The concept of ‘damage’ in a share purchase agreement

Summary

 

The definition of the term ‘damage’ (‘schade’ / ‘dommages’) in the event of a breach of the representations and warranties in a share purchase agreement is essential. In the absence of an explicit definition, general contract law does not define ‘damage’ for this kind of breach, which leads to legal uncertainty. Mere reference to the Civil Code can also lead to discussion. A clear contractual definition of the meaning of ‘damage’ is therefore recommended.

 

 

Contractual vs extra-contractual damage

 

Contractual damage arises when a party violates its contractual agreements. The parties have thus concluded a contract. Extra-contractual damage is damage without the existence of a contract between the parties involved. This damage can be caused by an intentional act or by negligence (including an omission).

 

In the Civil Code, contractual damage is defined as follows:

 

“The compensation payable to the creditor generally consists of the loss he has suffered and the loss of profits he incurred, subject to the exceptions and limitations set out below.”

 

The aforementioned ‘exceptions and limitations’ are described as follows:

–        only damage that was foreseeable at the time of entering into the contract must be compensated (unless in the case of intent); and

–        the compensation only takes into account damage that is an immediate and direct consequence of the breach of contract.

 

Extra-contractual damage is defined in the Civil Code as follows:

 

“Every human act, which causes damage to another person, obliges the person by whom the damage was caused to compensate it.

Everyone is liable not only for the damage that he has caused by his act, but also for damage that he has caused through his negligence or his carelessness. “

 

Notwithstanding the existence of two separate legal provisions, the two concepts of damage have converged over the years as a result of doctrine and jurisprudence, and are interpreted today as follows: “the claimant must be placed in the condition he would have been in if the error had not occurred”. The claimant will therefore have to indemnify the claimant in full.

 

In principle, this definition includes indirect damage. Indirect damage is damage caused by the breach of contract, but is not a direct consequence thereof. For example, loss of raw material or additional personnel costs are considered indirect damage resulting from damage to a high-voltage cable (being the direct damage). Reputation loss or loss of revenue (lost profits) can also constitute indirect damage.

 

Finally, the damage can be patrimonial, moral and economic in nature.

 

Damage due to incorrect representations and warranties

 

Representations and warranties

 

Since general contract law offers little protection to the buyer of shares, the seller usually provides representations and warranties. These representations and warranties describe the position of the underlying company or companies (informative effect) or describe how the buyer has assessed the position when purchasing the shares, as well as who will bear the risk in the event of a violation thereof (risk allocation). Consequently, the parties agree that the seller will indemnify the buyer if the representations and warranties provided prove to be incorrect.

 

Damage due to incorrect representations and warranties

 

There is discussion in legal doctrine as to whether the concept of damage under contractual liability law as defined in the Civil Code applies if the parties have not included a definition of damage in the share purchase agreement (“SPA”). According to the aforementioned legal doctrine, there is definitely no contractual liability if the representations and warranties are violated, and therefore one cannot simply fall back on the contractual concept of damage under the Civil Code. It remains unclear what the applicable general concept of damage is if the parties have not agreed on a definition. Because of this uncertainty, it is advisable to define the concept of damage in the SPA.

 

In practice, as a definition of ‘damage’, reference is often made to the applicable articles of the contractual damage concept in the Civil Code. However, legal doctrine and jurisprudence have interpreted these articles in a way that does not correspond with the literal legal text anymore. Furthermore, account must also be taken of the fact that a breach of the representations and warranties does not in itself constitute contractual damage. It is therefore appropriate to include a clear definition of the concept of damage (see further under damage clauses).

 

Damage due to other violations of the share purchase agreement

 

The clause in which incorrect representations and warranties are sanctioned must be distinguished from a violation of another obligation included in the SPA. In the latter case, the contractual damage is purely contractual, to which the rules of the Civil Code apply. A choice can be made to declare the definition of damage applicable only in the event of a breach of the representations and warranties, or in the event of any breach of the agreement (including representations and warranties).

 

Damage clauses in the share purchase agreement

 

Clauses in favor of the buyer

 

As a buyer, one benefits from the broadest possible definition of damage. Based on the broad concept of damage in contractual liability law, the following clause can thus be considered:

“Damage is the difference between the condition of the buyer and the condition he would have been in, if [the breach had not occurred or] the representations and warranties had been correct and accurate.”

This definition also includes indirect damage, moral damage, reputation damage and loss of profit.

 

Clauses in favor of the seller

 

As a seller, one can keep the aforementioned clause, but then stipulate which damage will not be compensated. Such a clause may look like this:

“Damage is the difference between the condition of the buyer and the condition he would have been in, if [the breach had not occurred or] the representations and warranties had been correct and accurate, excluding indirect damage, moral damage, reputation damage and loss of profit.”

Finally, we should mention that in a SPA, the seller’s obligation to indemnify the buyer is usually contractually limited by means of de minimis arrangements, a basket and a maximum amount (cap).