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 5 August 2020
Case Reference : 4A_221/2020

Facts

Two companies (A. AG in Switzerland and B. Inc. in Seychelles) entered into an agreement in 2006 wherein A. AG borrowed approx. EUR 4,000,000. The loan was to be repaid on 31 December 2016 with interest payments accruing annually from 31 December 2008. The interest rate was 3.5% per annum with an additional 2% interest rate applied to sums in arrears. A. AG failed to make timely interest payments, leading B. Inc. to terminate the loan agreement in March 2016 and initiate debt collection proceedings in Switzerland.

Meanwhile, B. Inc. borrowed USD 15,000,000 from I. & Co., a Scottish company. The contract could be terminated at any time by giving three months’ written notice. In 2017, I. & Co assigned part of its claim (USD 6,000,000) against B. Inc. to A. AG. The latter did not terminate the agreement or claim repayment of the monies. Ultimately, I. & Co. was the only party to file a declaration of termination, which it did nearly two years after assigning its claim to A. AG.

This situation can be graphically represented as follows:

During the debt collection proceedings, A. AG declared that it had offset its debt to B. Inc. with the assigned claim. However, both the court of first instance and the court of appeal (the Cantonal Court of Zug) rejected this argument by holding that A. AG had not terminated the assigned loan agreement and that, as a result, the claim had not become due and could not be used to offset the debt.

A. AG. appealed the decision of the Cantonal Court before the Federal Supreme Court.

Issue

The Federal Supreme Court was called upon to decide whether I. & Co.’s termination and A. AG’s set-off declarations were sufficient to settle B. Inc.’s claim by way of set-off.

Decision

AG challenged the decision of the Cantonal Court on three distinct grounds.

1. AG first claimed that the declaration of termination made by I. & Co. was valid and opposable to B. Inc. Even if I. & Co. was not the owner of the claim against B. Inc., it could be implied from the circumstances that I. & Co. was acting as a representative of A. AG., as evidenced in the wording of the termination letter where I. & Co. claimed “the repayment of any sums paid under such agreement”. However, according to the Federal Supreme Court, mere awareness of the assignment was insufficient to consider that B. Inc. should have implied an agency relationship or a termination of the assigned part of the loan.

2. AG further contended that the set-off declaration implicitly terminated the loan agreement. The Federal Supreme Court rejected this view, as the contract required terminations to be drafted in a specific form (“[…] executed in writing and sent by facsimile and hand delivered […]”). These requirements were not met in the case at hand and, indeed, could not be met in case of an “implicit” termination given that – by definition – such termination would not have any form. As the termination was not effective and the claim was not due, the set-off declaration was not valid.

3. Finally, A. AG alleged that the three months’ written notice only applied for the full amount of the loan (USD 15,000,000), and not for a partial loan such as the one in the case at hand. The Federal Supreme Court dismissed this argument with reference to the relevant clause, which stated that “The Loan shall be repaid by the Borrower in full or in part at any time upon receipt of at least three months’ notice from the Lender” (emphasis added). In any case, immediate termination would not have been possible as, under Art. 318 of the Swiss Code of Obligations (SCO) and absent any provision to the contrary, a loan must be repaid within six weeks of the first request by the lender, and is not discharged immediately (Art. 75 SCO).

In conclusion, the Federal Supreme Court dismissed the appeal and affirmed the decision of the Cantonal Court.

Key takeaway

Any party relying on a declaration should ensure that the declarant had ownership of the claim or was a representative of the owner, and that the contractual requirements – if any – are met.

Comments

Swiss law is fairly liberal regarding the form of declarations between parties to an agreement. It rarely requires a specific form for the conclusion or termination of a contract (Art. 11 para. 1 SCO) and routinely accepts that implied expressions of intent may lead to the conclusion of a contract (Art. 1 para. 2 SCO). This is viewed as a means to encourage business and prevent the validity of a contract from being too easily disputed.

However, these general rules cannot be relied upon too heavily, as there is no certainty as to which interpretation the courts will make, and because it takes place months, if not years, later. In case of doubt – such as in the case at hand – confirming the declaration and making sure it meets the contractual requirements in order to ensure the effectiveness of the termination is an easy fix.

Other sources discussing the case

IusNet Droit Bancaire, Cas de la semaine n°48/2020 : remboursement d’un prêt par compensation de créance