Irish society of comparative law



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IRISH SOCIETY OF COMPARATIVE LAW

Third Annual Conference

Dublin April, the 29 & 30 2011


The breakdown of negotiations in M&A operations

Comparative approach

By Professors

Alain COURET 1 & Bruno DONDERO 2

1. The question of the breaking off of negotiations shows very classic legal aspects that one can find among lots of writers. The financial crisis that stroke the world starting summer 2007 gave again a real topicality to it, and more especially in the field of merger and acquisition. Lots of ongoing negotiations have been brutally stopped because of the deteriorated financial context, either that buyers were not anymore able to finance the operation, or that the necessary industrial redeployments led to totally rethink group’s strategies. For what France is concerned, the increase of litigation concerning these breaking offs has been spectacular. However, the crisis cannot explain the phenomenon by itself. Experience shows that, in more favorable times, investment funds in the position of seller do not hesitate to interrupt the negotiation if they consider that there is a chance for them to sell later at a better price3. Besides, a considerable increase of the cost of pre-contractual studies has been revealed, in the same time as the temptation to put it on the charge of the party responsible for the breaking off4. It is probable that this phenomenon also exists in other industrialized countries. These breaking offs are naturally not without any legal consequences.

2. Now, on this level, the issue of the breaking off of negotiations in the context of M&A operations presents certain specificities compared to common legal principles that usually frame the breakdown. M&A’s operations are not made in one day: relevant operations involve lengthy procedures meant to give the buyer a better knowledge of the company. It is an observation that is exterior to the parties will, but that has an unavoidable consequence on the assessment of the final prejudice: this period of time is indeed very often at the origin of the compensation claim because it created for the victim the illusion that the operation will be carried out, the only doubt being on the final conditions. Notably, the irreducible time that takes the audit of the company is cumulating with the period of pure negotiations.

3. There is a huge diversity of harms that can potentially be caused: it goes from purely material damages, lost investments and expenses, to more subtle ones, such as image or reputation damages. The entity concerned is most often a firm, which means a production unit. The sudden withdraw of the one that appeared as the only possible buyer may cause the stoppage of the activity on a more or less short term. The stakes are usually substantial, and often go beyond the direct actors to affect a whole industrial sector and with it the stability of dozens or even hundreds of jobs.

4. With fewer consequences, the withdrawal of a potential buyer may have a negative influence on the value of the shares of a public company. Therefore, the breaking off obviously causes a damage to three types of actors:


  • to the potential seller of the shares

  • to the company controlled by this seller

  • to the minority shareholders of the company that should have been took over

It is a specificity of the breaking off of negotiations in M&A’s operations that the sphere of victims is expanding beyond the seller5.



5. Besides, parties rarely have a total mastery of the situation. Employees, creditors, the State government itself may tempt to weight on negotiations to incite parties to make them fail. Circumstances beyond control excluded, there is no doubt that stakeholders behavior is not without any influence on the decision to break off negotiations that are already lasting for a certain period of time.
Likewise, the financial perspectives of the company that is not entirely imputable to the potential seller, especially if he is not an executive, may have a huge impact on the decision to sell or not. Case law reveals situations in which the financial position of the sold company has deteriorated all along the negotiation period and provoke the decision by the potential buyer to break them off6. The company may be declared in official receivership during the negotiations without any party having any possible influence on this event7.

6. Therefore, comparing responses that the different legal systems are giving to this issue is particularly interesting, especially because of the multiplication of cross-border deals. When such operations occur, negotiators of different cultures are called into action, with the consequence that common practices…are not common anymore! Indeed, it is never useless to know about the solutions adopted by other systems. Beyond this trite consideration, comparative law is very relevant regarding the negotiation of a contract. A company that starts negotiating an important contract with a potential business partner does not feel bound. A letter of intent may be signed by the potential contractual partners, but often reveals “non-binding”, which can lead the parties to believe that they are not yet concerned by provisions of the law. However, let’s point out that a too strict legal formalization of the negotiation, for instance through the presentation of clauses framing tightly the negotiation and its possible breaking off, may result in the failure of the negotiation. As a matter of fact, frightening the other party by having her believe that it is already bound by a contract may reveal extremely barrenness, even though the first intention was to secure de negotiation process. Here, the legal adviser, either internal or external to the company, must have a particular sensibility.

7. Nonetheless, the will not to enter into the contract as long as the negotiation process is in course may be a source of danger. There is no contract yet because consents have not been exchanged. All right then, but is it always the case? Isn’t there a risk that the other party starts complaining through unforeseen claims based on the law she is submitted to? If the legal system that applies to one of the parties provides that one should not be considered as bound as long as no written document is signed, isn’t it possible that according to the legal system to which the other party is submitted, the contract is formed when negotiations lasted for a determinate period of time?

8. Of course, not having concluded a contract and though not having conventionally determined the applicable law to the parties is very dangerous. Therefore, wisdom would consist in the initial setting of the applicable law through agreements framing the negotiations. Here, the question that arises is to know which law will be the most efficient to deal with the consequences of a breaking off. Are the parties willing to be able to freely break off the negotiations? Or, in the opposite, do they want to organize more strictly those consequences? As pointed out by Professor Jean-Flavien LALIVE8: “given the fact that the notion of pre-contractual liability does not exist in common law, some American companies have been very surprised to see damages claims petitioned against them and their liability involved because the law that had already been chosen – or could be determined through obvious clues – were establishing the principle of this liability, which they ignored”.

9. The chosen law has a very strong influence, as it rules :

Whether the parties are under a duty to negotiate in good faith and what is the effect of breaking off of negotiations.

-Whether there are liabilities for negotiating in bad faith.

-What remedies are available to the victim of a breaking-off of negotiations ?

-Is there any obligation to continue to negotiate until there is proper reason to withdraw?

-Whether a bare agreement to negotiate has legal content9 or can be totally deprived of legal effects. As a consequence, it is important to choose a law from which an optimum is awaited, concerning the duties of the parties to the negotiation, and concerning the setting of the consequences of a tortious breaking off of negotiations.



10. Those are the two points that will be researched in this paper. We’ll research what are the answers that some of the mostly used contract laws provide in these matters: what are the duties of the negotiating parties (I), and then what are the consequences when such duties are breached (II).

I – Duties of the parties to the negotiation

11. One can notice that in most legal systems, parties are required to respect several obligations during the time of the negotiation. These duties find their origin in fairly different sources (A). Besides, these duties have different perimeters because, behind them are hiding more or less extended obligations (B).

A – Sources of the duties
12. Sometimes, the legislator can formulate obligations that are weighting on the parties to a negotiation (1°). More often, this formulation is made by the judge (2°). However, the parties may also frame their negotiation themselves by establishing an appropriate agreement (3°).


1° - The setting by the legislator of specific duties:
13. Such obligations can be found in the German BGB (a), as much as in the Italian civil Code (b). They are annunciated in French law (c) and can also be found in provisions with an international scope (d).


  1. Provisions of the BGB



14. In 2002, the German legislator has codified the idea of Culpa in contrahendo in the § 311 II of the BGB. The doctrine of culpa in contrahendo is based on a prominent article by Jhering, published in 1861 and entitled “Culpa in contrahendo, oder Schadensersatz bei nichtigen oder nicht zur Perfektion gelangten Verträgen10. This doctrine is founded on the ancient Roman law of obligation and postulates that in pre-contractual negotiations future parties must employ the ‘necessary diligentia’. A party, who, through blameworthy conduct, causes the contract to be invalid or prevents a contract from being formed, should be liable for damages suffered by the innocent party who relied on the validity of the prospective contract11. From the point of view of Jhering, the German common law, known as Gemeines Recht, was seriously defective in not paying sufficient attention to the needs of commerce12. To give an example: The buyer who unintentionally ordered 100 pounds instead of the intended ten was not liable to reimburse the seller for the costs of transporting the merchandise rejected13. These and similar circumstances convinced Jhering to raise the issue whether the blameworthy party should not be held liable to the innocent party who had suffered damages to relying on the validity contract14. Giving an affirmative answer, Jhering suggested that the law has to provide the restoration of the status quo by giving the damaged party his ‘negative interest’ or reliance damages (Vertrauensschaden, negatives Interesse). In contrast, the injured party will not be able to recover the value of the promised performance, namely the expectation interest (Erfüllungsinteresse, positives Interesse)15.


15. The German civil code (Bürgerliches Gesetzbuch) was enacted in 1896 and came into force on January 1, 190016. Correspondingly, the doctrine of culpa in contrahendo was known during the formation of the BGB. Nevertheless, the civil code did not adopt the general theory of culpa in contrahendo17. Indeed, the German legislature established this doctrine in different articles within the BGB such as articles 12218, 179 BGB (old and new version), 307, 309 BGB (old version) in favour of the party that is injured due to the nullity of the contract. Additionally, German courts had established the doctrine of culpa in contrahendo in terms of a legal institution. According to the German jurisdiction, in particular the Supreme Court of the German Reich (Reichsgericht) and the Federal Court of Justice (Bundesgerichtshof), each pre-contractual relationship between the parties engenders a mutual trust between the parties similar to that arising from a contract, so that the parties are obligated to observe customary standards of care19. The application area of the culpa in contrahendo covered amongst others the following situation: In case of loss that one party suffered during the contract negotiations, in case of an inopportune rupture of the contract negotiations by one of the parties, in case of the nullity of the contract (or a contract that disadvantages one of the parties) due to a culpable behaviour by one of the parties20.

16. Given that German tort law has not adopted a general tort liability for injury, cases have been viewed as contractual or quasi-contractual even in those instances where negotiations did not result in a contract21.

17. The German Law dated November 26, 2001 – the so-called modernization of contract Law (Gesetz zur Modernisierung des Schuldrechts) – came into force on January 1, 2002. The law was finally adopted after long discussions that began in summer 200022. The original purpose of the draft law was to transfer three European Directives into German Law before January 1, 2002 (regarding to the sale of consumer goods, times of payment and e-commerce). Therefore, the legislator favoured a simultaneous implementation of a wider reform of contract law instead of a simple modification of the BGB in order to integrate these directives into German Law23. This modernization has formed new concepts in contract law, extremely modified the legal rules governing sales contracts and limitation periods and has codified various different laws within the BGB24. Inter alia, the new law codified jurisprudential solutions such as the “culpa in contrahendo”25. According to Articles 311 II and 241 II BGB, mutual duties concerning loyalty or good contractual faith arise upon the commencement of contract negotiations26. Contrary to the French law, the responsibility according to Articles 311 II and 241 II BGB presents a contractual basis27.

18. At present, the Culpa in contrahendo is governed by articles 311 II28, 241 II29 and 280 I30 BGB. According to German law, contractual obligations engender responsibilities pursuant article 241 II BGB. Correspondingly, the German law diverges between duties of care pursuant to article 241 II BGB (nicht leistungsbezogene Nebenpflichten) and main duties pursuant to article 241 I BGB (leistungsbezogene Hauptpflicht) that exist side by side31. According to articles 241 II BGB, the parties have to to take account of the rights, legal interests and other interests of the other party even in pre-contractual situation that are listed in article 311 II BGB. The non-fulfillment of these duties of care (nichtleistungsbezogene Nebenpflicht) in pre-contractual situation gives grounds for a liability according to article 280 I BGB32.

19. The type of damages recoverable under articles 311 II, 241 II and 280 I BGB do not include ‘positive interest damages’, but only ’negative contractual interests’ or reliance damages such as useless expenses33.


  1. Provisions of the Italian civil Code



20. Italian legal system34 adopts a different approach than other Latin systems since article 1337 of the 1942’s civil Code provides that “parties, during the negotiations of the contract, must act in good faith”.
Moreover, article 2 of the Italian Constitution imposes to every party entered in an obligation relationship the duty to act in such way to preserve mutual interests35.


21. c. The French projects

They are now the draft-projects






2005 Catala’s Contract law reform project.
This text, which has been partly reused by further projects, would create, inside of the civil Code, a section dedicated to the formation of the contract, and where one could find three articles dealing with the negotiations:
Article 1104 The initiative, the progress and the breaking off of negotiations are free, but have to comply with good faith requirements.

The failure of a negotiation can only be a source of liability if it is imputable to one party’s fault or bad faith.


Article 1104-1 Parties have the possibility, trough an agreement in principle, to bind themselves to subsequently negotiate a contract for which the elements are still to determine, and to work in good faith toward their determination.
Article 1104-2 The rules governing the agreements aimed to set the progress or the breaking off of negotiations is subject to the provisions of the subtitle hereby.

One of the subsequent projects, emanating from the Government and spread during year 2008, used these provisions while slightly modifying them.


2008 Ministry of Justice pilot study
Section 1: The negotiation
Article 20

The initiative, the progress and the breaking off of pre-contractual negotiations are free.

The tortious running or breaking off of these negotiations requires, from its author, a compensation on the basis of liability in tort. The misdemeanor is notably constituted when one of the parties started or carried on negotiations without the intention to reach an agreement.

The damages allowed should not aim at compensating the loss of the profits expected from the unconcluded contract.


Article 21

Independently from any breaking off, the one that uses, without authorization, confidential information obtained during negotiations commits his liability in tort.


Article 22

The agreement in principle by which the parties are bound to subsequently negotiate a contract for which the elements are still to determine is subject to the provisions of the subtitle hereby.





  1. Texts with international scope


22. Beyond the particular case that constitutes the law of every state, it is necessary to mention sources with international scope. We will successively consider Unidroit and European contract law principles.

23. First, UNIDROIT principle (2004 version).
Article 2.1.15 tackles the question of bad faith in negotiations. As for article 2.16, it tackles the issue of confidentiality duty.

Article 2.1.15 – Negotiation in bad faith

(1) A party is free to negotiate and is not liable for failure to reach an agreement.

(2) However, a party who negotiates or breaks off negotiations in bad faith is liable for the loss caused to the other party.

(3) It is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party.



24. Then, the European contract law principles.
Article 2.301 (ex. art. 5.301) – (1998 version) – Negotiations Contrary to Good Faith
(1) A party is free to negotiate and is not liable for failure to reach an agreement.

(2) However, a party who has negotiated or broken off negotiations contrarely to good faith and fair dealings is liable for the loss caused to the other party.

(3) It is contrary to good faith and fair dealing, in particular, for a party to enter into or continue negotiations with no real intention of reaching an agreement with the other party.


2° - The setting of the duties by the judge:

25. Today, in the French legal system, the step of negotiations is not framed by specific contract law provisions. Given that French contract law is based on the principle of freedom of the parties to bind themselves or not, it is always possible to decide not to continue with just stared or far carried negotiations. It is an exception, that case law recognizes, and on the bases of liability in tort (contractual liability being excluded), duties weighting on the party that blameworthy broke the negotiations off.
Finally, it must be recalled that the contract law reform projects are expressing the wish that the French legislator supervises more this negotiation period (see above).

26. Such specific legal duties36 neither exist in the Belgian legal system.

Nevertheless, principles have been developed around article 1134 and 1382 of the Belgian civil Code. The freedom of breaking off the negotiations is tempered by a duty of good faith that governs the execution of the contract as much as its formation. “From the principle of good faith that arises from article 1134 pas. 3 of the civil Code, objective behavior rules can be deducted. Thus, parties are bound by a general obligation of integrity, loyalty, and collaboration in the conduct of negotiations37.



27. Swiss case law is keeping with the same perspective. It considers that the use of the power to break off may result in a contractual liability in certain circumstances. However, it is an exception to the principle of free breaking off of negotiations38, the Swiss Federal Court reminding that “each party has the right to break the negotiations off without having to give any reasons for it39.

28. Now, if we leave continental legal systems for common law countries, the doctrine frequently recalls that these systems are ignoring the notion of tortious breaking off of negotiation. And, indeed it seems that there is no equivalent to the blameworthy breaking off of negotiation in the English legal system. One can notice that there is no general rule in common law requiring the parties to negotiate in good faith 40 (although the parties are always free to bind themselves to act in such a way, by a letter of intent or a memorandum of understanding, and commonly do so when negotiating an M&A agreement). A party can decide to break off the discussions, even though they have been carried pretty far and without having to explain her reasons41. Generally judges never use good faith in that field42.
« As a general rule, a party to pre-contractual negotiations may break them off without liability at any time and for any reason – a change of heart, a change of circumstances, a better deal – or for no reason at all. The only cost of doing so is the cost of that party’s own investment in the negotiations in terms of time, effort, and expense”43.
Lord ACKNER adds: “How can a court be expected to decide whether, subjectively, a proper reason existed for the termination of negotiations? The answer suggested depends upon whether the negotiations have been determined “in good faith. However, the concept of a duty to carry on negotiations in good faith is inherently repugnant to the adversarial position of the parties when involved in negotiations. Each party to the negotiation is entitled to pursue his (or her) own interest, so long as he avoids making misrepresentations44.
However, the magistrate goes even further: “the concept of a duty to carry negotiations in good faith is inherently repugnant to the adversarial position of the parties when involved in negotiations”.
The underlying philosophy is easy to perceive, as the author is pointing it out45: “the common law principle of freedom of negotiation reflects a concern that negotiating parties will be hesitant to enter into negotiations if they fear pre-contractual liability. Thus, if the parties do not match offer and acceptance, the common law permits the negotiations to lapse without imposing liability based on a moral obligation of good faith dealing. In the case of pre-contractual negotiations, the common law has chosen the predictability of the legal outcome over equitable justice or potentially vague concepts of fairness”.

29. As for English Law, it appears that the American judge occasionally relies on the parties’ preliminary agreement (letter of intent) to recognize the obligation to negotiate in good faith. Consequently, signing this agreement at the beginning of negotiations presents more than a simple symbolic importance.
As for the rest, apart from a special agreement to negotiate in good faith, each party may break off the negotiations at any given moment without any good reason. However, there are some necessary corrections formed by American judges.
Thus, in the famous case law FELDMAN V. ALLEGHENY INTERNATIONAL, the court held: “Good faith is no guide. In a business transaction both sides presumably try to get the best of the deal. That is the essence of bargaining in the free market … So one cannot characterize self interest as bad faith. No particular demand in the negotiations could be termed dishonest, even if it seemed outrageous to the other party. The proper recourse is to walk away from the bargaining table, not to sue for bad faith negotiations”46.


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