In this article we shall analyse the case resolved by the Spanish Supreme Court in its judgment issued on 1st July 2020 in which the assessment of an error as a defect of consent is resolved. The case in question deals with a contract of purchase and sale of shares between companies whose sale price is fixed on the basis of erroneous information available to the parties at the time of undertaking the contract.
The factual situation of the case consists of two companies with a participation in the share capital of a third company, both with a participation of below 10% of the share capital. The investee company agrees a share capital increase and facilitates information regarding the value of the company and profits which allow it to fix the sale price of the shares at Euro 30, divided into shares with a nominal value of Euro 6 and an issue premium of Euro 24.
One of the companies interested in the purchase of the shares wished to subscribe shares for a value of Euro 2.5 million, and so the other company participating in the investee company offered the former a packet of 33,000 shares of the issuing company at a price of Euro 29 per share, with a consequent saving of Euro 1 per share. This agreement is formalised in a purchase and sale agreement with the aforementioned conditions, and consequently the purchaser of the shares did not participate in the share capital increase. Note also the importance of the effects of this, as we shall now see, fixing the price of the purchase and sale between the participating companies on the basis of the issue price of the issuing company.
A few months later following the signing of the contract, the company auditors communicated to the board of directors that they had detected important deficiencies, since, profits were not what they had been estimated at first, but four times lower. Therefore, the value of the company was inferior to that which was initially expected. As a consequence of these changes, the
issuing company reduced the price of the shares to Euro 12 and returned to the subscribers of the issued shares the difference of Euro 18 in relation to the Euros 30 paid.
The company which had signed the purchase and sale contract for the 33,000 shares filed a claim for nullity of an error as a defect of consent, claiming the return of the money paid upon the return of the purchased shares. Secondarily, a partial nullity action for an error was sought, ordering the defendant to pay the difference between the price paid per share (Euro 29) and the recalculated share price (Euro 12).
The court of the first instance understood that there was no error in the consent regarding the value of the shares taken into consideration for fixing the price, as this is always relative and depends on what is agreed by the purchaser and seller parties. It also added that the mistake was not excusable, as both parties were shareholders of the issuing company and were able to know the true value of the issued shares.
The posture of the Supreme Court, which is contrary to that of the court of first instance, establishes that:
- In order for the error to be invalidating of the consent given in a contract, it must be essential, that is to say, it must be projected onto the circumstances (whether they are personal, or in relation to the qualities or conditions of the object of the contract) which were the main reason for undertaking the contract. In this case, it is understood to be essential, in that the price of the purchase and sale of the shares is fixed depending on the price fixed for the subscription of the new shares; specifically, one Euro less per share. The determination of the price of the new shares issued in the course of the share capital increase was as such in accordance with the value of the company and the profits obtained as reflected its accounting, and as verified by an auditor’s report.
In this respect, the Supreme Court specifies that the erroneous circumstances may be past, present or future; but, in any case, they must have been taken into consideration at the time of executing the contracts. What is decisive is that any new developments in the execution of the contract are in contradiction with the contractual rule. If it is not so, it will be merely a matter of events occurring after the generation of the contract, which would not be invalidating.
However, the particularity of contracts which are projected over the future (continuous performance contracts, for example) must be taken into account here, given that they already have a certain component of randomness, so that, if the knowledge of the randomness of the contract and the essence of the risks assumed are correct, the incorrect representation of what the result would be would not be considered an error. Therefore, a more restrictive criteria is given to this type of contracts.
- On the other hand, the error must be excusable, as well as relevant. Case law denies protection to those who, with the use of the diligence that was required in the concurrent circumstances, would have known what they did not know when they entered into the contract. In this case, no greater diligence can be demanded of the buyer than to have fixed the price on the basis of the audit report that determined the original value of the shares, which then changed.
The exceptionality of this case lies in the fact that the error is due to an erroneous price in the issue of the shares that led to the formalisation of the contract and the price
stated therein, in view of said issue price. This exceptionality is assessed by the High Court when it says that the error in the assessment may be excusable when it is brought about by a previous error regarding the qualities of the object or the parameters that determine its value. Regarding the case at issue, the error in the valuation of the share, which determined the price of the sale, was caused by a prior error regarding the value given by the issuing company in view of its accounts and the profits obtained; so that, had it known that the real data were different, a lower sales price for the shares would have been fixed or the contract of sale would not have been entered into.
Jaime Madero
Vilá Abogados
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17th July 2020
