Judgment of the Federal Supreme Court of 29 July 2024

Case Reference: 4A_505/2023

Facts

Between 2014 and 2016, B. LLC (“the IT Provider”) carried out various IT services for a company active in commodities trading, A. SA (“the Client”).

The Client and the IT Provider (collectively “the Parties”) concluded a first contract in 2014 (for a term of one year). In 2015, the Parties concluded a second contract for a term of three years ranging from January 1, 2015 to December 31, 2017, with tacit renewal for a year unless terminated with a three-months’ advance notice (“the Contract”). Under the Contract, the IT Provider undertook to carry out various IT services, including the maintenance of the Client’s IT infrastructure, for a monthly fee of CHF 20,500.

The Contract provided for early termination per the following terms:

• If a party breaches any material term of the Contract and does not remedy the breach within 30 days of receiving notice, the other party may terminate the Contract in writing. If it is impossible to remedy the breach within the 30-day period, a further reasonable period, not exceeding 60 days from receipt of the notice, shall be granted.

• In addition, either party may terminate the Contract with immediate effect in the event of gross negligence or intentional wrongful conduct.

The IT Provider was run and managed by C, who had formerly been employed by the Client as its (in-house) IT system engineer. During the Contract, C/the IT Provider worked in close collaboration with the Client’s IT department.

Every year, the Client conducted an internal and external IT audit. These audits did not raise any particular issue or security problem during the term of the Contract, except for a few recommendations that had always been promptly followed.

However, the relationship between the Client and the IT Provider deteriorated between 2015 and 2016:

• On March 26, 2015, C (on behalf of the IT Provider) sent a complaint via email to the Client stating that the Client’s IT operations had been negatively impacted by the Client’s delay to renew specific IT contracts (e.g. those related to servers and archives). C expressed his concern related to that delay, which had a considerable impact on “all of the [IT] department’s functions”. He indicated that he would continue to make every effort to provide quality service under these conditions, but he expressly refused to bear any responsibility caused by any delay, negligence or lack of management with regard to the administrative and operational functions of the IT infrastructure.

• In the fall of 2015, the Client admitted it was facing financial difficulties and asked its employees if they would be willing to work part-time.

• In April 2016, the Client hired a new IT Department Head who commissioned a third party (G) to conduct an audit of its IT system. In its report, G identified various issues affecting the Client’s IT system, which did not meet current standards and required upgrades. The report also alleged security flaws and pointed to a wide disparity in the equipment used. Overall, the equipment was deemed obsolete and in need of replacement.

The very same day that the Client received G’s report, it sent the IT Provider a notice of termination of the Contract with immediate effect for gross negligence. In essence, the Client accused the IT Provider of numerous breaches of the Contract and of accepted IT best practices, which it claimed had led to major security breaches. These alleged breaches included non-compliance with security standards and norms, shortcomings and omissions relating to services and maintenance, and a blatant lack of information about the shortcomings that had been – or should have been – identified.

Following the termination of the Contract, the Client hired several companies to carry out additional IT audits, which all reported various problems affecting the Client’s IT infrastructure.

In 2017, the Client initiated civil proceedings against the IT Provider to claim over CHF 250,000 in damages corresponding to costs incurred to restore the Client’s IT system as well as the costs of audits and legal fees. The IT Provider counter-claimed for outstanding and future fees that it was entitled to under the Contract, which was initially set to expire on December 31, 2017.

The cantonal courts (both first and second instance) ruled that the Client’s termination of the Contract lacked good cause and was therefore unjustified and ineffective. As a result, the IT Provider was awarded full compensation, corresponding to the contractually agreed fees due for the remaining term of the Contract (i.e. from April 2016 to December 31, 2017). The Client appealed to the Federal Supreme Court.

Issue

Before the Federal Supreme Court, only two issues were in dispute:

(1) Despite the fact that the Contract was terminated without good cause (i.e. that the performance of the IT Provider did not justify the immediate termination of the Contract by the Client), was the IT Provider nonetheless contractually liable under Art. 97 para. 1 SCO for damages (allegedly) caused to the Client?

and

(2) With regards to the damages awarded to the IT Provider, should certain earnings, savings or avoidable expenses following the termination of the Contract have been deducted by the cantonal courts?

Decision

A brief look at the judgment of the Cantonal Court of second instance

Before delving into the decision of the Federal Supreme Court, it is worth noting two key points of the judgment of the cantonal court of second instance (“the Cantonal Court”):

• First, the Contract was qualified as a maintenance contract, i.e. a contract under which one party undertakes to monitor an asset and maintain it in working order (e.g. an IT system) for a fee. Under Swiss contract law, this contract must be qualified as a long-term, ‘sui generis’ unregulated (or innominate) contract with similarities to the contract for works and services (363 et seq. SCO). The Cantonal Court held that where the parties provide for a detailed termination mechanism in their contract (which was the case here under the Contract), there was no need to determine whether legal provisions governing regulated contracts apply to termination.

• Second, the Cantonal Court ruled that the Client termination lacked good cause and was therefore unjustified and ineffective. It found that the real reason for the Client terminated the Contract appeared to be financial in nature, given that it had been experiencing financial difficulties prior to the termination. Witness testimony also showed that the Client wished to cut costs by relocating its IT department to Eastern Europe (which it eventually did after it notified the IT Provider of the termination of the Contract).

Moreover, even if numerous patches and updates had not been installed by the IT Provider, the Cantonal Court found that this did not amount to a material breach of the Contract nor did it constitute a violation of good IT practices by the IT Provider. The reason being that some patches could not be installed because the Client’s IT infrastructure was obsolete (the Client’s IT budget was insufficient to replace ‘end-of-life’ hardware), while other patches were deliberately avoided because they could paralyze the Client’s business activities.

In addition, the Cantonal Court found that the facts of the case demonstrated that the Client was generally satisfied with the IT Provider’s services as the Client never issued any warnings to the IT Provider, and never expressed dissatisfaction during the entire contractual relationship, even though the Client’s IT department was subject to an external and an internal audit every year.

In this sense, by failing to notify the IT Provider that its conduct would amount to a breach of the Contract, the Client was deemed to have accepted the services provided by the IT Provider under the Contract, and was precluded from relying on these events as valid grounds for immediate termination of the Contract.

All in all, the breaches cited by the Client in its termination notice were deemed to be no more than a pretext to terminate the Contract that had in reality become too costly.[1]

Finally, the Cantonal Court held that the Client could have applied the contractually agreed mechanism and granted the IT Provider a notice to remedy any alleged breaches before terminating the Contract. It failed to do so and therefore had to bear the consequences of its actions.

These findings were not challenged before the Federal Supreme Court.

The decision of the Federal Supreme Court

The Federal Supreme Court ruled on two issues.

(1) First, it had to determine whether the IT Provider had a duty to pay damages to the Client based on Art. 97 para. 1 SCO. It began by recalling the four conditions for contractual liability: (1) damage; (2) a breach of contract (i.e. non-performance or improper performance of a contractual obligation); (3) a causal nexus [between the breach and the damage]; and (4) fault, which is presumed. The claimant bears the burden of proof (Art. 8 SCC) and must properly allege the first three conditions.

The Cantonal Court did not rule out the possibility that a breach of contract – which would not in and of itself amount to good cause for terminating the Contract – could nevertheless cause damage and give rise to contractual liability on the part of the breaching party under Art. 97 para. 1 SCO. However, in this case, the Cantonal Court found that the Client had failed to establish a breach of contract by the IT Provider. In addition, the causal nexus between such potential contractual breach and the poor state of the Client’s IT infrastructure was not established.

Given that two of the above-mentioned conditions were not met, the Federal Supreme Court upheld the Cantonal Court’s refusal to award damages to the Client under Art. 97 para. 1 SCO.

(2) Second, the Federal Supreme Court had to review the decision of the Cantonal Court to award the IT Provider full compensation of the contractually agreed monthly fee for the remaining term of the Contract (i.e. from April 2016 to December 31, 2017).

The Client argued that certain earnings and savings made following the termination of the Contract should have been deducted from the damages sought by the IT Provider. The Client alleged that the IT Provider had lost its only customer and was no longer operational, while its manager C. was receiving unemployment benefits. Therefore, the IT Provider was allegedly saving on operational costs.

However, the Client claimed that it was unable to provide the exact amount which should be deducted from the damages due to the IT Provider. For this reason, it claimed that based on Art. 42 para. 2 SCO, the courts should have estimated the value of the alleged savings/earnings at its discretion.

The Federal Supreme Court found, however, that the Client had failed to establish the amount the IT Provider would have saved or earned following the termination of the Contract. It further added that even if Art. 42 para. 2 SCO were applicable, the party alleging damage must still establish all of the circumstances that would enable the court to determine an estimate. Yet the Client had failed to show which of its allegations covered the relevant facts. It also failed to demonstrate that it had unsuccessfully requested evidence from the IT Provider – evidence that would have enabled it to prove these facts to the court’s satisfaction.

On this basis, the Federal Supreme Court held that the Cantonal Court had not misapplied the rules of Swiss contract law when deciding not to deduct any alleged savings or earnings from the damages awarded to the IT Provider.

Key takeaway

In order to validly terminate a long-term IT maintenance contract for breach of contract (namely for alleged IT security breaches), clients must diligently track, document and notify breaches committed by their IT provider. Depending on the nature of the breach in question and the agreed termination mechanism, the client may have to grant its IT provider a reasonable time-period to remedy the breach(es).

If a client has wrongfully terminated its IT maintenance contract with immediate effect (i.e. without good cause), it is, as a rule, liable for its undue or unjustified notice of termination. As such, the client must pay damages corresponding to the contractual fees owed to the IT provider until the originally agreed term expired. The client may attempt to reduce the damages to be awarded by any earnings or savings made by the IT Provider as a result of the early termination, based on the IT provider’s duty to mitigate its damage (Art. 44 para. 1 SCO applicable to contractual damage claims via Art. 99 para. 3 SCO). This requires the client to meet its burden of proof and to properly allege all relevant facts regarding the alleged earnings or savings made by the IT provider.

Comments

1) First, as noted above, the courts found that the Client failed to prove a breach of contract by the IT Provider within the meaning of Art. 97 I SCO.

In denying the existence of breach on the part of the IT Provider, the courts gave significant weight to three factual elements:

• The Client was late in validating the renewal of certain IT contracts (in particular maintenance contracts for HP servers as well as contracts for electronic storage). This was evidenced by an email sent by the IT provider to the Client, in which the IT Provider complained that the Client’s delay was negatively impacting “all the [IT] department’s functions”. In that same email, the IT Provider had expressly warned the Client that it refused to bear any responsibility, namely with respect to the functioning of the IT system, caused by the Client’s delay, negligence or lack of management.

• The general state of the Client’s IT infrastructure and its budgetary constraints. The Client’s IT infrastructure was obsolete and its IT budget was insufficient to replace ‘end-of-life’ hardware. As such, the Client’s budgetary constraints obligated the IT provider to operate with outdated IT infrastructure.

• The fact that the Client had never issued any warning to the IT Provider, nor expressed any (substantial) dissatisfaction with its services during the entire contractual relationship. In this sense, the Client was deemed to have accepted the services provided by the IT Provider under the Contract. In these circumstances, it was not sufficient for the Client to spontaneously commission an external audit and to rely on the findings of the audit report in order to justify the immediate termination of the contract.

These elements made it difficult for the Client to establish a breach by the IT Provider of its contractual obligations.

As evidenced by the first two factors (see (1) and (2) above), the performance of an IT maintenance contract by an IT provider may depend on its client duly performing its own contractual obligations or duties (“incombances”/“Obliegenheit”).[2] This shows the potential interdependence between the contracting parties in a long-term IT maintenance contract and the shared responsibilities that may result from this, particularly where the IT provider works in close collaboration with the client or under the supervision of the client’s in-house IT staff. In this sense, a client may struggle to claim that its IT provider breached its contractual obligations if the client itself has not taken the necessary measures to ensure that the IT Provider can perform its obligations (e.g. by validating the renewal of IT contracts in a timely fashion and by allocating sufficient resources to address its IT needs). Moreover, depending on the industry in which the client operates, companies can be bound by stringent legal obligations that oblige them to maintain a certain standard of cybersecurity. This can particularly result from rules on the protection of personal data (e.g. Art. 8 Data Protection Act/Art. 3 Data Protection Ordinance; Art. 32 GDPR), as well as certain industry-specific rules (e.g. FINMA Circulars applicable to the financial industry)[3] or cross-sectorial rules (e.g. EU NIS2 (2022/2555) Directive).[4] From this perspective, companies may have legal obligations to ensure a sufficient level of cybersecurity and for which they must therefore allocate adequate resources.[5]

With regards to proof of a breach of contract (see (3) above), the lesson is that clients should establish a track record of their IT Provider’s performance. Thus, in addition to possible reports, audits or other quality control documents collected during the term of the contract, any issues in maintenance services should ideally be substantiated in writing between the parties or using a well-documented complaint mechanism (e.g. IT support tickets or lists of submitted requests).

Finally, a contracting party under a long-term contract may be expected to notify breaches to the other party and to give a reasonable time period for curing such breach before proceeding to terminate the contract. This is what was agreed upon in the Contract in the case at hand. This also results from certain provisions in Swiss contract law (e.g. Art. 107 SCO, Art. 366 SCO).[6] Certain circumstances may justify the termination of the contract with immediate effect (i.e. with no notice period), namely if the relationship of trust is broken (which equates to good cause for termination). For instance, a major IT security breach or cyberattack may warrant immediate termination for good cause, but this was not the scenario at play here.

2) In its second argument, the Client argued that the IT Provider had violated the duty to mitigate its damages, i.e. its duty to do everything that can reasonably be expected of it to reduce the damage that it has suffered. This duty is derived from the principle of good faith (Art. 2 SCC) and its breach may result in a reduction of the amount of damages awarded to the aggrieved party (Art. 44 SCO applicable via Art. 99 III SCO).[7] The party claiming a breach of this duty (by the other party) bears the burden to prove it (Art. 8 SCC).

The SCO expressly provides for such a duty to mitigate damages, for instance, in the event of a premature and unjustified termination of an employment contract (see Art. 337c II SCO).[8] For other contracts, a general argument is made in legal literature that, based on the duty to mitigate damages, the party at the receiving end of an unjustified notice of termination may see certain earnings or savings deducted from the damages owed to it by the terminating party.[9]

In the case at hand, the Client claimed that the damages that it was found to owe to the IT Provider should be reduced by the amount corresponding to any savings made by the IT Provider following the early termination of the Contract. It argued that given that the Client had been its only customer for many years, the early termination of their agreement meant that the IT Provider was saving on operational costs. The Client failed, however, to adequately allege and substantiate facts in relation to these alleged savings.

The issue was thus summarily dismissed by the Federal Supreme Court, with no discussion of the relevance of the duty to mitigate damages, nor its scope and extent. And yet the question is one of significant practical importance. Indeed, damages for unjustified termination of a long-term contract aim to restore the other party in the position that it would have been in had the contract been performed until the originally agreed term expired, typically providing full compensation under the contract. Depending on the term (duration) of the contract, this can imply considerable financial compensation (in this case, over 18 months’ worth of fees at CHF 20,500/month(!)). The ability to deduct earnings made by the other party from substitute mandates, as well as savings related to costs that the other party has avoided or could have avoided in good faith after termination (e.g. software licences, subscriptions and other business costs) could have a substantial impact on the amount of damages owed by the terminating party.

Other source commenting the case

Federal Supreme Court Upholds IT Support Contract Termination: Key Lessons on Evidence and Timely Complaints, ICT & Digital @MLL Legal, LinkedIn Post (https://www.linkedin.com/posts/ict-digital-mll-legal_schweizerisches-bundesgericht-willkommen-activity-7237353475691429889-Mygt?utm_source=share&utm_medium=member_desktop)

 

[1] This approach resonates with another recent decision of the Federal Supreme Court which also dealt with the unjustified termination of a long-term IT contract and in which the real cause for termination was deemed to be financial in nature as well (i.e. lost profits due to outdated equipment). See the judgment of the Federal Supreme Court, 4A_573/2020/4A_575/2020, commented on this platform: Maxime Francis/Marianna Sorton, Unilateral termination of a long-term IT contract: when is good cause not good enough?, published on: Swiss Contract Law, August 16, 2022, https://scl.cultureweb.ch/18/.

[2] A duty can be defined as an act (or set of acts) that a party must abide by in order to avoid losing the benefit of certain rights; unlike an obligation, a party cannot be compelled to perform a duty (see Pierre Tercier/Pascal Pichonnaz, Le droit des obligations, 7 ed. 2024, N 326). 

[3] See e.g. FINMA Circular 2023/1 on Operational risks and resilience – banks (entered into force in January 2024).

[4] The EU Directive 2022/2555 on measures for a high common level of cybersecurity across the Union as well as the EU Commission Implementing Regulation for IT-Service providers 2024/2690 (EU-CER (2022/2557) ; see in particular Art. 2 et seq. and related Annex).

[5] A commitment to conformity with standards can also be voluntary, see e.g. ISO/IEC 27001 Standard for information security management systems (ISMS).

[6] For another example, see judgment of the Federal Supreme Court, 4C_393/2006, of April 27, 2007, para. 3.3.3, where a provider was expected to put its client on notice before terminating a software-development contract.

[7] According to some legal commentators, the duty may be attributed to Art. 42 SCO instead (see Franz Werro/Vincent Perritaz, art. 44 N 26 and references, in Commentaire Romand, Code des obligations I [Luc Thévenoz/Franz Werro, edit.], 3 ed., Basel 2021).

[8] Under this provision, damages will be reduced by any amount that the employee has saved as a result of the early termination of the employment relationship or that it has earned by doing other work (or would have earned had it not intentionally foregone such work). See also: Art. 264 para. 3 SCO (early termination (restitution) in a lease agreement) or Art. 377 SCO (termination of a contract for works and services against full compensation of the contractor).

[9] See Marie-Noëlle Venturi-Zen-Ruffinen, La résiliation pour justes motifs des contrats de durée, 2007 Fribourg, N 1510; on IT contracts in particular, see Michel Jaccard/Vincent Robert, Les contrats informatiques, in: Pascal Pichonnaz/Franz Werro (ed.), La pratique contractuelle, Genève 2009, 95 et seq., at 123.

Judgment of the Federal Supreme Court of 20 December 2022
Case Reference: 4A_490/2021

Facts

C. SA (“C.”) had outsourced its internal mail and courier service to A. SA (“A.”). A. subsequently subcontracted the performance of the services to its subcontractor Z. SA (“Z.”) through a service contract (“the Contract”). In essence, Z. had to handle any incoming mail and distribute it throughout C., as well as collect and process any outgoing mail.

The term of the Contract was set to five years (“the Term”). Less than two months after the beginning of the Contract, A. asked to reduce the Term to two years, however, Z. refused.

One year after the beginning of the Contract, A. terminated the Contract, arguing that its client C. itself (allegedly) terminated its relationship with it following an internal reorganization. A. saw this as a cause for termination of the Contract, despite the satisfactory performance of the Contract by Z.. The latter objected and filed a claim with the lower courts.

Both the First Instance Court and the Cantonal Court upheld the claim brought forward by Z.. They both considered that A. and Z. were legally bound by a 5-year contract for work and services, which did not allow for early termination, except for cause. As the (alleged) reorganization of C. was not considered a valid cause – A. could and should have added a specific provision to this effect in the Contract, linking its fate with the contract with C., but did not do so – Z. was entitled to positive damages, i.e. compensation for the lost profits due to the untimely termination.

A. filed an appeal with the Federal Supreme Court.

Issue

The Federal Supreme Court had to determine how the Contract should be characterized, and whether A. was within its right to terminate the Contract before the expiry of the Term.

Decision

A. claimed the contract was to be characterized as a Simple Agency Contract (governed by Art. 394 et seq. SCO) or a Contract of Carriage (Art. 440 et seq. SCO), which allow for immediate termination without indemnification.

A Simple Agency Contract can be terminated at any point in time (Art. 404 SCO), a rule that the Federal Supreme Court deems mandatory, despite criticism from some scholars. Indemnification for termination is due only if it occurs “at an inopportune juncture” (Art. 404(2) SCO). A Contract of Carriage applies the same rules (Art. 440 para. 2 SCO).

In order to characterize the Contract, the Cantonal Court and the Federal Supreme Court reviewed the obligations of the parties. In the case at hand, the parties had agreed upon a certain level of service – in particular, Z. had an obligation of result (where at least 95% of mail had to be processed in a timely manner), which is not compatible with a Simple Agency Contract, based on an obligation of means. The existence of an obligation of confidentiality and a relationship based on trust is not itself sufficient to consider that the Contract was a Simple Agency Contract, given that other contracts can also rely on a relationship of trust.

Regarding the carriage aspect, the fact that Z. had to “carry” C.’s mail on-site or from the site to the post office is not sufficient to characterize the Contract as a Contract of Carriage. In fact, the scope of the obligations was much broader, and the price was set as a flat rate rather than per volume of mail.

In conclusion, the Contract was characterized as an innominate contract, including some aspects of a Contract for Work and Services (Art. 363 SCO), but not of a Simple Agency Contract nor a Contract of Carriage. Thus, A. cannot validly rely on Art. 404 SCO to terminate the Contract.

Alternatively, A. claimed it was entitled to terminate the contract due to the internal reorganization of C.. A Contract for Works and Services can be terminated “where completion of the work is rendered impossible” (Art. 378 SCO) and, a as general rule, an impossibility of performance extinguishes the obligation (Art. 119 SCO).

A. alleged that the reorganisation of C. rendered it impossible to carry out the Contract. This point was challenged by Z. during the proceedings. A. could not claim that Z. had accepted the existence of the alleged impossibility, nor was it able to prove it, despite bearing the burden of proof. On these grounds, the Cantonal Court and the Federal Supreme Court considered that there was no cause to justify the termination of the Contract and, therefore, that Z. was entitled to damages.

In conclusion, the Federal Supreme Court rejected the appeal and confirmed the decision of the Cantonal Court.

Key takeaway

The characterization of a contract has a direct effect on the conditions surrounding the termination of said contract. Swiss law provides that parties to a Simple Agency Contract (and related contracts) are entitled to immediately terminate the contract without cause. However, given that the characterization of the contract is not left to the free determination of the parties but rather depends on the content of the contract itself, one should not simply rely on the title given to the contract. Indeed, where the parties have agreed upon an obligation of result, the application of the rules of the Simple Agency Contract may be set aside, and in the absence of a specific provision on the matter, the parties may not be able to terminate the contract without risking a claim for damages.

Comments

This decision illustrates the difference between the economic and legal standpoints of chains of contracts (in this case the main contract entered between the final client and its service provider and the subcontract between the service provider and the subcontractor). From a purely economic standpoint, C., A., and Z. are all involved in the same process. However, from a legal standpoint and given the doctrine of privity of contact as applied in Switzerland, the termination of the main contract between C. and A. has no direct effect on the subcontract between A. and Z.. Therefore, the termination of the main contract does not constitute a just cause for termination of the subcontract and does not make the performance of the obligations under the subcontract subsequently impossible within the meaning of Art. 119 SCO.

A. might have overlooked the risk related to termination by C. on its other contract. When drafting a subcontract, one should thus make sure to reserve the same termination rights or to unequivocally link the termination of the main contract to the subcontract.

Judgment of the Federal Supreme Court of 11 October 2021

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

Facts

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

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

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

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

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

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

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

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

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

Issue

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

Decision

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

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

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

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

• First, it held that the technical problems relating to the IT System did not exceed what was tolerable in the performance of a long-term contract of such nature. Moreover, it was held that the Hotel had failed to properly document and to demonstrate the severity of the technical issues that it relied upon as the primary ground for termination.

• Second, despite the technical issues raised by the Hotel, the real reason for termination was deemed to be economic in nature. This finding relied on exchanges between the parties, in which the Hotel complained that the equipment was outdated and too expensive, and that the IT System had become less profitable due to advances in technology and customer habits. In this regard, the Federal Supreme Court noted that (i) the IT Company was not to be held liable for the change in habits of the Hotel customers; and (ii) in entering into a long-term contract, the parties had accepted the risk that the equipment supplied could become outdated.

• Finally, the previous instance also found that the Hotel had failed to terminate without delay, as required by the relevant case law, but had instead (i) endured the maintenance and technical issues for several years; (ii) let several months lapse after the last major breakdown before resorting to termination; and (iii) terminated without immediate effect (i.e. termination announced in April for the end of July). Furthermore, the fact that the parties held negotiations from January to March showed that the current Contract was not in fact intolerable for the Hotel, subject to certain adjustments. These latter points seem not to have been challenged before the Federal Supreme Court, who abstained from commenting thereon.

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

Key takeaway

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

Comments

This decision calls for two key comments:

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

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

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

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

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

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

Judgment of the Federal Supreme Court of 5 August 2020
Case Reference : 4D_7/2020

Facts

A. SA (the Buyer) bought from B. (the Seller) 21 tons of oranges. At the time of conclusion of the contract, the parties did not agree on specific qualities or characteristics, nor did the Buyer disclose the purpose of the contract.

During the delivery, the Buyer tested and tasted the oranges, and refused the goods, arguing they were too acidic for their intended purpose, which in this case was the production of orange juice. The sugar content of the oranges delivered was indeed too low for the juice to be sold as orange juice under Swiss regulations.

The goods were temporarily stocked in the Buyer’s warehouse, but the parties failed to reach an agreement and the oranges were eventually donated to a charity after the Buyer had terminated the contract.

The Buyer claimed damages for the storage costs and the Seller claimed payment of the purchase price. The Buyer prevailed before the first instance court, but the appellate court reversed the decision. The Buyer appealed to the Supreme Court.

Issue

The Federal Supreme Court was called upon to decide whether the oranges delivered were of the quality required by the contract.

Decision

The Buyer claimed to have lawfully terminated the contract and, as such, refused to pay the purchase price and sought damages for the storage costs. The buyer bears the burden of proving non-conformity.

The first step of the reasoning was that the parties did not agree on the quality. Indeed, no specific quality or purpose – such as a minimal sugar content – was explicitly included in the contract. The Federal Supreme Court also pointed out that no implied quality or purpose could be deduced from the circumstances of the case. The Buyer was active not only in the production and sale of orange juice, but also various other (fruit-based) meals. The Seller could not reasonably deduce the intended purpose of the sale from this information. Nor could the price or size give any indication as to their use.

The second step of the reasoning was that the Buyer could not have expected the intended quality in good faith (Art. 197 of the Swiss Code of Obligations [SCO]). In this case, the standard should not have been whether the oranges were suitable for producing orange juice – as this could not reasonably be deduced from the circumstances of the case – but whether they were suitable for human consumption. Under this standard, the Buyer failed to prove that the goods did not conform to the contract, especially given that they were donated to charity.

Finally, the Buyer did not specify before the conclusion of the contract that the sugar content would be tested or the oranges would be sampled. The appellate court and the Federal Supreme Court stated that the Buyer could not rely on its own negligence to terminate the contract, especially in view of the fact that it had been active for far longer than the Seller on this market (thirteen years, rather than one year, at the time of conclusion of the contract).

In conclusion, the Seller delivered goods that conformed to an agreed standard and to the good faith expectations of the Buyer, and the appeal was therefore dismissed.

Key takeaway

Swiss law imposes a series of duties on buyers wanting to terminate their contracts or claim damages (examination, notice of defects, statute of limitations), but this case serves as a reminder that buyers are required to be careful even before the conclusion of the contract. The Buyer cannot simply rely on a general description of the goods, especially where those goods can be used for multiple purposes.

Comments

This case applies Swiss (domestic) law, but the reasoning of the Federal Supreme Court would have been similar under the United Nations Convention on Contracts for the International Sale of Goods (CISG). Indeed, Art. 35(2)(a)-(c) CISG list three similar conditions, namely “fit[ness] for the purposes for which goods of the same description would ordinarily be used”; “fit[ness] for any particular purpose expressly or impliedly made known to the seller at the time of the conclusion of the contract […]” and “qualities of goods which the seller has held out to the buyer as a sample or model”.

The Buyer’s claim would certainly have also been rejected under the CISG, as the oranges were fit for ordinary use (human consumption) and no particular purpose was disclosed by the Buyer. As the Seller did not hold out a sample – nor did the Buyer request one – the Buyer could not rely on it. The goods would therefore be considered to conform to the contract.

Other sources presenting the case

Dario Galli/Markus Vischer, Zum Fehlen einer vorausgesetzten Eigenschaft bei Orangen, in: dRSK, publiziert am 16. Juni 2021

Judgment of the Federal Supreme Court of 5 August 2020
Case Reference : 4A_221/2020

Facts

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

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

This situation can be graphically represented as follows:

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

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

Issue

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

Decision

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

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

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

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

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

Key takeaway

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

Comments

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

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

Other sources discussing the case

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