Rolling back share sale: the consequences of error

It is regularly reported in the news that one company takes over another. A recent example is the acquisition of the online bank Knab by the Austrian BAWAG Group AG last February. Corporate acquisitions, however, do not always go off without a hitch. The question always remains whether the buyer of a company is not buying a cat in the bag after all. To prevent this, an investigation of the company, also called due diligence, is conducted prior to the acquisition. After the due diligence is completed, the transaction documents are drawn up. Still, it can happen that after the purchase agreement is concluded, the buyer finds out that the company is in a much less rosy state than previously thought. In some cases, the purchase agreement can then be annulled by invoking the so-called “error”. Recently, the Supreme Court issued a ruling on the consequences of the annulment of the share purchase agreement after a successful appeal to error. In this article, I will elaborate on this ruling.

What is error?

Error is defined in Article 6:228 of the Civil Code (“BW”). That article states the following:

(paragraph 1) A contract that has been concluded under the influence of error and would not have been concluded in the event of a correct representation of the facts is voidable:

(a) if the error is due to an information of the other party, unless the other party was entitled to assume that the contract would have been concluded even without this information;
(b) if the other party should have informed the erring party of what he knew or should have known about the error;
(c) if the other party based the conclusion of the contract on the same erroneous assumption as the erring party, unless it should not have understood, even on a correct presentation of the facts, that the erring party would thereby be deterred from concluding the contract.

(Paragraph 2) Annulment may not be based on an error which concerns an exclusively future circumstance or which, in connection with the nature of the contract, generally accepted practice or the circumstances of the case, should be borne by the errant.

In short, the contract can be annulled if there is a defect of will. This is the case, for example, if a party would not have entered into the contract had he known that the facts would turn out to be quite different after all. So, for example, in the case of an acquisition of a company, the acquisition balance sheet as agreed upon between the parties may turn out to be largely contrary to reality. In other words, the buyer entered into the agreement with a certain assumption that later turns out to be incorrect.

A note here is that the seller’s duty of disclosure and the buyer’s duty to investigate are always important as well. Generally speaking, it can be said that the duty of disclosure carries more weight than the duty to investigate. This is not always true and depends on the circumstances of the case. It should also be judged by the test of reasonableness and fairness

Destruction

If a party successfully appeals for the annulment of the contract, it means that the contract never legally existed. Annulment of the contract has a so-called retroactive effect. This means that the (legal) acts that have already been performed must in principle be undone.

Mistake in share purchase agreement

In share purchase agreements, the doctrine of error is usually explicitly excluded. Nevertheless, it is sometimes then still possible, based on reasonableness and fairness, to legitimately invoke error, even if error is excluded in the purchase agreement. As a result, the purchase agreement can be annulled and, in principle, the performance that has already been carried out must therefore still be undone.

Objectionable undoing

Article 3:53 paragraph 1 of the Civil Code stipulates that the annulment works back to the moment the legal act (entering into the purchase agreement) was performed. It may be that the performance already carried out is already far-reaching or that its undoing is no longer possible. For example, if a contract has been concluded for the renovation of a house and the work is already advanced, it is not possible to undo the performance. The annulment cannot then be “performed.

Article 3:53 paragraph 2 of the Civil Code stipulates that a party can ask the court to deny the effect of the annulment – i.e., the undoing of the performed acts – in part or in full. Instead, the aggrieved party can request the court to impose the obligation to pay a monetary benefit on the party benefiting from it.

Supreme Court ruling

The Supreme Court ruled on this issue in a case involving the annulment of a share purchase agreement. Briefly, ABC Hekwerk Participatie B.V. (“ABC”) sold its shares in Promis Security Systems B.V. (“Promis”) to Rookie B.V. (“Rookie”). Rookie had conducted due diligence after which a share purchase agreement was entered into. The parties would continue to work together after the acquisition. Over time, the cooperation did not go well and Promis was declared bankrupt. Rookie subsequently claimed that ABC’s balance sheet guarantee in favor of Rookie reflected an inaccurate valuation of work in progress and thus the guarantee was breached. In addition, Rookie set aside the purchase agreement on the grounds of mistake and claimed that ABC provided false information to Rookie. In doing so, the company also claimed repayment of the purchase price.

The court dismissed the claim for annulment based on mistake. And ruled that ABC could only be condemned on breach of warranty grounds. Rookie appealed this to the trial court. The Court of Appeal ruled that there had been an error, but also ruled that the transfer of the shares could not be reversed (as described in Article 3:52(2) of the Dutch Civil Code). It ruled this because Promis had gone bankrupt and the company had already been sold by the liquidator to a resuming party. In other words, Rookie could not return the shares in Promis in the same condition as before the bankruptcy and for that reason it would be too objectionable to undo the share transfer.

Supreme Court ruling

The Supreme Court then ruled that the circumstance that the shares had already been transferred did not qualify as objectionable within the meaning of Article 3:52(2) of the Civil Code. As follows from the legislative history, Section 3:52(2) of the DCC should be applied with restraint. Also in this case. This means that the situation that the shares have already been transferred and the shares cannot be delivered back in the same condition is not sufficient for a successful reliance on Article 3:52 paragraph 2 of the DCC. The shares will therefore still have to be delivered back after which the purchase price will have to be repaid.

Conclusion

In principle, a successful reliance on error as a result of the provision of incorrect information during the due diligence investigation for the purchase of shares will result in the performance having to be reversed. In principle, the fact that the shares have already been transferred and that the company is no longer in the same condition does not alter this.

Questions?

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