, which justifies, to a certain extent, not awarding him any additional amount. Such considerations could be interpreted as an implicit recognition of the status quo.

---

[1] See in particular Article 17 of the company’s articles of association: “Composition […] The board of directors of the company shall consist of three or more members”.

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 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