Judgment of the Federal Supreme Court of 5 November 2024
Case Reference : 4A_379/2024

Facts

Albert (the “Plaintiff”) founded C. AG (the “Employer”), which employed Benoît (the “Defendant”). In 2018, the Plaintiff, the Defendant as well as Ernest, Fabienne and Gaston (the “Other Shareholders”) incorporated D. AG (the “Company”). Upon incorporation, the shareholders entered into a shareholders’ agreement (the “SHA”).

The SHA contained, among others, the following provisions:

• Right of first refusal (Section 3.2 of the SHA): if a shareholder intends to transfer its shares in the Company to another shareholder or a third party, the transferring shareholder must first offer them for sale to the other shareholders in writing. The non-transferring shareholders may exercise their right of first refusal within 50 days of receiving written notice, but only with respect to all the shares intended for transfer.
• Obligation to sell (Section 3.4.3 lit. d of the SHA): if the Employer terminates the employment of a shareholder of the Company, the terminated shareholder is obliged to sell their shares in the Company, with Section 3.2 of the SHA applying mutatis mutandis, granting the other shareholders a right of first refusal.
• Liquidated damages (Section 6 of the SHA): In case of breach of the SHA by a party, the other parties may claim liquidated damages in the amount of CHF 50,000.

On September 3, 2019, the Plaintiff and Gaston, acting on behalf of the Employer, terminated the Defendant’s employment contract. On September 26, 2019, Gaston informed the Defendant that the Other Shareholders wished to acquire all of his shares in the Company for CHF 55,000. The following day, Gaston reiterated this by email, copying the Plaintiff. However, no sale was concluded at that time. On January 26, 2021, the Other Shareholders once again requested that the Defendant sell his shares. The transaction was completed on February 4, 2021 for a total of CHF 52,250.

On March 21, 2021, the Plaintiff accused the Defendant of breaching his notification obligation under Section 3.2 of the SHA and demanded payment of the contractual penalty of CHF 50,000 stipulated under Section 6 of the SHA. The Defendant refused to pay.

On May 17, 2021, the Plaintiff filed a claim before the First Instance Court of Zurich, requesting that the Defendant be ordered to pay him CHF 50,000 under Section 6 of the SHA. The First Instance Court dismissed the claim. The Plaintiff appealed to the Zurich Cantonal Court, which also rejected his claim.

He subsequently appealed to the Federal Supreme Court.

Issue

The Federal Supreme Court was asked to determine whether the Defendant was obliged to formally offer his shares for purchase to the Plaintiff following the termination of his employment contract.

Decision

The Federal Supreme Court upheld the Cantonal court’s judgment and rejected the Plaintiff’s appeal.

First, the Federal Supreme Court made a distinction between a right of first refusal and a pre-emption right. A pre-emption right grants its beneficiary the right to acquire ownership of an asset through a unilateral and unconditional declaration, provided the person bound by the pre-emption right sells the asset to a third party. A purchase agreement is entered into when the beneficiary exercises its right. Conversely a right of first refusal only creates an obligation to offer the shares to the beneficiaries of such a right before selling it elsewhere.

The Federal Supreme Court then elaborated on how a right of first refusal is generally applied. The right of first refusal typically arises when the offeror decides to sell its shares. Since the intention to sell is a private, mental act, the offeror must notify the beneficiaries of its intention to sell. If such notification is omitted and the beneficiaries are unaware of the event triggering a right of first refusal, the offeror may be held liable for breaching its notification obligation.

However, the parties to a share purchase agreement do not have to link the event triggering the right of first refusal exclusively to the intention to sell. On the contrary, they can determine that the right of first refusal will be triggered by other events, such as external factors. The occurrence of the right of first refusal, which only triggers the obligation of the offeror to notify the beneficiaries, must be distinguished from the actual sale of the shares, which typically occurs when the beneficiary accepts the offer.

In the case at hand, the Federal Supreme Court acknowledged that the SHA contained a right of first refusal under Section 3.2, as well as an obligation to sell under Section 3.4.3 lit. d. The obligation to sell was triggered by the termination of the Defendant’s employment contract, which in turn triggered the purchase right of the other shareholders. The Federal Supreme Court found that the reference contained in Section 3.4.3 lit. d of the SHA to Section 3.2 of the SHA related solely to the modalities for exercising the right of first refusal, and not the intention to sell.

In this case, the right of first refusal was triggered by an external event – namely, the termination of the Defendant’s employment contract – with the Plaintiff himself (together with Gaston) having signed the termination letter. The Plaintiff thus personally triggered the obligation to sell, and consequently the right of first refusal of the remaining shareholders, and cannot claim to have been unaware of the resulting obligation for the Defendant to offer his shares. The Defendant would only have been liable for failing to notify if the beneficiary had otherwise been unaware of the event triggering the right. The Plaintiff, however, was unable to demonstrate any advantage he would have gained from being formally notified of a fact already known to him.

In light of these considerations, the Federal Supreme Court upheld the Cantonal court’s judgment and confirmed that the Defendant was not liable for breach of the notification obligation under Section 3.2 of the SHA.

Key takeaways

In the case at hand, the Federal Supreme Court substantially considered that a shareholder was not liable for liquidated damages despite failing to satisfy his duty to inform the other shareholders of the occurrence of a purchase option. This is due to the fact that the claimant shareholder was unable to demonstrate that he would have gained any advantage from having received such notification.

Comments

The solution reached by the Federal Supreme Court in this decision is convincing: the right of first refusal is not exercised in a vacuum but must be understood within the context of a particular case. While it is generally true that, as a rule, a shareholder’s decision to sell its shares may not be obvious to the other shareholders, this is different when the other shareholders have expressly provided for specific events that entail an obligation to sell. In such cases, since the share sale is tied to a predetermined event, the other shareholders are able to exercise their right of first refusal without the need for a formal notification from the selling shareholder.

The pragmatic approach adopted by the Federal Supreme Court in the case at hand prevents the claimant from demanding payment of liquidated damages solely on the basis of a formal breach, without showing any actual disadvantage. Ultimately, this decision reflects the principle of good faith: a shareholder who deliberately refrains from exercising their right of first refusal, while already aware of the triggering event, cannot later claim they were prevented from exercising said right due to purely formal reasons.

This case highlights the risks associated with internal cross-references in contractual clauses. Although the solution reached by the courts could have also been reached by the parties through straightforward contractual interpretation, it is advisable to draft such cross-references with maximum clarity and precision in order to avoid disputes of this kind. , to avoid any potential disputes it would be preferable to draft such cross-references as carefully and precisely as possible.

Other sources presenting the case

Schmidlin Adrian, Vorhand- und Vorkaufsrecht in einem Aktionärsbindungsvertrag, in legalis brief 2024 Gesellschaftsrecht 16.12.2024.

Judgment of the Federal Supreme Court of 24 September 2024

Case Reference : 4A_202/2024, 4A_212/2024

Facts

B. (the “Plaintiff”) is a company specializing in human resources, management, strategy and planning. It operates under multiple brands, including “Construction21”.

On December 11, 2020, the Plaintiff and A. (the “Defendant”), Chairman of the Board of Directors of the newly founded Arkadium company, together (the “Parties”), jointly notified the clients of Construction21 that Arkadium would assume responsibility for all employees and ongoing recruitment processes previously managed by Construction21.

A week later, on December 18, 2020, the Parties entered into a share purchase agreement that included a non-competition clause. This clause prohibited the Defendant and all affiliated entities from using the name components “Prime”, “GetTemp”, “Construction”, “Care” and “21” to compete with the Plaintiff. A contractual penalty of CHF 100,000. per breach was stipulated.

On January 11, 2021, the Defendant sent a letter to all Construction21’s experts (workers that are to be placed in construction industry companies) informing them that Arkadium had taken over Construction21’s operational activities as well as all current employment contracts. The letter featured “CONSTRUCTION21” logo in the header and included the Plaintiff’s name next to the defendant’s signature.

Claiming this communication violated the non-competition clause, the Plaintiff filed a claim in the Court of first instance seeking CHF 100,000 as a penalty. The initial claim was dismissed. However, on appeal, the Cantonal Court partially granted the Plaintiff’s claim and awarded CHF 10,000. Both Parties appealed to the Federal Supreme Court: the Defendant sought either complete dismissal or a reduction to CHF 1,000, while the Plaintiff sought full payment of the CHF 100,000.

Issue

Two issues had to be addressed by the Federal Supreme Court:

1. Whether the Defendant’s letter to the experts constitutes a breach of the non-competition clause; and
2. If so, what were the legal consequences of said breach.

Decision

The Federal Supreme Court found the language in the Defendant’s letter , specifically its reference to a “retroactive takeover of Construction21’s operational business”[1] problematic regarding the non-competition clause. The earlier letter to clients mentioned a “retroactive takeover of placement processes of Construction21 candidates”,[2] and there was no legitimate reason to change that phrasing in the second letter regardless of the fact that the two statements are equally correct.

The Federal Supreme Court interpreted the wording change as an attempt by the Defendant and Arkadium to distance themselves distinguish themselves from both the Plaintiff and Construction21, thereby violating the non-competition clause. Mentioning the takeover of Construction21’s business twice in the letter was unnecessary, and it would have been enough to simply inform the candidates that they would now need to contact Arkadium due to organizational changes. In that context, the Defendant was also not allowed to use the “CONSTRUCTION21” logo in the letterhead or to place the name of the Plaintiff below his signature.

A further breach of the non-competition clause was found in the letter, when Arkadium stated that “as a leading headhunter in the construction & property sector, [Arkadium] acts as a source of information for the experts” and “Arkadium specializes in the construction and property sector and focuses exclusively on the following sectors: architecture, civil engineering, construction logistics, building services engineering, energy sector, property, asset and real estate management, lean construction and digitalization”. Both these statements were clearly advertisement (the Defendant did not deny it) and using them alongside the Construction21 trademark only shed more light on the breach of the non-competition clause.

The Federal Supreme Court then had to analyze the consequences of said breach. Under Swiss law, and according to art. 163 paras. 1 and 3 of the Swiss Code of Obligations (SCO), parties may freely stipulate the amount of a penalty, however, the courts are authorized to reduce it if it is manifestly excessive. Importantly, the penalty remains payable even if no if no financial loss has occurred (art. 161 para. 1 SCO). If the judge considers that a reduction is necessary, restraint must be shown as to not infringe too much on contractual freedom. Such a reduction is justified in particular if there is a blatant disproportion between the amount agreed upon and the loss suffered from the contractual breach.

Such a blatant disproportion existed in the case at hand, according to the Federal Supreme Court. It considered the violations of the non-competition clause to be extremely minor, and took into account the fact that the Plaintiff did not suffer any quantifiable loss from them. On that basis, it upheld the lower court’s decision to reduce the penalty from CHF 100,000 to CHF 10,000.

Key Takeaway

Interpretation and scope of the non-competition clause in a share purchase agreement

Art. 18 para. 1 SCO establishes that the contract must be interpreted according to the real and common intention of the parties rather than being limited to the wording used. This principle, which is essential in contract law, can be broken down into two stages: subjective interpretation and objective interpretation.

Application and reduction of the penalty clause (art. 163 SCO)

While penalty clauses are permitted, art. 163 para. 3 SCO allows the court to reduce an excessive penalty clause when there is a clear imbalance between the agreed sum and the actual harm.

When a court reduces a penalty clause, restraint is required in order to respect the principle of contractual fidelity and freedom of contract (art. 163 para. 1 SCO).

In this judgment, the Federal Supreme Court upheld the reduction of the penalty clause.

Comment

The Federal Supreme Court’s decisions 4A_202/2024, 4A_212/2024 concern a non-competition clause contained in a share purchase agreement concluded between two companies.

The parties were bound by a contract (business-to-business contract). They never challenged its conclusion (art. 1 seq. SCO) or its validity (art. 11 seq. of the Swiss Civil Code (SCC), arts. 11-16 SCO, arts. 19-20 SCO, art. 21 and arts. 23-24 SCO). Instead, the parties were disputing the interpretation and enforcement of a specific contractual clause and the proportionality of the associated penalties.

The primary issue was whether the defendant had actually breached the non-competition clause in the contract.

In addition, the contract contained a penalty clause applicable in case of such a breach, which could be reduced if the amount was deemed excessive. While the Federal Supreme Court confirmed that the clause had been breached, it ruled that the contractual penalty was excessive and upheld its reduction under art. 163 para. 3 CO.

This commentary will analyze three core themes:

1. Freedom of contract and the general principles of contract law (arts. 19 and 20 SCO).
2. Contractual interpretation and the will of the parties (art. 18 para. 1 SCO).
3. The application and judicial reduction of the penalty clause (art. 163 paras. 1 and 3 SCO).

1. General principles of contract law: freedom of contract

A. Foundations and scope of freedom of contract

Although this Federal Supreme Court’s decision does not call into question the validity of the contractual clause, it is nonetheless important to recall the legal framework that such a clause must respect before analyzing its scope.

The fundamental principle of Swiss contract law is based on freedom of contract, enshrined in art. 19 para. 1 SCO, which allows the parties to freely determine whether or not to enter into a contract, with whom, and under what terms and conditions. This principle is a corollary of respect for private autonomy, which is supported in several constitutional and legal guarantees.[3]

While freedom of contract is a fundamental principle, it is not absolute. Art. 19 para. 2 SCO imposes general restrictions, specifying that contractual clauses must not be unlawful, immoral or contrary to public policy. Furthermore, Art. 20 para. 1 SCO provides for the nullity of contracts that relate to an impossible, illicit or immoral object.

However, additional limitations may apply to specific contracts. For example, art. 340 et seq. SCO imposes strict limitations on non-competition clauses included in an employment contract, particularly with regard to their duration, geographical and material scope, in order to protect the employee’s economic freedom.

B. Application to non-competition clauses in a share purchase agreement

Non-competition clauses in share purchase agreements are not governed by any specific provision of the SCO and are subject to the general principles of the law of obligations. Unlike non-competition clauses in an employment contract (art. 340 et seq. SCO), they are assessed exclusively according to arts. 19 and 20 SCO.

The main question put to the Federal Supreme Court here concerns the interpretation of the scope of the non-competition clause and enforceability of the agreed sanction.

Accordingly, the Federal Supreme Court’s analysis initially focused on the contractual interpretation of the non-competition clause in order to determine its scope (art. 18 SCO) and whether the alleged conduct constituted a breach .

2. Contractual interpretation and the intention of the parties

A. Interpretation of the contract

Art. 18 para. 1 SCO establishes that the interpretation of a contract must be done according to the true and common intent of the parties rather than merely limiting it to the wording used. This principle, which is essential in contract law, can be broken down into two stages:

1. Subjective interpretation: The court seeks to establish the true and common intent of the parties by relying on contextual elements such as previous negotiations or the parties’ post-contractual behavior (ATF 144 III 93, para. 5.2.2).
2. Objective interpretation: If the parties’ common will cannot be ascertained, the court must resort to normative (or objective) interpretation, i.e. seek out their presumed will by determining the meaning that, according to the rules of good faith, each of them could and should reasonably attribute to the declarations of will of the other. This is an interpretation in accordance with the principle of trust, itself deduced from art. 2 para. 1 CC. The determination of the objective will of the parties, according to the principle of trust, is a question of law, which the Federal Supreme Court examines freely; to decide it, however, it is necessary to base oneself on the content of the expressions of will and on the circumstances, which are a matter of fact (ATF 144 III 93, para. 5.2.3).

B. Interpretation means and maxims

When interpreting a clause, the court uses various means of interpretation. The text of the contractual clause is the primary means of interpretation (ATF 148 III 57, para. 2.2.1). However, others include but are not limited to contextual (ATF 148 V 70, para. 5.1.1), historical (ATF 77 II 154 para. 4), teleological (ATF 144 V 84 para. 6.2.1), commercial usages (ATF 132 III 460, para. 4.3).

With regard to maxims of interpretation, some legal authors, with whom we agree, consider that the wording of a clause does not take precedence over other means of interpretation.[4] Consequently, the wording of the disputed clause is merely an indication of the parties’ intentions, in the same way as the other means of interpretation. For the Federal Court, this lack of primacy of the text applies both to subjective interpretation (4A_290/2017, para. 5.4) and to objective interpretation (4C.94/2000, para. 2c).

In this decision, the Federal Supreme Court largely relied on the literal wording of the non-competition clause in order to determine its scope. On this basis, it found that the defendant had breached the non-competition clause (4A_202/2024, 4A_212/2024, paras. 4.2.1 – 4.2.5).

As one might expect, this practice is not necessarily contrary to the practice of the Federal Court, in its ATF 136 III 186 para. 3.2.1, the Federal Supreme Court points out that ‘there is no reason, however, to depart from the literal meaning of the text adopted by the parties when there is no serious reason to believe that it does not correspond to their wishes.’[5] Furthermore, although the Federal Supreme Court does not express this directly in its ruling, the weight of the contractual clause may be reinforced by the fact that the contracting parties are professionals (business-to-business contract).

3. Application and reduction of the penalty clause (art. 163 SCO)

A. Nature and function of the penalty clause

The parties are free to determine the amount of the penalty clause. However, if said amount is found to be excessive, the court may reduce it as it sees fit (art. 163 paras. 1 and 3 SCO). The penalty is due even if the creditor suffered no actual damage (art. 161 para. 1 SCO).

A penalty clause is an accessory contractual undertaking that sanctions the non-performance or breach of an obligation.[6]

It fulfils two functions:

1. Repressive: It deters the obligated party from breaching its contractual obligation; and
2. Compensatory, restorative: It compensates for the loss suffered in the event of a breach without the creditor needing to prove any damage.

In the case under review, the penalty clause served to guarantee the effectiveness of the non-competition clause by imposing a financial penalty in the event of a breach.

Excessive penalty clauses must be reduced by the courts. However, this does not mean that the court must intervene ex officio. The burden of proof lies with the debtor, who bears the consequences of failing to allege the conditions justifying a reduction, and of failing to prove them. However, the allegation need not be formulated in a particularly rigorous manner. The debtor need not explicitly request a reduction in the contractual penalty: it is sufficient for him/her to conclude, by way of exception, that the action has been dismissed in its entirety and to invoke facts, whether established or contested, that justify a reduction. The creditor may be required to indicate their loss and to contest with supporting reasons the allegation that the loss is non-existent or insignificant; they are not, however, required to prove their interest with supporting figures.[7]

B. Legal grounds for judicial reduction of excessive penalties

Art. 163 para. 3 SCO allows the court to reduce an excessive penalty clause if it clearly exceeds the damage suffered.

When a court reduces a penalty clause, restraint is required in order to respect the principle of contractual fidelity and freedom of contract (art. 163 para. 1 SCO). Judicial intervention in the contract is only justified where the agreed penalty exceeds the reasonable threshold compatible with law and equity (ATF 133 III 201, para. 5.2 ; ATF 133 III 43, para. 3.3.1).

A reduction in the penalty clause is particularly justified where there is a clear disproportion between the agreed amount and the creditor’s interest at the time of the breach of contract. This assessment must be based on the specific circumstances of each individual case.

Factors to be taken into account include: the nature and duration of the contract; the seriousness of the fault and breach of contract; the creditor’s interest in compliance with the clause; and the economic situation of the parties, particularly that of the debtor of the obligation.

Other relevant factors include any dependencies arising from the contractual relationship and the commercial experience of the parties. A reduction is more easily justified when an economically weaker party is involved, rather than in a contract concluded between partners of equal economic strength and experience in business (ATF 133 III 201, para. 5.2 ; ATF 133 III 43, para. 3.3.2)

In this judgment, the Federal Supreme Court upheld the reduction of the penalty clause for several reasons:

• The minor nature of the breach;
• The absence of proven or potential damage;
• The previous court had already reduced the penalty clause to CHF 10,000 on the grounds that the initial amount was disproportionate.

The Federal Supreme Court upheld this reduction, considering that this sum constituted an adequate penalty that is both proportionate and dissuasive.

This ruling illustrates the rigorous approach of the Federal Supreme Court to apply the principles of contractual interpretation in commercial matters, as well as its measured use of judicial discretion in reducing penalty clauses. It underscores the importance of contractual clarity in a business-to-business context and shows that the Swiss courts will intervene sparingly to modify a penalty clause, except in cases of manifest disproportion.

[1] The letter reads as follow in the original German version: “Rückwirkenden Übernahme des operativen Geschäfts der Construction21”.

[2] The letter reads as follow in the original German version: “Rückwirkende Übernahme Vermittlungsprozesse von Kandidaten der Construction21”.

[3] Guillod Olivier/Steffen Gabrielle, art. 19-20, no. 1-5, in: Thévenoz Luc/Werro Franz (éd.), Commentaire romand du Code des obligations I, 3 éd., Bâle (Helbing Lichtenhahn) 2021, (hereinafter: CR-CO-I-Auteur).

[4] D. Oppliger, Interprétation contractuelle – Poids du texte du contrat et clause d’intégralité, in Aktuelle Juristische Praxis – Pratique Juridique Actuelle (AJP/PJA), 2022, p. 1054 ss.

[5] In French : « Il n’y a cependant pas lieu de s’écarter du sens littéral du texte adopté par les intéressés lorsqu’il n’existe aucune raison sérieuse de penser qu’il ne correspond pas à leur volonté » (ATF 136 III 186 para. 3.2.1).

[6] CR-CO-I-Mooser, art. 163, no. 4.

[7] CR-CO-I-Mooser, art. 163, no. 6.

Judgment of the Federal Supreme Court of 22 June 2023

Case reference : 4A_25/2023

Facts

Albert (the “Plaintiff”), Benoît, Christian and Denis (together, the three “Defendants”) are the four sons of Ernest and Fabienne.^[1] The latter were also the owners of two family businesses, B. AG (the “Company”) and C. AG (the “Second Company”). When Ernest and Fabienne divorced, Fabienne took over the shares of the Company, while Ernest took over a large majority of the shares of the Second Company.

In 2011, the four sons and their parents entered into a publicly notarized agreement governing the succession of their family businesses (the “Agreement”). Under the Agreement, (i) Ernest transferred his shares in the Second Company equally amongst his sons; (ii) Fabienne donated her shares in the Company equally amongst her sons, subject to a right of usufruct in her favor; and (iii) if a shareholder intended to sell his shares, those shares must first be offered to the remaining shareholders (brothers) at a preferential price (the “Option Right”). The relevant clause read as follows: “The current bearer shares [of the Company] are to be converted into nominal shares with restricted transferability. The shares are to be restricted in the sense that, in the event of a planned sale, they must be offered for purchase to the remaining shareholders and must also be taken up by them (call and put option). The price to be paid per share in this respect shall be determined on the basis of a valuation report to be prepared by E. […]; it [the price] shall amount to 75% of the value calculated by E. The shares are to be taken over by the remaining shareholders equally. Should one of the remaining shareholders not be willing to make such an acquisition, the other shareholders shall each have the right to acquire his portion equally. Should none of the remaining shareholders be willing to purchase, the shares shall be offered for sale to [Fabienne] – and, should the latter not buy – to [Ernest] on the basis of 75% of the value determined by E. Should he also not wish to buy, the remaining shareholders are obliged to take over the offered shares equally on the basis of 75% of the value determined by E.”^[2]

In 2018, the Plaintiff granted D. SA (the “Third Company”), which was owned by his father Ernest at the time, an irrevocable emption right over the Company shares that had been donated to him under the Agreement. Thereupon, in accordance with the Agreement, the Defendants communicated to the Plaintiff that they wish to exercise the Option Right over his Company shares equally. To that effect, Fabienne handed the shares of the Company that she had previously donated to the Plaintiff (the “Litigated Shares”) over to the Defendants.

In 2019, the Plaintiff filed a claim before the First Instance Court of Zurich, where he essentially requested the court to (i) order the Defendants to return the Litigated Shares back to him, and (ii) acknowledge his ownership of the Litigated Shares. The Defendants sought to dismiss the claim and filed a counterclaim demanding the Plaintiff’s consent to transfer the Litigated Shares. The First Instance Court found that the Plaintiff was indeed the owner of the Company shares, but it obliged him (in accordance with the Defendants’ counterclaim) to give his consent to transfer the shares to the Defendants.

The Plaintiff filed an appeal against this decision to the Zurich Court of Appeal; the Defendants filed a cross-appeal. In its judgment, the Court of Appeal upheld the cross-appeal and affirmed that the Defendants had validly acquired the Litigated Shares upon exercising their Option Right. Therefore, the Plaintiff was no longer the owner of the Litigated Shares.

The Plaintiff challenged this ruling before the Federal Supreme Court.

Issue

In its ruling, the Federal Supreme Court analyzed a variety of legal issues, which can be grouped into two categories: (i) those relating to the interpretation of the Agreement; and (ii) those relating to the transfer of ownership of the Company’s shares.

With regard to the first category, the Federal Court had to determine whether: (i) the Option Right provided for in the Agreement was legally binding; (ii) the Option Right actually constituted an emption right and not a right of first offer; and (iii) a case of “planned sale” which would trigger the Option Right had actually occurred. With regard to the second category of legal issues, the Federal Supreme Court had to determine whether (i) the transfer of movable property requires a “proprietary” contract; and (ii) a transfer of possession had actually taken place in this case.

Decision

The Federal Supreme Court confirmed the judgment of the Court of Appeal and thus rejected the appeal filed by the Plaintiff.

Turning first to the interpretation of the Agreement, the Federal Supreme Court confirmed the binding nature of the clause providing for the Option Right in favor of the brother-shareholders if one of them planned to sell his shares of the Company. The facts of the case showed that the parties intended this clause to be legally binding, and that all the essential points of the sale agreement triggered by the exercise of the Option Right had been agreed upon by the parties.

Secondly, the Federal Supreme Court confirmed that the disputed clause granted the other brother-shareholders a proper emption right, and not a mere right of first offer. Among other factors, the Federal Supreme Court noted that granting the Option Right in favor of the brother-shareholders better reflected the purpose of the Agreement, which was to ensure that the Company’s shares remained within the family. Indeed, exercising the emption right enabled the Defendants to immediately enter into a share purchase agreement with the Plaintiff, conferring on them a greater protection than a simple right of first offer.

Finally, the Federal Supreme Court confirmed that the grant of an emption right to the Third Company – at the time solely owned by Ernest – did indeed constitute a case of a “planned sale” which could trigger the Option Right within the meaning of the Agreement. Indeed, even if a “planned sale” can be interpreted more or less broadly, conferring an emption right on a third-party company already constitutes the beginning of the execution of a possible sale, and therefore a “planned sale”. If the parties intended the exercise of the Option Right by the other brother-shareholders to be conditional on the entry into a legally binding undertaking to sell the Company’s shares to third parties, they would have stated this expressly in their Agreement. In this regard, the Federal Supreme Court considered decisive the fact that the Plaintiff had fundamentally lost control over the Litigated Shares by granting an emption right to the Third Company – which was not controlled by the Plaintiff – even if the Plaintiff pleaded that this transaction was part of internal family-restricted operations.

With regard to the issue of proprietary rights over the Litigated Shares, the Federal Supreme Court first noted that the transfer of movable property presupposes a valid cause (a causa, generally a contract) and a transfer of possession (traditio). On the other hand, the requirement of a “proprietary” contract (“dinglicher Vertrag” or “contrat reel”, i.e. an agreement between the parties relating specifically to the transfer of ownership) is still subject to debate among legal scholars, even if such a requirement has been previously mentioned by the Federal Supreme Court in another case regarding a pledge agreement (see ATF 142 III 746). However, considering that the doctrinal debate about the necessity of a “proprietary” contract had no impact on the outcome of this case, the Federal Supreme Court declined to rule on this issue.

Finally, in order to decide whether or not the Plaintiff retained ownership of his shares of the Company, the Federal Supreme Court had to determine whether a transfer of possession of the Litigated Shares from the seller (i.e. the Plaintiff) to the acquirer (i.e. the Defendants) had indeed taken place.

According to Art. 922 para. 1 of the Swiss Civil Code (“SCC”), the transfer of possession may take place by delivery of the contractual goods to the purchaser. In this case, it was an undisputed fact that no physical delivery of the Litigated Shares had occurred, given that they remained under the control of Fabienne who held a right of usufruct over them. However, Art. 924 SCC provides for other means of transfer of possession without delivery of the goods (so-called substitutes to the transfer of possession). In particular, Art. 924 para. 1 SCC provides that possession can be acquired without transfer when a third party remains in possession of the goods by virtue of a special title (transfer by way of delegation of possession, “Besitzanweisung” or “délégation de possession”). In such a case, the transfer of possession results from a simple agreement between the parties. In this case, the Defendants had successfully argued before the Court of Appeal that by granting them the Option Right in the Agreement, the Plaintiff had also expressed his will to transfer the possession of the Litigated Shares to them if they exercised the Option Right. Therefore, when the Defendants exercised the Option Right, they also immediately acquired possession of the Litigated Shares by application of the principle of delegation of possession, which directly resulted from the clause providing for the Option Right in the Agreement.

The Plaintiff tried to argue that the Agreement did not contain any provision concerning the transfer of possession over the Litigated Shares, but the Federal Supreme Court indicated that his consent to the transfer of possession was implicit in the Agreement. Indeed, the Agreement did not indicate that the acquisition of the Litigated Shares was subject to any other condition. Moreover, a different interpretation of the Agreement whereby the Plaintiff would have to expressly consent to the transfer of possession after exercising  the Option Right would have enabled him to easily defeat the purpose of the Agreement and hinder the enforceability of the Option Right.

In light of all of these considerations, the Federal Supreme Court upheld the judgment handed down by the Court of Appeal and confirmed that the Defendants had indeed become the owners of the Litigated Shares.

Key takeaways

When parties enter into a contract which establishes a conditional option right to buy shares of a company, the parties must clearly define the conditions that can trigger the exercise of the option right as well as the steps to implement the valid transfer of the shares if the option right is exercised.

Comments

One of the challenges of shareholders’ agreements lies in implementing the transfer restrictions contractually agreed upon by the parties, in particular, call options. This judgment sheds some light on one of the tools available to shareholders to enhance the practical enforceability of such rights:  the transfer of possession of the shares without physical delivery.

As mentioned above, the Swiss Civil Code recognizes that one can transfer (physical) possession of a good by delivering it, but one can also transfer (virtual) possession of a good by a simple agreement between the parties involved. In the context of the transfer of shares represented in share certificates, this means that either (i) the transferor delivers the physical share certificates to the acquirer, or (ii) a third party previously holding the share certificates on behalf of the transferor agrees to hold such share certificates on behalf of the acquirer. While the first option requires an active step from the transferor, this is not necessarily the case for the second.

Implementing a transfer of shares simply by a virtual transfer of the possession over such shares can be advantageous for the acquirors of the shares, namely it makes it easier to carry out the transfer restrictions set out in the shareholders’ agreement, by limiting the involvement of the transferor, at the time when the option right is exercised, and by transferring the burden of litigation on the unsatisfied transferor.

That being said, such mechanism should not be seen as a “one-size-fits-all” model that addresses all of the challenges arising from transfer restrictions in a shareholders’ agreement. This mechanism raises various practical difficulties:

• First, having the shares incorporated in physical certificates (which is required for this mechanism to apply) is not practical and is becoming less and less common, in particular for companies with numerous shareholders. In this respect, shares are more generally represented as uncertificated securities or ledger-based securities. This limits the risk of share certificates being lost and the need to initiate the associated burdensome legal action in order to cancel the lost certificates and issue new ones.
• Second, identifying an appropriate third party to hold onto the share certificates may not always be as straightforward as was the case here (e. Fabienne kept the shares certificates). Indeed, while the third party was, in this case, the beneficiary of an usufruct over the shares (and a relative of the parties), this will not be the case in most situations. Accordingly, the parties will need to identify a third party they are all comfortable with and who would accept to act in such a capacity.
• Third, provided that a third party can be found, a third party acting as an escrow agent will likely request to enter into a standard escrow agreement, which will likely provide that, if the parties disagree on the release of the shares held in escrow, the escrow agent will only be obliged to release such shares upon a valid order of a court of competent jurisdiction. Accordingly, even if a call option is validly exercised, the escrow agent will not accept to release the shares to the acquirer unless and until a court orders it to do so.

These numerous challenges may thus bring the parties back to square one: difficulties in implementing the transfer restrictions set out in the shareholders’ agreement.

As a result, although the transfer of property of the shares on which the buy option has been exercised by simple (virtual) transfer of possession may appear to be, at first glance, the magical solution to ensure the enforceability of share option rights in shareholders’ agreements, it is not always necessarily the case.

Other sources presenting the case

Luca Bartolomei / Dario Galli / Markus Vischer, Rechtsgeschäftliche Eigentumsübertragung an Aktien ohne separates Verfügungsgeschäft?, in digitale Rechtsprechungs-Kommentar (dRSK), published on  January 23, 2024 (https://www.walderwyss.com/assets/content/publications/Rechtsgeschaeftliche-Eigentumsuebertragung-an-Aktien-ohne-separates-Verfuegungsgeschaeft.pdf)

[1] Fictional names were used for the purpose of clarity.

[2] The original German clause read “Die derzeitigen Inhaberaktien B. sollen in vinkulierte Namenaktien umgewandelt werden. Die Aktien sollen in dem Sinne vinkuliert sein, dass sie bei einem geplanten Verkauf den übrigen verbleibenden Aktionären zum Kauf angeboten und von diesen auch übernommen werden müssen (Call- und Put-Option). Der pro Aktie diesbezüglich zu bezahlende Preis bestimmt sich auf der Basis eines durch die E. auszuarbeitenden Bewertungsgutachtens, das nach analogen Grundsätzen erstellt wird, wie die in Nachachtung dieser Vereinbarung in Auftrag gegebene E.-Bewertung; er beträgt 75 % des durch die E. errechneten Wertes. Die Aktien sind durch die verbleibenden Aktionäre je zu gleichen Teilen zu übernehmen. Sollte einer der verbleibenden Aktionäre nicht zu einem solchen Erwerb bereit sein, so haben die übrigen verbleibenden Aktionäre je zu gleichen Teilen das Recht zum Erwerb dieser Quote. Sollte keiner der verbleibenden Aktionäre zum Erwerb bereit sein, so sind die zu verkaufenden Aktien vor einem Verkauf an Dritte auf der Basis von 75 % des durch E. ermittelten Wertes an F.A. – und, sollte diese nicht kaufen – an E.A. sen. zum Kauf anzubieten. Sollte auch er nicht kaufen wollen, so sind die verbleibenden Aktionäre verpflichtet, die angebotenen Aktien auf der Basis von 75 % des durch E. ermittelten Wertes zu gleichen Teilen zu übernehmen.”

Judgment of the Federal Supreme Court of 10 June 2022

Case reference : 4A_58/2022

Facts

On November 5, 2012, A (the “Seller”) and B (the “Buyer”) entered into a sale agreement (the “Agreement”), under which the Seller had sold its “online marketing” activities to the Buyer (asset deal). Under Article 2 of the Agreement, the purchase price consisted of a short-term cash payment and of subsequent payments in the form of sharing of revenues. The short-term cash payment amounted to CHF 25,000, payable by March 31, 2013. The subsequent revenue share payments would be based on the net operating income relating to the sold activities. The amount due to the Seller depended on the amount generated within the first semester of a year, the second semester of a year or the full year. The Agreement did not provide for the duration during which the Buyer would have to pay a share of its revenues to the Seller, but stipulated that the maximum purchase price would be CHF 100,000, after which the revenue share expired.

On March 29, 2019, the Seller filed a claim against the Buyer before the Commercial Court of the Canton of Zurich (the “Commercial Court”), requesting the payment of an amount of CHF 52,059.88 with interests, or, alternatively, that the Buyer be compelled to provide the Seller, inter alia, with information on the turnover generated by some clients relating to sold “online marketing” activities since January 1, 2013, so as to allow the Seller to calculate its claim towards the Buyer. The amount claimed corresponded to the difference between CHF 100,000 and the amount that had actually been paid to the Seller.

By partial judgment of December 21, 2021, the Commercial Court held that the purchase price under the Agreement was composed of a fixed portion, in the amount of CHF 25,000, and of a variable portion, which depended on the turnover generated by the sold activities (the “Earn-Out”), knowing that the Parties had not contractually defined the term of the obligation of payment of this variable portion of the purchase price. The Commercial Court consequently held that there was a gap in the Agreement. It filled it by holding that the period during which the obligation of the Buyer to share its revenue was two years after the consummation of the transaction, namely from January 1, 2013 to December 31, 2014 (the “Earn-Out Period”). The Commercial Court thus compelled the Buyer to provide the Seller with information and documents on the turnover generated by the Buyer with the relevant business during the Earn-Out Period only in relation to certain clients.

The Seller filed an appeal before the Federal Supreme Court requesting that the Buyer be compelled to provide information on the turnover generated by the relevant business since January 1, 2013, in relation to all clients. In addition, the Seller did not agree with the findings of the Commercial Court because it considered the purchase price of CHF 100,000.00 to not be variable and was thus due in any event. It further challenged the duration of the Earn-Out Period of two years (as determined by the Commercial Court).

Issue

The Federal Supreme Court had to answer three questions: first, did the Commercial Court correctly qualify the revenue share as a variable portion of the purchase price instead of a payment modality of a fixed purchase price; second, did the Commercial Court correctly hold that the Agreement contained a gap regarding the time limit for the obligation of the Buyer to share its revenue (earn-out) and that such gap had to be filled; third, did the Commercial Court correctly set the duration of the Earn-Out Period to two years?

Decision

The Federal Supreme Court first confirmed the qualification of the revenue sharing mechanism made by the Commercial Court as constituting a variable portion of the purchase price. The use of “revenue share”, in particular by opposition to “cash portion”, implies a variable component. Such interpretation is confirmed by the mention of a “maximum” purchase price, set at CHF 100,000. If the parties intended the revenue share to be a modality of payment of a fixed purchase price, they would have drafted the provision so as to provide that “the revenue share amounts to CHF 75,000 and will be paid as follows”. Finally, the complexity of the mechanism to calculate the amount due under the revenue share, together with the information rights relating to the calculation thereof, would be unlikely in a situation where the parties had simply agreed on a fixed purchase price of CHF 100,000 and where revenue sharing would only be a payment modality thereof.

The Federal Supreme Court then confirmed the ruling of the Commercial Court which qualified the absence of a time limit for the revenue share as a contractual gap that needed to be filled.

The Federal Supreme Court presented the legal principles applicable to the circumstances at hand. A contractual gap exists if the parties have not, or have not completely, regulated a legal question relating to the content of the contract. Whether such gap needs to be filled must be determined by a subjective (or empirical) interpretation and, if inconclusive, by an objective (or normative) interpretation (ATF 115 II 484, cons. 4a). If a gap must be filled, the court must determine, in the absence of applicable legal provision, what the parties would have agreed in good faith had they considered the unregulated point. In determining this hypothetical intent of the parties, the court must be guided by the thinking and actions of reasonable and honest contracting parties, as well as by the nature and purpose of the contract (ATF 133 III 421, cons. 4.1). The result of this normative activity is reviewed by the Federal Supreme Court freely, but with a certain restraint (ATF 127 III 300, cons. 6b), since filling a gap in a contract is generally within the discretion of the cantonal courts (ATF 129 III 380, cons. 2).

Applying these legal principles, the Federal Supreme Court held that a variable purchase price component presupposes a limitation in time of the Earn-Out Period. The Commercial Court correctly stated that the influence of the Seller on the success of the business would diminish over time and, conversely, the Buyer would not be inclined to share with the Seller earnings that are attributable to its own successful management of the business for an unlimited period of time.

On this basis, the Federal Supreme Court held that the Commercial Court rightfully limited the Earn-Out Period to a duration of two years. The Commercial Court defined the duration of two years for the Earn-Out Period by referencing various provisions of the Agreement: first, the non-compete undertaking binding the Seller had a duration of two years; second, the Buyer was authorized to use an identification name owned by the Seller for a duration of two years. The Federal Supreme Court then confirmed that the duration set by the Commercial Court was within the usual earn-out duration mentioned by Swiss legal scholars. Given that the Seller did not make any convincing arguments in order to justify that the Earn-Out Period should be longer than the two years duration set by the Commercial Court, the Federal Supreme Court confirmed the ruling of the lower court.

On this basis, the Federal Supreme Court rejected the appeal filed by the Seller.

Key takeaway

Why did the parties end up in front of the court? Because they had not specified the period during which the earn-out was to be calculated in the Agreement.

The key takeaway of this ruling is the importance for parties to set, in the transactional documentation, the key terms of the earn-out and, more specifically, the earn-out period. Agreeing upfront on the terms of the earn-out and reflecting them clearly in the contract is essential in M&A transactions where an earn-out mechanism is use, as this will allow the parties to reduce post-completion litigation risks and avoid uncertainties deriving from the perilous exercise of gap filling by the courts.

In addition, this ruling gives some useful insight on how the Federal Supreme Court approaches contract interpretation and supplementation of contractual gaps. While another high court may have kept a certain distance with regards to the contract and remained on a high level of legal debate, the Federal Supreme Court took a pragmatic and “hands-on” approach to determine the hypothetical intent of the parties much like the Commercial Court. In particular, the Federal Supreme Court ruled out the qualification of the Earn-Out as a simple modality of payment of a fixed purchase price on the basis that the parties would have expressly provided for this in the Agreement had they desired such a purchase price structure. In this context, the Federal Supreme Court even suggested how such clause may have been drafted (“the participation to the turnover amounts to CHF 75,000 and shall be paid as follows:“).

Comments

On paper, earn-outs are pricing mechanisms that are generally beneficial to both parties: a portion of the purchase price is contingent on the future success of the target and the payment thereof thus deferred in time. For the buyer, an earn-out is a way to partially reduce the risk and uncertainty inherent to valuation exercises, and to partially finance the purchase price through future profits of the business. For the seller, an earn-out is a way to (potentially) obtain a higher price than what the buyer would (or simply could) have paid upfront (Rudolf Tschäni/Hans-Jakob Diem/Matthias Wolf, M&A-Transaktionen, Zurich (Schulthess) 2021, pp.172-173; see also Urs Schenker, Unternehmenskauf, Bern (Stämpfli) 2016, p. 250-251).

However, do these theoretical benefits pass the test of reality? The answer is (unsurprisingly) one a lawyer would have: it depends.

For example, when a transaction involves a drug development company, it is standard to tie the payment of a portion of the purchase price to the achievement of future regulatory or commercial events. In this context, milestone payments can typically be triggered by the start of a clinical trial, the obtaining of marketing approval from regulatory authorities (US Food and Drug Administration or the European Medicines Agency), and the first sale of a product in a given market. In the drug development industry, an earn-out is generally mutually beneficial as it enables the parties to reduce the negative impact on valuation deriving from the uncertainty inherent to the drug development process.

That being said, there is one principle that is generally acknowledged by practitioners: earn-outs tend to end up in court or arbitration proceedings (Tschäni/Diem/Wolf, p. 173; Schenker, p. 250). First, because the parties cannot foresee the future and anticipate all potential issues in the contract. When an unforeseen event happens after completion, two parties with interests that are not necessarily aligned will have different views. Second, because as from completion, the buyer is in charge of the target and may have a strategy that diverges from that of the seller’s. For example, whereas the seller may have had a conservative investment strategy, the buyer may wish to invest heavily in business growth, thus reducing the profit it generates. In other situations, the seller would have only considered the profitability of the target, while the buyer may decide to optimize the profit at group level, which may adversely affect the profitability of the target (Schenker, pp. 250-251). Third, because the parties, often having diverging interests after completion, may simply not agree on how the contractual provisions relating to the earn-out are to be interpreted. For example, in 4A_56/2017, the parties did not agree on the manner in which the earn-out was to be calculated, as well as which financial elements relating to the target were to be taken into account to determine the amount of the earn-out.

This empirical findings seem to be corroborated by the case at hand, although the litigation related to the existence of an earn-out (which is generally not debated) and its duration, rather than whether the buyer prevented the earn-out from becoming due (which is often disputed) or how the earn-out must be calculated (which was debated in 4A_56/2017).

There is one point to take away from this finding and the case at hand: if the parties to an M&A transaction decide, for whatever reason, that the purchase price will be variable and depend on future events, they must aim to draft a contractual provision that is as complete as possible and, if possible, include an example of how the earn-out will be calculated. This will reduce post-completion litigation risks and help avoid uncertainties deriving from the perilous exercise of gap filling by the courts. In the end, it’s better to be safe than sorry: anticipate, discuss and clearly express the agreement (even if it may be obvious). These elements are key to a successful transaction.

Judgment of the Federal Supreme Court of 30 July 2020

Case reference : 4A_186/2020

Facts

The dispute concerned a share purchase agreement (the “SPA”) between Z (the “Seller”) and X. SA (the “Purchaser”) for shares of the company W. SA (the “Target Company”). At the time of the conclusion of the SPA on December 3, 2007, both parties were aware that the Target Company had an ongoing conflict with a former agent of the Target Company (the “Agent”) who had initiated court proceedings in which he claimed the payment of CHF 738,500 from W. SA. The risk of said dispute was reflected in Article 6 of the SPA as follows:

“In view of the potential procedural risk of the claim raised against [the Target Company] by [the Agent], the [S]eller shall undertake to secure this risk to the [P]urchaser by issuing of a first-rate bank guarantee of CHF 850,000, which shall be maintained until a final and enforceable judgment is rendered on the matter, but which shall be fully released by February 28, 2012 at the latest in any event and without any further condition.
In the event that [the Target Company] should lose in these proceedings, the said guarantee shall be released subject to the amount charged to W. SA”.^[1]

In execution of the SPA, the Purchaser paid the last installment of the sales price on July 30, 2008. The Parties signed a SPA closing protocol on the same day, by which they confirmed the obligation of the Seller to issue a bank guarantee. Upon instruction of the Seller, a bank issued a bank guarantee on the same day that was valid until February 28, 2012 (pursuant to Art. 6 of the SPA). The bank guarantee was released on that date.

The court proceedings initiated by the former Agent against the Target Company ended only on March 17, 2016 (i.e. over four years after the release of the bank guarantee). The Target Company was ordered to pay CHF 363,000 plus 5% interest as of September 30, 2001 and expenses amounting to CHF 39,000. On February 17, 2017, the Purchaser sued the Seller before the Court of First Instance claiming the payment of approximately CHF 880,000 on the grounds that the Seller had the contractual obligation to reimburse the costs of litigation with the Agent. The Court of First Instance rejected the Purchaser’s claim, which was later upheld by the Court of Appeal.

Issue

The Federal Supreme Court had to decide on the interpretation of Art. 6 of the SPA. In other words, it had to assess whether the Seller was no longer liable through the application of this contractual provision (which was the verdict reached by the Cantonal Courts). More specifically, the issue was whether Art. 6 of the SPA set a time limit for the liability of the Seller whereby the liability would expire when the bank guarantee was to be released (i.e. February 28, 2012).

Decision

The Federal Supreme Court was confronted with two vastly diverging interpretations of Art. 6 of the SPA. The Purchaser claimed that the Seller was obliged to reimburse him for any costs incurred in the proceedings against the former Agent without limit in time, and without being bound by the time limit for the release of the bank guarantee, which had to be released at the latest on February 28, 2012. The Purchaser claimed in this respect that the bank guarantee to be provided by the Seller was only intended to confirm the Seller’s ability to perform its obligation to reimburse the Purchaser until February 28, 2012. The Seller, on the other hand, claimed that Art. 6 of the SPA had to be interpreted as meaning that its sole obligation was to provide a bank guarantee until February 28, 2012, with no further obligation following the expiration date of the bank guarantee.

In its decision (reference ACJC/292/2020), the Court of Appeal (similarly to the Court of First Instance) came to the conclusion that the contract, in particular Art. 6 of the SPA, expressed the real and common intention of the parties pursuant to Art. 18 of the Swiss Code of Obligations (“SCO”). It reached this decision by taking into account the documents that the Parties had used during the negotiations that led to the SPA: the annexes to the SPA, a clause in the agreement stating that the SPA shall replace all previous written or oral agreements between the Parties, other sections of the SPA, the SPA closing protocol, as well as the expectations of the parties with regard to the likely outcome of the proceedings between the Target Company and the Agent.

In its decision, the Federal Supreme Court summarily confirmed the Court of Appeal’s judgment that Art. 6 of the SPA expressed the real and common intention of the parties (based on subjective contract interpretation which looks at facts) and that Art. 6 only required the Seller to provide a bank guarantee that was limited in time. The Federal Supreme Court further stated that the Purchaser had not pleaded that the Court of Appeal had applied the wrong method of interpretation and had simply used the appeal to reiterate its arguments from the proceedings before the Court of Appeal.

Key takeaway

This case constitutes an important reminder of the precision required when formulating guarantee provisions in share purchase agreements. In particular, parties (and their counsel) are strongly advised to clearly set out what shall be the term of the liability of the seller for any third-party litigation risks. In this case, the liability of the Seller was set out in such a way that it was interpreted to consist only in the issuance of a bank guarantee that was limited in time and to be released at the latest by a certain date, which was well before the litigation, whose risk was at the heart of the issue, had terminated.

The case further illustrates that whenever a lower court reaches the conclusion that a contract corresponds to the parties’ true and corresponding intent on the grounds of subjective interpretation, it is a question of fact and thus not a question of law. This means that the review by the Federal Supreme Court is extremely limited and that a reversal of a lower court judgment is highly unlikely.

Comments

Swiss contract law distinguishes between subjective and objective contract interpretation. According to this principle derived from Art. 18 SCO, a contract has to be interpreted primarily subjectively. This means that courts are held to give the contract the meaning that corresponds to the common inner will of the parties at the time the contract was concluded. Only where such common intent cannot be established, should Courts resort to interpret the contract objectively, i.e. determine how a reasonable party in the position of the parties to the contract could have understood the agreement. It is clearly established by the Federal Supreme Court’s caselaw that the question of whether or not the parties had a common inner will at the time the contract was concluded, is a question of fact that cannot be reviewed by the Federal Supreme Court except in cases of manifest error. In other words, the Federal Supreme Court can only review decisions where the Cantonal Courts have resorted to objective interpretation.

In this case, the Court of Appeal had applied a subjective interpretation and came to the conclusion that Art. 6.1 SPA corresponds to the “real common intention” of the parties. The Federal Supreme Court pointed out that the Purchaser had not criticized the “method of interpretation” applied by the Court of Appeal in principal, but merely reiterated its own prior arguments. This might be seen as a hint that the Federal Supreme Court would have potentially been willing to scrutinize the decision handed down by the Court of Appeal more thoroughly if the Purchaser had pleaded that the method of interpretation applied by said Court was misguided and that the contract should have been interpreted in an objective manner. In the case of an objective interpretation, there could have potentially been additional arguments made to challenge the decision of the Court of Appeal.

 Other sources presenting the case

Judith Rothen / Dario Galli / Markus Vischer, Leistungs- und Sicherungsversprechen in

Aktienkaufverträgen, in: dRSK, published on June 7, 2021, https://www.walderwyss.com/user_assets/publications/210607-Leistungs-und-Sicherungsversprechen-in-Aktienkaufvertragen.pdf

Christoph Brunner / Dario Galli / Markus Vischer, Die Rechtsprechung des Bundesgerichts zum Kaufvertragsrecht im Jahr 2020, in: Jusletter November 29, 2021

[1] In the French original text « Compte tenu du risque procédural potentiel présenté par la demande en paiement formée contre W. SA par M.U., le vendeur s’oblige à garantir ce risque envers l’acquéreur par la remise d’une garantie bancaire de premier ordre à hauteur de 850’000 fr. qui sera maintenue jusqu’à droit jugé de manière définitive et exécutoire, mais qui sera totalement libérée au plus tard le 28 février 2012, en tout état et sans autre condition. Dans l’hypothèse où W. SA succomberait dans cette procédure, ladite garantie serait libérée à due concurrence des montants mis à sa charge […].»

Judgment of the Federal Supreme Court of 14 October 2021

Case reference : 4A_92/2021

Facts

With a plan to relocate from Germany to Switzerland, A contacted B (the “Seller”), who is the sole manager and quotaholder of a Swiss limited liability company (LLC) offering tax services in Switzerland (the “Target”), to discuss the acquisition of the Target. On January 4, 2016, the Seller and a Swiss LLC, incorporated by A for the purpose of the transaction (the “Buyer”), entered into a share purchase agreement (the “SPA”), under which the Buyer acquired the Target’s entire quota capital for a price of EUR 480,000.00. The transaction was completed upon the execution of the SPA.

The parties entered into the SPA on the basis that the 2014 financial statements of the Target were the basis for the transaction and on the common understanding that the business volume for 2015 would develop substantially in the same way as in 2014. However, shortly after the closing, the Buyer became aware that the Target registered a loss of CHF 40,000.00 in 2015 compared to a net profit of CHF 65,000.00 in 2014, and that the Target’s turnover had dropped by 26% in 2015 compared to 2014.

Given the significant discrepancy between the 2014 and 2015 financial results, the Buyer served a notice to the Seller on August 9, 2016, in order to rescind the SPA with retroactive effect (among other claims). On May 31, 2017, the Buyer filed a claim against the Seller, requesting, inter alia, the reimbursement of the purchase price, against the retransfer of the Target’s shares. The Court of First Instance granted the Buyer’s request. The Seller filed an appeal, which was dismissed. The Seller then brought the case before the Federal Supreme Court.

Issue

The Federal Supreme Court had to determine whether the Buyer had acted under a fundamental error within the meaning of Art. 23 et seq. of the Swiss Code of Obligations (SCO) when it entered the SPA and was thus entitled to retroactively rescind the SPA.

Decision

The Federal Supreme Court first reminded the general conditions allowing a party to retroactively rescind a contract if it entered into an agreement acting under a fundamental error within the meaning of Art. 23 et seq. SCO. A contract is not binding upon a party which entered into it acting under a fundamental error (Art. 23 SCO). An error is fundamental, for example, if it “relates to specific facts which the party acting in error considered in good faith to be a necessary basis for the contract” (Art. 24 para. 1 no. 4 SCO). The facts at the origin of the error should also objectively appear, in view of, or according to the requirements of fair commercial dealings, as a necessary basis for the contract. This is the case of a false perception of a fact, which was, for both parties, consciously or not, and objectively, an essential condition for the conclusion of the contract.

The Federal Supreme Court further reminded that a party may not raise a fundamental error in breach of good faith (Art. 25 para. 1 SCO). This is the case, in particular, when the rescission of the agreement would result in an obvious imbalance of the interests of the parties. To assess whether the rescission resulted in an obvious imbalance of the parties’ interests, the Federal Supreme Court compared the consequences of the rescission of the agreement for each party. If the rescission entails only a limited advantage to the party invoking the fundamental error, but results in particularly negative consequences for the other party, invoking the fundamental error will be considered to be made in breach of good faith and will thus not be possible (ATF 132 III 737, cons. 3.1). Further, a party’s negligence in causing the error does not generally prevent it from raising the fundamental error and in rescinding the agreement. However, in such a case, the party has to indemnify its counterparty for damages resulting therefrom (Art. 26 para. 1 SCO). Nevertheless, if a party fails to clarify specific and obvious questions arising in the negotiations, the other party may in good faith assume that the party does not consider these unclarified facts as a necessary basis for the conclusion of the agreement. In such case, the party is prevented from raising a fundamental error with respect to the unclarified facts, because doing so would be contrary to the principle of good faith.

Applying these legal principles to the facts, the Federal Supreme Court first noted that the parties entered into the SPA on the common understanding that the Target’s financial situation in 2015 would be substantially similar to that of 2014. When executing the SPA, the Buyer thought that the Target’s financial situation in 2015 would be similar to that of 2014 and had no reason to believe this would not be the case. However, after the closing when the Buyer ultimately got access to the Target’s 2015 financial statements, it became aware of the Target’s actual financial situation: i.e. a loss of CHF 40,000.00 in 2015 compared to a net profit of CHF 65,000.00 in 2014, and a decrease of its turnover by 26% in 2015 compared to 2014. The Buyer however did not act negligently given that it had requested up to date financials for 2015, but was assured by the Seller that these were not yet available.

The Federal Supreme Court then deemed the profitability of a target in the year prior to a transaction as being objectively a decisive element for a prospective buyer. An average person would not have left its home and professional activity in Germany for a loss-making company in Switzerland.

The Federal Supreme Court further found that the retroactive rescission of the SPA by the Buyer had not resulted in an obvious imbalance of the interests of the parties. The Buyer would be paid back the purchase price. However, it would have to rebuild its professional activity after having spent four years managing the Target. On the other hand, the Seller would be reinstated as owner of the Target against reimbursement of the purchase price. The possible lower value of the Target would not change this balance of interests given that the Target was already making losses in 2015, and that the Seller had refused a quick and amicable reversal of the transaction by the Buyer in 2016 to avoid a subsequent litigation and any potential negative consequences thereof on the parties and the value of the business.

The Federal Supreme Court thus upheld the judgment handed down by the Court of First Instance, holding that the Buyer had the right to rescind the SPA on the grounds of a fundamental error within the meaning of Art. 23 et seq. SCO .

Key takeaway

This case constitutes an important reminder of how the principles of fundamental error under Art. 23 et seq. SCO can apply to M&A transactions with respect to an error about the financial health of the target company. As shown in this case, a buyer can rescind the SPA on the ground that the financial results of the target are below the legitimate expectations of the buyer.

Lessons learned: in order to avoid these types of disputes, the Buyer should have clarified more carefully and diligently the financial results achieved in 2015 and shouldn’t have relied on statements made by the Seller. The Buyer could have negotiated a system by which it would have adapted the purchase price depending on the actual financial results achieved in 2015.

In other circumstances, where the evolution of the target or its business activities in the (near) future is uncertain, the Buyer could negotiate a purchase price structured with a fixed component and a variable or conditional component. The fixed component is paid at the closing of the transaction and the variable or conditional component may be due at a later stage, depending on whether milestones specified in the SPA are met. This component can be fixed, meaning that a fixed amount is due if the milestone is met. It can also be flexible, meaning that the amount of the additional consideration will depend on the extent to which the milestone is met. The milestones can be set based on the financial performance of the target, or depend on the achievement of specific R&D, operational or commercial objectives (as this is common for transactions in the life sciences industry).

Comments

This ruling implicitly raises the question of whether the remedies provided for by the Swiss legal system offer satisfactory resolutions to M&A disputes. Here, the issue was whether a retroactive rescission of the SPA, half a decade after its execution, was a satisfactory outcome for the parties. In the case at hand, it might be satisfactory. That said, in most circumstances, it probably is not. On the one hand, a seller, by selling its company, shows its desire to get out of its former business activities. On the other hand, as long as the litigation is not finally resolved, the buyer has to manage the company, but certainly does not do it with its initial impulse because it ultimately desires to return it to the seller.

If the principles relating to fundamental errors generally apply to M&A transactions, the parties can contractually avoid its – sometimes undesired – effects: they may contract around it and waive in advance their right to retroactively rescind the contract on the basis of a fundamental error or because of a default in various way. These tools may be used individually but also cumulatively within a single transaction.

First, the parties may limit the legal remedies available to them in the transaction agreement. This can be achieved by including a “sole remedy” clause, which substantially provides that the legal remedies set forth in the agreement are the only remedies available to the parties (see Tschäni Rudolf/Wolf Matthias, Vertragliche Gewährleistung und Garantien – Typische Vertragsklauseln, in Mergers & Acquisitions VIII, Zurich (Schulthess) 2006, pp. 94 ff., pp. 119-120). The effect of such clause is to prevent the buyer from rescinding the SPA based on a fundamental error or terminating the agreement for a breach by the seller. The only remedy available to the buyer under the SPA will be a reduction of the purchase price, to the extent required to compensate the damage it suffered from the seller’s breach.

Second, the parties may specify that the representations and warranties (“R&Ws”) provided for in the acquisition agreement are the only R&Ws given by a party to the other, to the exclusion of any R&W non expressly set forth therein. If a fact is not covered by the R&Ws, a party implicitly acknowledges that such fact is not a necessary element to the party’s decision to enter into the agreement. Accordingly, that party may not raise a fundamental error with respect to facts that are not part of the R&Ws (see, for example, Tschäni/Wolf, p. 109 or Schenker Urs, Risikoallokation und Gewährleistung beim Unternehmenskauf, in Mergers & Acquisitions VII, Zurich (Schulthess) 2005, pp. 240 ff., pp. 263-264).

Third, the buyer may carry out a due diligence on the target or – especially in the context of auctions – the seller may make a vendor due diligence report available to the potential buyers. Given that a fundamental error presupposes the misrepresentation of a fact, the buyer will not be able to claim it would fall under a fundamental error as long as the information provided to the buyer is true, complete and not misleading (see Tschäni Rudolf/Frey Harold/Müller Dominique, Streitigkeiten aus M&A-Transaktionen, Zurich (Schulthess) 2013, pp. 16 and 120).

Judgment of the Federal Supreme Court of 30 September 2021

Case reference : 4A_262/2021

Facts

On March 21, 2018, two parties entered into a share purchase agreement concerning 3,500 shares of a Swiss company. The purchaser had to pay a total consideration of CHF 735,000 of which CHF 70,000 had already been paid. According to the contract, the remaining amount (i.e. CHF 665,000) was to be paid upon receiving the shares.

On December 21, 2018, the seller filed a lawsuit against the purchaser before the Court of First Instance, requesting that the latter be ordered to pay the outstanding consideration. During these proceedings, the purchaser announced that he intended to invoke his right to withhold performance: indeed – as the purchaser further provided for in his closing arguments – the seller had not fulfilled his obligation to transfer ownership of the shares, nor had he offered to do so (doctrine known as exceptio non adimpleti contractus). The Court of First Instance considered the purchaser’s argument to be valid, however, the buyer’s right to withhold performance did not justify dismissing the case. On the contrary, the Court of First Instance ordered the buyer to pay the outstanding consideration, but this judgment was conditioned by the simultaneous delivery of the shares by the seller.

Both parties challenged this ruling before the Appeal Court, which found that by asserting the exceptio non adimpleti contractus only in its closing arguments, the purchaser had not raised this argument in a valid manner in the proceedings (i.e. it was too late from a procedural standpoint). The purchaser was therefore ordered to pay the sale price, without the seller being obliged to simultaneously transfer ownership of the shares. This ruling was challenged by the purchaser before the Federal Supreme Court.

Issue

The Federal Supreme Court had to decide whether the purchaser had the right to withhold the performance of his obligation to pay the outstanding consideration on the ground that the seller had not performed his obligation to transfer the shares, even if the purchaser had raised this argument late in the proceedings.

Decision

According to Art. 82 of the Swiss Code of Obligations (SCO), “[a] party to a bilateral contract may not demand performance until he has discharged or offered to discharge his own obligation, unless the terms or nature of the contract allow him to do so at a later date”. This provision establishes a dilatory defense, allowing a contracting party to withhold performance of an obligation until the other party performs (or offers to perform) the reciprocal obligation. Art. 82 CO is a provision applicable to all synallagmatic contracts, and in particular to sale contracts governed by Art. 184 et seq. SCO. It is up to the debtor to raise this defense: courts will not take it into account unless the debtor raises it. If the defense is justified, i.e. if the creditor has neither performed nor offered performance of his corresponding obligation, the court will order the debtor to perform simultaneously, i.e. under the condition of the performance of the reciprocal obligation of the creditor.

After having laid down these general principles, the Federal Supreme Court recalled a subtlety inherent to Art. 82 SCO: under the Swiss law of evidence, the party alleging a fact must generally prove it. However, this is not the case with the exceptio non adimpleti contractus. In fact, the debtor wishing to raise this defense must only allege that the creditor has not performed and has not offered to perform his obligation (Behauptungslast), but he does not have to prove this (Beweislast). Once the debtor has raised this claim, it is up to the creditor to show, by any admissible means of proof, that he has in fact performed (or offered to perform) his own obligation.

From a chronological perspective, the debtor may not allege this claim (under Art. 82 SCO) at any time, but must comply with the applicable procedural requirements. According to the Swiss Civil Procedure Code (SCPC), the parties have two opportunities to bring forth facts and evidence to the proceedings: first, during the first exchange of briefs, and secondly, either during a second exchange of briefs or – if none is held – at an instruction hearing (Art. 226 para. 2 SCPC) or “at the beginning of the main hearing” (Art. 229 para. 2 SCPC). Thereafter, the parties only have the right to submit new facts and evidence under the limited conditions set forth under Art. 229 para. 1 SCO (i.e. new facts and evidence must be submitted immediately and fulfill one of the following conditions: i) they occurred after the exchange of written submissions or after the last instruction hearing, or ii) they existed before the close of the exchange of written submissions or before the last instruction hearing but could not have been submitted despite reasonable diligence).

In the case at hand, the Federal Supreme Court held – as did the Appeal Court – that the purchaser had clearly failed to submit the claim supporting his right to withhold performance of his obligation to pay the purchase price in accordance with the applicable procedural rules. In this respect, the Federal Supreme Court noted that the allegation of new facts by the purchaser during his closing arguments was procedurally overdue. That the proof of these facts must ultimately be provided by the seller does not change the outcome. Thus, the purchaser’s appeal was rejected.

As a result, the purchaser was ordered to pay the outstanding consideration while the seller was not ordered to simultaneously perform his own contractual obligation (the transfer of  shares) on the grounds that Art. 82 SCO was not applicable.

Key takeaway

This case highlights the risks associated with raising legal arguments at the “eleventh hour” in court proceedings. The purchaser could and should have raised the exceptio at an earlier stage of the proceedings. The case also provides an interesting reminder when it comes to allocating the burden of allegation and of proof under Swiss law in matters of exceptio non adimpleti contractus.

Comments

The exceptio non adimpleti contractus is a well-known defense mechanism in civil law systems. It has notably been implemented in Art. 7.1.3 of the UNIDROIT Principles of International Commercial Contracts. Although the underlying ratio for the exceptio may seem sensible (in a nutshell, to avoid that one party performs first and thus loses all means of pressure on his counterparty, while assuming the risk of non-performance and of insolvency of the counterparty), this case shows that the parties do not necessarily understand: i) what the obligation of simultaneous performance means, ii) what the violation of this obligation implies, and iii) how the exceptio must be invoked in legal proceedings. In order to reduce the risk of a litigation ending up before a judge with each party demanding that the other “perform first”, it would be advisable for the parties to agree on the precise modalities regarding the simultaneous performance of their respective obligations in their contract. This could potentially be done by requesting that a formal closing session be held (with corresponding “closing actions” to be accomplished by the parties) in the course of which the respective obligations of each party must be simultaneously performed (see Tschäni Rudolf/Diem Hans-Jakob/Wolf Matthias, M&A-Transaktionen nach Schweizer Recht, 3rd ed., Zurich (Schulthess) 2021, § 378 ff., in particular 387).

Judgment of the Federal Supreme Court of 21 February 2020
Case Reference : 4A_357/2019

Facts

The dispute between a Swiss banking software and outsourcing provider (the “Software Provider”) and a Swiss bank (the “Bank”, which had acquired the majority of the assets and liabilities of a third party company [the “Company”], including the matter of the dispute), amounting to CHF 90 million plus interest, arose out of a former joint venture. The Company had outsourced its IT division since the late 1990s and had established a subsidiary (the “Subsidiary”) to develop its own software platform. This IT solution was later abandoned. By the end of 2007, the Subsidiary had acquired a software banking license from the Software Provider in which the latter made its know-how available to the former. The condition for this supporting role was that the Software Provider would acquire a majority shareholding in the Subsidiary. Furthermore, the service relationship between the Company and the Subsidiary was to be clearly governed by a contract. The Software Provider had acquired a 51% stake in the Subsidiary from the Company for CHF 32.5 million plus an earn-out payment until the end of 2015 totaling CHF 39.4 million. The service relationship between the Company and the Subsidiary was established through an Agreement on Outsourcing Services dated August 25, 2011 (the “Service Agreement”). The Software Provider and the Company also entered into a shareholders’ agreement dated August 29, 2011 (the “Shareholders’ Agreement”). The Shareholders’ Agreement provided for option rights regarding the Company’s remaining 49%-stake in the Subsidiary when contractually defined trigger-events had been met. The Software Provider had a call option and the Company had a put option.

On July 14, 2014, the Company’s former owner agreed to sell the Company to a Brazilian company. The transaction was completed on September 15, 2015. This change of control constituted a trigger-event within the meaning of the Shareholders’ Agreement. The Software Provider decided to exercise its call option to acquire the Company’s remaining 49%-stake in the Subsidiary. As the parties were unable to agree on the purchase price of the shares, they initiated an arbitration-based price-fixing process provided for in the Shareholders’ Agreement. Eventually, they agreed on the amount of CHF 90 million as consideration for the shares on January 29, 2016 outside the arbitration proceedings (the “Price Agreement”). The Software Provider paid this amount on February 5, 2016. On February 22, 2016, the Brazilian company further sold the Company to the Bank. As the Bank decided to integrate the Company into its own banking system going forward, the Company terminated the Service Agreement with the Subsidiary on March 11, 2016 as of December 31, 2017 (i.e., less than one and a half months after entering into the Price Agreement).

After termination of the Service Agreement, the Software Provider considered itself to be entitled to claim back the entire purchase price (i.e., CHF 90 million) pursuant to a so-called price reduction under the Service Agreement (the “Price Reduction”), based on the terms of the Shareholders’ Agreement. The Price Reduction was defined by the Shareholders’ Agreement as the sum equal to the difference between the option price before termination of the Service Agreement and the hypothetical price after termination of the Service Agreement. The Software Provider claimed that due to the termination of the Service Agreement, it had lost its biggest customer and had suffered a massive loss in value. It filed a lawsuit at the Commercial Court of the Canton of Zurich and requested that the Bank be ordered to pay it CHF 90 million plus interest at 5% since February 5, 2016. The plaintiff asserted that the Price Reduction was due upon exercise of the call option and not merely upon exercise of the put option.

The Commercial Court of the Canton of Zurich dismissed the plaintiff’s claim in its entirety on various grounds, namely: the subsequent conduct of the plaintiff proved, when entering into the Shareholders’ Agreement and in agreement with the Company, that no Price Reduction was owed upon exercise of the call option. In particular, the Court highlighted the behavior of the parties during the arbitration proceedings and negotiations, which resulted in the Price Agreement. Accordingly, it confirmed the existence of a real common contractual intent of the parties (i.e., the existence of a so-called “natural consensus” between the parties, in German: “tatsächlicher Konsens”; in French: “accord de fait”) as alleged by the defendant.

In its judgment of February 21, 2020, the Federal Supreme Court dismissed the plaintiff’s appeal without considering the merits of the case.

Issue

The Federal Supreme Court had to determine whether the Commercial Court’s findings of fact, according to which the parties to the Shareholders’ Agreement had a real common contractual intent regarding the scope of application of the Price Reduction as being limited to the defendant exercising the put option, were tainted by arbitrariness pursuant to Art. 9 of the Federal Constitution.

Judgment

Given that the issue at hand is a matter of contract interpretation, the Federal Supreme Court first underscored the fundamental principle under Swiss law that interpretation of contractual provisions is subject to ascertaining the true and common intention of the parties (Art. 18 para. 1 of the Swiss Code of Obligations). In order to determine the intention of the parties, a court has to take into account all circumstantial evidence, which includes not only the specific circumstances surrounding the conclusion of the contract but also the conduct of the parties after the conclusion of the contract.

If the court fails to determine the true and common intention of the parties or concludes that there is no consensus between the parties, the contract has to be interpreted pursuant to objective interpretation, which consists in analyzing the parties’ declarations and behaviors in light of the good faith principle. In other words, the subjective method of contract interpretation prevails over the objective method of contract interpretation. The distinction serves as a boundary to define the Federal Supreme Court’s power of judicial review. While objective interpretation is a matter of law, subjective interpretation is a matter of fact, to which the Federal Supreme Court is bound as a matter of principle (Art. 105 para. 1 of the Federal Supreme Court Act [FSCA]). Findings of fact such as the true and common intention of the parties may only be reviewed by the Federal Supreme Court with very limited judicial scrutiny, the standard of review being arbitrariness under Art. 9 of the Federal Constitution (cf. Art. 97 para. 1 FSCA and Art. 105 para. 2 FSCA). A court is deemed to have decided in an arbitrary manner when it disregards evidence that is likely to affect the decision without sound judgment, when it manifestly misinterprets its meaning and scope, or when it reaches untenable findings on the basis of evidence on the record.

The Federal Supreme Court reiterated that a judgment may be found to be arbitrary if both its reasoning and outcome are arbitrary. In addition, the reasons for arbitrariness must be precisely substantiated (cf. Art. 106 para. 2 FSCA). An appeal that does not meet these requirements will be dismissed without the Federal Supreme Court considering the merits of the case. Moreover, the statements must be made in the appeal itself; a mere reference to statements in other legal documents or to the files is not sufficient. Finally, the appellant may not use its right of reply to substantiate or strengthen an appeal. In the reply, only arguments which were first raised by the comments in the submission of another party to the proceedings are admissible.

The Federal Supreme Court then turned to the Commercial Court’s findings of fact and its conclusion that the parties had expressed their real common contractual intent regarding the scope of application of the Price Reduction subsequent to the conclusion of the Shareholders’ Agreement that shall apply exclusively in case of the Company exercising the put option. According to the Commercial Court, the arbitrator appointed as part of the arbitration proceedings had expressly requested the Software Provider and the Company to comment on a provision of the Shareholders’ Agreement regarding the Price Reduction. It was further established in this regard that the Company had specifically recognized that no Price Reduction was due if the call option had been exercised, a statement which was not refuted by the Software Provider. During the arbitration proceedings, the Software Provider had not argued that the Price Reduction regarding the call option was to be determined at a later stage if the Service Agreement was subsequently terminated.

Assuming that the Software Provider, when concluding the Price Agreement in January 2016, had interpreted the Shareholders’ Agreement as providing for a Price Reduction in case of exercise of the call option and of subsequent termination of the Service Agreement by the Company (which, as a practical matter in light of the Company’s right to terminate the Service Agreement by mid-March 2016, was likely to happen given the on-going takeover negotiations regarding the Company), the Software Provider would have been in a position to receive the CHF 90 million it paid as part of the 49%-stake in the Subsidiary while keeping the shares. This position, however, was inconsistent with the Company’s statement in the arbitration proceedings that no Price Reduction was owed upon exercise of the call option or even afterwards. Furthermore, the Commercial Court found that the Software Provider’s argument that it had already contested a natural consensus between the parties had no merit. More specifically, as stated by the Commercial Court, the contractual provisions referred to by the Software Provider in both the Price Agreement and the Shareholders’ Agreement to contend that no real common contractual intent was expressed by the parties did not provide for the right to a Price Reduction in case of exercise of the call option. It was, therefore, not established that the Software Provider was contractually entitled to a Price Reduction in case of exercise of the call option, or that it could rely on a corresponding subjective intent of the parties supporting this position.

The Federal Supreme Court subsequently examined whether the Commercial Court’s conclusion that the parties had mutually agreed on the scope of application of the Price Reduction to be limited to the exercise of the put option was arbitrary under the facts of the case. It emphasized that the Software Provider’s main argument, which relied on its interpretation of the Shareholders’ Agreement upon conclusion of the Price Agreement as providing for a Price Reduction in the instance where the call option was exercised, had already been addressed – and dismissed – by the Commercial Court. The Software Provider had not disproved the Commercial Court’s finding that there was sufficient evidence stemming from the conduct of the parties after their entering into the Shareholders’ Agreement, namely during the arbitration proceedings, to conclude that the Software Provider and the Company had mutually agreed on the scope of application of the Price Reduction to be limited to the exercise of the put option. In any case, the Federal Supreme Court found that the Software Provider had not demonstrated in a legally adequate manner that the Commercial Court’s reasoning as to the parties’ real common contractual intent and outcome was arbitrary. In addition, it pointed out that the Software Provider’s statement in its reply that the Price Reduction shall not be calculated ex ante and hypothetically upon exercise of the call option, but ex post and specifically upon termination of the Service Agreement, was not admissible for two reasons: 1) this argument was belated, because it was raised only in the reply; and 2) it could not call into question the merits of the Commercial Court’s conclusion as to the existence of the real common contractual intent of the parties.

As a result, the Federal Supreme Court ruled that the Commercial Court’s conclusion that the Software Provider and the Company had expressed their real common contractual intent regarding the (limited) scope of application of the Price Reduction under the Shareholders’ Agreement was not arbitrary. It therefore dismissed the Software Provider’s appeal without considering the merits of the case.

Key takeaway

At least two key takeaways arise from this judgment of the Federal Supreme Court.

The first one – which relates to substantive law – is a reminder that the subjective method of contract interpretation under Swiss law supposes that a court shall go beyond the text in order to assess the existence of a real common intention of the parties. In order to determine the real and common intention of the parties, the court not only takes into account all the circumstances that lead to the conclusion of the contract (i.e., negotiations, correspondence, or any other expression of intent), but also those that occur after the conclusion of the contract, such as the parties’ subsequent conduct. The parties’ subsequent conduct is relevant to the subjective interpretation if it provides convincing evidence of the will of the parties upon conclusion of the contract. Subjective interpretation is a point of fact that, as a matter of principle, cannot be reviewed by the Federal Supreme Court when hearing an appeal on questions of law.

The second one – which relates to procedural law – is that pleas in law and arguments put forward in an appeal must be provided in the appeal itself and not in a subsequent submission (in this case in the reply). In the reply, new pleas in law and arguments are inadmissible unless they refer to and address statements contained in the submission of another party to the proceedings.

Comment

This case illustrates (once again) the importance of careful contract drafting in complex business transactions. It also confirms that the distinction between the subjective method and objective method of contract interpretation (this last method applies only if the subjective method cannot apply and consists in analyzing the parties’ declarations and behaviors in light of the good faith principle [cf. Art. 2 para. 2 of the Swiss Civil Code]), may be difficult to apply in practice. The application of the good faith principle refers to the content of the parties’ declarations and the circumstances (facts). This distinction is nonetheless imposed by the Federal Supreme Court because it arises from the distinction between facts and law and demonstrates the power of judicial scrutiny. This case is also interesting because it constitutes one of the few cases where the court is in a position to determine the real common intent of the parties (based on the subjective method of contract interpretation). In most cases, the courts cannot establish the facts that prove the real common intent of the parties and as a result must apply the objective method of contract interpretation by default.