The concept of pre-contractual liability is still associated with a number of issues, despite its legislative anchoring in the Civil Code, the resolution of which is left to the decision-making practice of the courts. One of these aspects that has not yet been resolved – namely, whether the entitled party is entitled to compensation for lost profits from a contract that has not been concluded (or lost performance under such a contract) – has become the subject of judicial review, and it appears that (at least for the time being) the courts’ conclusions on this issue have become settled.
In its decision of 31 October 2023, Case No. 23 Cdo 3191/2022 (hereinafter as the “Decision“), the Supreme Court concluded that the mere fact that a contract was not concluded as a result of the termination of one of the parties’ negotiations to conclude such a contract without just cause is not grounds for compensation for lost profits from a contract not concluded (or lost performance under such a contract). This conclusion was subsequently confirmed by the Constitutional Court.[1]
In the following article, we will summarise the issue of pre-contractual liability in general and in relation to the obligation to compensate for damages.
General circumstances of the Decision
The issue of pre-contractual liability in relation to the right to compensation for damages from a contract not concluded came before the Supreme Court in the context of proceedings in which the applicant (the contractor) sought compensation for damages as a result of the defendant’s (the client) dishonesty in pre-contractual negotiations for the conclusion of a works contract. In the end, the contract was not concluded and, according to the applicant, the negotiations for the conclusion of the contract were terminated by the defendant without justification and completely unexpectedly. The damages claimed by the applicant should have covered both the costs incurred in drawing up the design of the work for the purpose of the performance of the contract in question and the loss of profit on the contract in question which the applicant would have made had the contract been concluded, and the costs of drawing up an expert’s report to establish the damage suffered by the applicant in connection with the negotiations for the conclusion of the contract.
In the proceedings, several issues were submitted to the Supreme Court for consideration, in particular the scope of the right to compensation for damages resulting from the breach of pre-contractual liability, or what specific costs or potential damages arising from the unjustified termination of negotiations on the conclusion of the contract must be compensated by the obliged party to the entitled party.
Conditions of pre-contractual liability
The starting point for the resolution of questions concerning pre-contractual liability is Section 1729(1) and (2) of Act No. 89/2012 Coll, Civil Code, as amended (hereinafter as the “CC“), which provides that if the parties reach such a point in the negotiation of a contract that the conclusion of the contract appears highly probable, the party who, despite the other party’s reasonable expectation of the conclusion of the contract, terminates the negotiation of the contract without having a just reason for doing so, acts dishonestly (par. (1) and the party who acts dishonestly shall compensate the other party for damages, but not more than to the extent of the loss resulting from the failure to conclude the contract in similar cases (par. 2). A question that has not yet been resolved in the case-law is what is meant by ‘loss under an unconsummated contract’ in accordance with the wording, meaning and purpose of the above provision.
Pre-contractual liability, or liability for the termination of negotiations on the conclusion of a contract as it is conceived in Section 1729 CC, is a special fact of breach of a legal obligation and the creation of a right to compensation for damages in relation to the general Section 2910 CC.
In order for this to be fulfilled, and consequently for the right of the affected party to compensation for damages to arise according to the diction of Section 1729(2) of the Civil Code, three conditions must be cumulatively fulfilled:
- Wrongful conduct – in this context, a breach of the duty of good faith in legal dealings[2], where the negotiations for the conclusion of a contract have reached a stage where one of the parties, as a result of the conduct of the other party, had a good faith belief that the contract would be concluded (the conclusion of the contract appeared highly probable to it), and the other party terminated the negotiations for the conclusion of the contract without having a fair reason to do so;[3]
- injury – the occurrence of damage quantifiable in monetary terms to the party concerned; and
- a causal link (causal nexus) between the above conditions, i.e. a causal relationship between the unlawful conduct of one party and the occurrence of the injury of the other party.
In order to determine whether these conditions are met, it is essential to define exactly “what” the party who terminated the contract negotiations without just cause is liable for. In the Decision, the Supreme Court agreed with the proposition, confirmed by legal theory and much of the literature[4] , that the liability of the party who terminated the contract negotiations without just cause means liability for creating the expectation of the conclusion of the contract in the injured party, not liability for the subsequent failure to conclude the contract. Damages under Section 1729(2) CC are intended to bring the injured party to a lawful state, i.e. to a state in which the injured party knows that the contract will not be concluded or need not be concluded, and not to a state in which the contract would have been concluded.
On the basis of the above facts, the Supreme Court concluded that the failure to conclude the contract as such is not unlawful within the meaning of Section 1729(1) CC, therefore Section 1729(2) CC does not entitle the injured party to compensation for the loss resulting from the failure to conclude the contract. In particular, the injured party is not entitled to the loss of profit resulting from the non-execution of the contract, since that loss is not causally linked to the termination of the other party’s conduct in concluding the contract without just cause within the meaning of Section 1729(1) CC. In other words, Section 1729(2) CC provides for a limitation on the amount of compensation for such damage, not a specific ground for the right to compensation.”[5]
Just cause for termination of negotiations
Termination of contract negotiations without just cause, i.e. conduct contrary to the principle of good faith, may be classified as an unlawful act. However, for a correct legal qualification and legal certainty for the parties, it is necessary to answer the question – what reasons can justify the termination of contract negotiations.
The expert community and the commentary literature agree in their majority that objective unforeseeable circumstances are just cause, not only those that would exclude liability for breach of contract (see Section 2913(2) CC), but also those that would constitute a material change of circumstances (see Section 1765 (1) CC) However, less intense objective reasons, including those that would make the performance of the negotiated contract more difficult and do not normally affect the performance of the contractual obligations, could also constitute just cause (see Section 1764 CC).[6]
However, the fairness of the reason for terminating the contract negotiations must always be assessed in relation to all the circumstances of the case and in particular the reasonable expectation that the dishonest party has created in the other party[7]. The Supreme Court has already expressed its views on this issue several times before, in this context in particular in its decision of 30 October 2018, Case No. 25 Cdo 856/2018, according to which the assessment of the fairness of the reason must not be too strict (in doubt, i.e. in favour of the fairness of the reason) and any rational reasoning of the negotiating party, based on objective reality, but also on a defensible subjective conviction supported by the specific circumstances at a given place and time, should be assessed as a fair reason.
A frequent factor in contract negotiations, even in larger and more complex transactions, is the potential for a better offer from a third party. According to the conclusions of the above-quoted decision of the Supreme Court and looking at such a situation through the lens of the main legal principles – the principle of autonomy of will and freedom of contract – such a situation will be subject to a case-by-case assessment by the court. Particularly in such a case, all the attendant circumstances of the negotiation, such as the pre-agreed exclusivity of the negotiation or a similar arrangement (even if only indicated by one of the parties) which would exclude the acceptance of a more advantageous offer as a fair reason for terminating the negotiation, will be relevant. Neither the Decision nor the Supreme Court’s existing decisional practice has yet explicitly reached a clear conclusion. However, even in light of the Supreme Court’s decision of 27 May 2021, Case No. 25 Cdo 15/2021, confirmed by the Constitutional Court’s ruling of 29 September 2021, Case No. III ÚS 2510/21, it can be assumed that the unambiguous advantageousness of an offer from a third party could be a fair reason.[8]
Reasonable expectations of the other party
Another legally relevant moment is when one of the negotiating parties has a reasonable expectation that a contract will be concluded. This too is still open to interpretation and depends on the specific circumstances, but in general terms the accompanying features of conduct giving rise to a reasonable expectation of the conclusion of a contract can be summarised.
The conclusion of the contract must appear to the other party as almost certain, i.e. there is agreement on the entire content of the contract and all that is awaited is its confirmation in the agreed or prescribed form or when a specific fact occurs. In such a case, it will not even be necessary for the dishonest party to expressly confirm the apparent fact that the conclusion of the contract appears virtually certain, it is sufficient that the impression of the injured party is not contradicted in any way. However, if it contradicts such an impression, for example by indicating that nothing is certain until the contract is actually signed, no reasonable expectations can arise. If any marginal issues remain to be resolved, then it is again a matter of assessing the specific active conduct of the dishonest party, which should, in its own interest, clearly communicate that the issue in question is or is not important enough for it to be the reason for (not) concluding the contract. Notwithstanding the various possible stages of negotiation and the parties’ reservations, it is true that the contract negotiations must reach at least the stage where the parties have reached agreement on all the essential provisions of the contract, in any event.[9]
In practice, this may lead to a situation where the contract is already negotiated in its full content, it is already printed and only awaits the parties’ signatures, and yet there is no room for a reasonable expectation of the parties to conclude the contract.
Practical recommendations
The decision provided a clear answer to the question of what is substituted for the obligation to indemnify in the context of pre-contractual liability and what conditions must be met. However, it does not provide any clear conclusions as to the just reasons for terminating the negotiations or for creating a reasonable expectation that a contract will be concluded.
In particular, it may be advisable to set out in advance and clearly define the specific conditions for the termination of the negotiation of the contract or contracts in question, whether in a letter of intent, term-sheet or similar document. At the same time, it is recommended to communicate clearly in the negotiations what priority the individual provisions and elements of the contract have for your party, especially those that cannot be considered essential for the type of contract to be concluded in the future.
Conclusion
The Supreme Court slightly clarified the previously unresolved issue of the scope of compensation for damages in the context of pre-contractual liability in the Decision when it determined that the lost profit from the unconsummated contract is not causally related to the termination of the party’s conduct in concluding the contract without just cause within the meaning of Section 1729(1) CC.
Section 1729(2) CC provides for a limitation on the amount of compensation for such damage, not a specific ground for the right to compensation. However, as regards the equitable grounds for the termination of the conduct or the creation of a reasonable expectation that the contract will be concluded, it is still necessary to assess the individual circumstances of the particular cases, even if their assessment is based on general conclusions (both those derived from case law and the literature).
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[1] Resolution of the Constitutional Court of 15 May 2024, Case No. III ÚS 391/24.
[2] According to § 6 para. 1 CC.
[3] See the conclusions of the Supreme Court judgment of 30 October 2018, Case No. 25 Cdo 856/2018.
[4] BŘÍZA, P., PAVELKA, T. § 1728. In PETROV, J., VÝTISK, M., BERAN, V. et al. Civil Code. 2nd edition, 2nd update. Prague: C. H. Beck, 2022, marg. no. 16, respectively § 1729, marg. no. 8 and 9.
[5] Decision at 35.
[6] BŘÍZA, P., PAVELKA, T. § 1729 [Liability for termination of pre-contractual negotiations]. In: PETROV, J., VÝTISK, M., BERAN, V. et al. Civil Code. 2nd edition (2nd update). Prague: C. H. Beck, 2023, marg. no. 4.
[7] Sub. 6.
[8] Sub. 6.
[9] BŘÍZA, P., PAVELKA, T. § 1729 [Liability for termination of pre-contractual negotiations]. In: PETROV, J., VÝTISK, M., BERAN, V. et al. Civil Code. 2nd edition (2nd update). Prague: C. H. Beck, 2023, marg. no. 3.
Mgr. Martin Heinzel, Senior Associate – heinzel@plegal.cz
Rachel Kouklíková, Legal Assistant – kouklikova@plegal.cz
19. 10. 12. 2024