Canada: Can You Engage Your Liability By Walking Away From Contractual Negotiations? An Important Confirmatory Judgment From The Quebec Court Of Appeal

In a judgment dated June 30, 2015 in the case of Singh v. Kohli (2015 QCCA 1135), the Quebec Court of Appeal issued very interesting and up-to-date statements about the inherent risks of entertaining business discussions and then terminating same.

The appellant Singh is the founder and president of Kripa Energy Inc. ("Kripa"), a small oil-drilling company, who in the fall of 2010 engaged into discussions with the respondent Kohli and his related company (the "Respondents") on the possible acquisition of new units and corresponding injection of capital. The Respondents soon indicated they wanted to discuss sharing control of Kripa with Singh. Singh had initially presented his co-shareholders as silent investors and mentioned that they would follow any recommendation he would make.

At some point during the discussions, on November 12, 2010, the Respondents provided a draft Memorandum of Understanding ("MoU") setting out the general terms of the transaction they were proposing, but Singh did not agree with same. Amongst other things, he advised that he would need to consult with his co-shareholders given the Respondents' demands on shareholder structure to address control of Kripa. A few days later on November 15, 2010, during a meeting between the parties, Singh apparently changed his mind and agreed to the terms set out in the MoU. He also agreed to meet with the Respondent's lawyer to discuss a new shareholder agreement and finalize the transaction. The Respondent's lawyer testified at trial that during this meeting, which took place the next day on November 16, 2010, everybody seemed in agreement over the terms of the MoU and that he reviewed the document with the parties in order to draft the new shareholder agreement. He also testified that Singh vouched again for his co-shareholders who would do as he decided.

However, the transaction was never finalized as Singh never followed up on the documentation he had undertook to deliver and on November 27, 2010, 11 days after the meeting with the Respondent's lawyer, Singh advised the Respondents that there would be no deal because his co-shareholders did not want him to share control of Kripa.

The Respondents took action against Singh, with Kripa called as an impleaded party. They asked the Superior Court to force Singh and Kripa to comply with the MoU and proceed to the transaction, and also claimed damages against Singh. The trial judge found that the MoU constituted a binding contract and forced the issuance of additional shares of Kripa in consideration of the amount of money the Respondents were willing to invest. Hence the appeal procedures instituted by Singh.

In its judgment, the Court of Appeal discusses the binding nature of the MoU, the concepts of the apparent mandate and indoor management rule, as well as Singh's liability for having terminated the negotiations the way he did. In this article, we will limit ourselves on discussing the Court of Appeal's position on the latter, but we certainly recommend that you read the judgment on these other points if they are of interest to you, as the Court of Appeal provides great insights and up-to-date analysis on these matters.

The issue at hand with regards to the personal liability of Singh resulting from his termination of the contractual negotiations is summarized as follows by the Court of Appeal:

"[65] (...) under the general rules of the Civil Code of Québec, can the appellant be personally liable for the prejudice, if any, caused by his conduct during the negotiations with the respondents, including his refusal to enter and have Kripa enter into the contract that his counterparts were hoping to conclude? (...)"

The Court of appeal states that the general rule is the freedom of contract which, as a demonstration of free will, also entails freedom not to enter into a contract. As such, refusal to enter into a contract is not considered blameworthy and no personal liability may result from such a refusal, whatever the reasons may be (except in exceptional circumstances which are not present in this case, such as for instance when one has contractually agreed to enter into a subsequent contract). However, failure to negotiate in good faith and to collaborate loyally may be sanctioned, as a violation of the provisions of the Civil Code of Québec which stipulate that every person is bound to exercise his or her civil rights in good faith, that no right may be exercised contrary to the requirements of good faith, and that parties must at all times conduct themselves in good faith.

The Court of appeal acknowledges that even though negotiations are generally undertaken with the anticipation that a contract will result from same, this does not mean that one party cannot change his or her mind along the way, even at the last minute. Good faith will not limit freedom to contract or not to contract, but will ensure that parties act honestly and loyally during the negotiations.

In that context, the Court poses that disagreement between parties and failure to reach an agreement cannot, in and of themselves, be taken as a sign of lack of collaboration, bad faith or abuse from one party or the other. Also, to determine whether a party did not act in good faith, the conduct of both parties, and not only that of the party who ended the discussions, must be examined as well as the general context of the negotiations. The Court also indicates that the threshold to conclude to bad faith is high and will depend on a case-by-case, multi-factored analysis.

The Court considers that until the morning of November 15, 2010, Singh's conduct may have been "somewhat muddled", but cannot be qualified as dishonest or abusive. Until that time, Singh had never agreed to the MoU and had, on the contrary, expressed many reservations about the terms proposed by the Respondents. However, the Court finds Singh's conduct afterwards to be difficult to understand: he abruptly changed his mind on November 15, 2010 and accepted the MoU, even though same did not contain complete and comprehensive terms of the transaction. Nevertheless, by agreeing to the MoU, Singh was agreeing to pursue negotiations. He also at that moment "recklessly" vouched for the other Kripa's shareholders.

As the Court of Appeal puts it:

"[84] If the appellant committed a fault, it was then. And when he realized that he had gone too far (this is the only possible explanation for his next step), he discontinued the negotiations, but did so in an underhanded way that was also blameworthy. Rather than speaking frankly to the respondents, he decided not to follow through on his commitments to send the required documentation to Mtre Silverstein, after the November 16 meeting, and remained silent. (...) Nothing ensued, and as far as we know from the documents filed in appeal, the appellant did not respond to his former vis-à-vis before November 27 and confirmed his refusal in writing on December 7, 2010. This was certainly an inelegant manner to end the discussions."

But the Court of Appeal also looks into the Respondents' conduct during the same period. They are experienced businessmen who had every reason to be suspicious about the sudden and unexpected change of mind of Singh during the November 15, 2010 meeting and his renewed claim that his co-shareholders would simply follow his instructions. The Respondents had been provided in the past with a copy of the current shareholder agreement which provided for the approval of 66% of the unit holders in order to change Kripa's corporate structure or issue more shares. In that context, the Court remarks that the Respondents could not reasonably believe that the shareholders would simply follow Singh's lead, nor could they let themselves deceived by Singh's statement to that effect, and certainly not without any further inquiry. In fact, previous email correspondence exchanged between the parties hinted to the fact that some shareholders would disagree despite Singh's reassurances to the contrary. This apparently impacted the Court's reasoning, which wonders why the Respondents would decide to close their eyes on this problem as of the afternoon of November 15.

This lead to the Court's concluding as follows:

"[87] In short, until the morning of November 15, 2010, there was no meeting of the minds, no agreement and no expectations of an agreement anymore. On November 15 and 16, because of the appellant's change of mind, expectations were revived and the parties agreed to pursue their negotiations along the lines set out in the MoU. In the absence of the shareholders, however, neither party could reasonably expect that an agreement would ensue (which remained a mere possibility), and the respondents could not reasonably trust the appellant's claim in this regard. In fact, considering the terms of the MoU, the appellant, in the absence of the shareholders, had actually no other choice but to withdraw from the negotiations. That he was not exactly forthright with the respondents is certainly not commendable, but did not actually affect the outcome of the negotiations."

Therefore, it this context, the Court of Appeal refuses to hold Singh's liable for his termination of the negotiations, as the respondents were not justified to entertain any reasonable expectations that the negotiations would lead to a favorable outcome.

Interestingly enough, the Court also indicates that even if it were to conclude that the Respondents were justified to entertain such expectations, Singh's conduct could not be sanctioned as there is no evidence that it caused any compensable loss to the Respondents. Wasting time in negotiations is an inherent risk of any contractual negotiations and cannot be considered a prejudice for which compensation may be obtained, except in the most exceptional of circumstances. As for the profits expected by the Respondents, the Court acknowledges that the Respondents certainly lost the opportunity of buying Kripa's shares and receiving dividends, but since there was never any binding agreements to that effect nor a promise to contract (contrary to the trial judge, the Court of Appeal ruled that the MoU was not comprehensive enough and left too much to be negotiated to be considered as a binding contract), this loss is not a prejudice for which compensation can be awarded.

This judgment is a clear illustration of the case-by-case, multi-factored analysis that must be carried out before concluding to the bad faith of a party, and of the importance of the specific fact matrix of a case. Singh's conduct was certainly not commendable, but there was some wilful blindness on the part of the Respondents about the co-shareholders' approval. Overall, the Court of appeal made sure to look at both parties' behaviour to resolve the issue.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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