Negotiations disrupted? Beware of pre-contractual liability

Does pre-contractual liability arise if the negotiation of the sale and purchase of a shareholding fails? Let’s look at three rulings together.

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negotiations disrupted

In the purchase and sale of corporate shareholdings, negotiations can become impasse, stall and fail to result in the conclusion of a contract, even a binding preliminary contract.

The negotiation phase represents precisely the initial stage of an M&A transaction during which the parties get to know each other and evaluate the aspects of the transaction, with the possibility, in general, to break off negotiations if one is not convinced of the transaction’s merit.

However, in some cases, the non-terminating party may be able to claim compensation for the interruption of negotiations.

The Italian Civil Code regulates pre-contractual liability in Article 1337: “the parties, in the conduct of negotiations and in the formation of the contract, must behave according to good faith.”

Let us see together how this article is interpreted and applied in three judgements.

 

First Judgment: Court of Bologna, Oct. 5, 2021, G.R. 12297 2018

In the present case, the negotiations, which began in August 2015, had continued for several months, until February 2016, in a non-smooth and non-continuous manner, through repeated exchanges of correspondence and contacts between the two parties, both with the assistance of their respective professionals.

About 4 months after the last contact (so in June 2016), there was a final attempt to contact the buyer, which the seller refused to follow up on. The prospective buyer then sued the prospective seller seeking damages under Article 1337 of the Civil Code.

The Court of Bologna holds that, under these conditions, there is no pre-contractual liability of the possible seller because in the face of negotiations that went on for several months with discontinuous progress and without ever reaching a full agreement – as well as in the face of absolute inertia on the part of the potential buyers who remained totally silent for several months – the refusal by the possible seller to give new and further course to the negotiations does not constitute conduct contrary to the duty of good faith posed by Article 1337 Civil Code.

According to the ruling, in order for withdrawal from negotiations to be considered contrary to duty of good faith, it is necessary that negotiations have reached an advanced stage, that is an appreciable approximation to a successful outcome has been reached.

 

Second judgment: Court of Milan, Nov. 3, 2017

A shareholder owning approximately 41% of the share capital of an S.r.l. intends to divest his shareholding because it is in conflict with the other shareholders. Negotiations are thus initiated with the majority shareholders for the possible sale of the stake. The potential buyers make purchase proposals subject to the fulfillment of several conditions. The negotiations fade because the parties fail to reach agreement on some key issues. The prospective seller, embittered by the failure to complete the transaction, sues the prospective buyers.

The Court of Milan, hearing the case:

  1. rules out the existence of an obligation to the conclusion of the share purchase and sale transaction;
  2. finds that there were disagreements on relevant issues, such as the guarantees required by the buyers, the possibility of deferred payment of a price’s part, and the non-compete obligation of the alienator.

Agreement on these circumstances, according to the Milan court, must be considered essential, so that, in their absence, the prospective buyers cannot be held liable for withdrawing from the negotiations. In conclusion, the Milan court rejects the claim for damages made by the would-be seller, since the negotiations have not reached such an advanced state that their termination would constitute bad faith.

Third ruling: Court of Cassation No. 7545/2016

With this ruling, the Supreme Court summarizes the position that the same Court had previously reiterated on the subject of pre-contractual liability: in order to consider such liability integrated, it is necessary that the negotiations:

  1. are in an advanced state, that is, have reached a stage capable of engendering, in the party invoking the liability of others, a reasonable expectation that the transaction will be concluded;
  2. have been interrupted, without a justifiable reason, by the party charged with said liability.

 

Conclusions

At the commencement of negotiations, it is reasonable to assume that all parties involved hope and desire the successful outcome of the negotiations by means of the conclusion of the definitive (so-called Closing). However, it is necessary to be mindful of Article 1337 – and the relevant jurisprudential interpretation – in order to understand whether, how and when it is possible to unilaterally withdraw from a negotiation without running the risk of having to be ordered to pay a sum of money to the counterparty as pre-contractual liability.

LDP (with an integrated and close-knit group of professionals covering the legal, tax, payroll and finance areas) has been supporting its clients for decades in all phases of extraordinary transactions, from the NDA (Non Disclosure Agreement), to the DD (Due Diligence), up to the so-called Closing, including the negotiation phase which, as seen, should be set up from the outset in the best possible way also to avoid any pre-contractual liability.

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