The Court of Appeal's recent decision clarified the scope of the promisor's obligations in a "promises to stand surety for another" surety bond. (1)
A "promises to stand surety for another" is defined in article 1120 of the Luxembourg Civil Code as follows:
one can act as a guarantor for a third party, promising the latter's action, except for compensation against the one who has acted as a guarantor or who has promised to have the action ratified if the third-party refuses to keep the commitment.
Thus, a person (the promisor or guarantor) undertakes to the beneficiary that another person (the third party) will ratify or execute an agreement. If the promisor does not keep the promise, they may be liable.
It is perfectly possible, in the same contract, for a person to be personally liable to the creditor, but also promise (to the same creditor) that a third person will perform for the creditor. This is frequently the case when there are several debtors against the same creditor.
On 28 September 2012, via a contract (agreement one), company A transferred to C the shares of company E which operated a restaurant.
Article 2 provided that the transfer price of the shares was €1,100,000.
Article 6 provided that company C commits that company E conclude an employment contract with person B, with specific provisions on his remuneration. This remuneration constituted a net monthly salary of €9,000 for the period from 1 October 2012 to 31 December 2012, and then a net monthly salary of €5,000 from 1 January 2013. In case of termination of the contract before 31 December 2016, the parties provided for a severance payment of €5,000 multiplied by the number of months remaining until 31 December 2016.
By a second contract on 28 September 2012 (agreement two), company E concluded an employment contract with person B. The remuneration and compensation in case of early termination on 31 December 2016 are word for word the provisions of article 6 of agreement one. Person B was the manager of company A and had personally worked for the success of the restaurant.
On 29 October 2012, company E – which changed its name to D1 – terminated person B's employment contract for gross misconduct.
Person B filed a claim against D1 in the Luxembourg labour courts for unfair dismissal. The court qualified the contract and concluded that the parties had no employment contract and declined jurisdiction.
On 13 April 2016, company A and person B then filed a suit against companies C and D1 before the Luxembourg District Court.
According to their analysis, articles 2 and 6 of agreement one concerned the transfer price of the shares. The remuneration under article 6 of agreement one should, in their view, have been qualified as a supplement to the transfer price of the shares. Person B also claimed damages for, in his view, the unfair termination of his contract.
On 11 January 2018, the district court decided that the transfer price was fixed in clause 2 of agreement one. The court qualified clause 6 of agreement one as a "promise to stand surety for another". Company A had undertaken to C that company E and person B would conclude a contract on specific terms. As this contract had been concluded, company A was not liable.
Finally, the court decided that the termination of agreement two was justified. Thus, person B was not entitled to any damages.
Company A and person B appealed on 5 March 2018.
They requested that companies A and D1 be ordered to pay a supplement to the transfer price. They still considered that the remuneration provided for in article 6 of agreement one and included in the agreement to be supplemental to the transfer price of the shares.
Alternatively, they considered that the scope of the "promise to stand surety for another" was not limited to the signing of a contract with person B, but also extended until its execution until 31 December 2016 – the date until which person B was supposed to be bound to D1. Thus, if company A failed to take the necessary steps to maintain person B's contract until 31 December 2016, it would be liable as a promisor.
Companies A and D1 requested that the judgment of the court of first instance be confirmed in this respect.
Court of Appeal
The Court's reasoning was in three parts.
First, concerning the transfer price, the Court of Appeal noted that article 2 entitled "transfer price" about which there was no ambiguity. The parties did not contractually provide for a supplement to the transfer price in the case where agreement two with person B was terminated before 31 December 2016.
Second, regarding clause 6 of convention one, the Court of Appeal decided that it was indeed possible to bind oneself for the ratification of an agreement by a third party and/or for the performance of an agreement by a third party.
If company B were to commit itself regarding the performance of agreement 2, then it would incur contractual liability towards the beneficiary (company A). There would then be an order to pay damages, but never an order to perform the agreement in kind or by equivalent.
The Court analysed clause 6 and held that this clause had not been misinterpreted. Company A only undertook that D1 would conclude a contract with person B. The promisor had no obligation towards A regarding the performance of agreement two. Since the result had been achieved (a contract was indeed signed between E and person B), company A had fulfilled its obligation as promisor and was not liable.
Finally, the Court held that person B had indeed committed faults that justified the termination of agreement two to his detriment.
It is often the case that, in the context of a share transfer agreement, the parties agree that the manager of the transferor company will still be involved in the transfer, either under an employment contract or a service contract (eg, as a consultant). These financial clauses are drafted at the same time.
However, these clauses have two different purposes. It is necessary to draft the clause on the transfer price of the shares correctly, and to provide for a supplement to the transfer price, if necessary, in case agreement two is terminated before a certain date.
Regarding the "promise to stand surety for another", this decision confirms that a promisor may incur contractual civil liability in the case of a third party's failure to execute a contract. Nevertheless, the promise must be properly specified so that the promisor understands what they are committing themselves to.
Finally, even if the agreement provided for an earn-out and the promise to stand surety extended to the performance of agreement two, the transferor will not be contractually liable in case of serious misconduct justifying the termination of agreement two. However, by agreement, the parties may define what they consider to be serious misconduct.
Originally Published by Lexology
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