Are you about to start an M&A negotiation in the Czech Republic? Are you already part of one? If so, you should be aware of a relatively new and comprehensive regulation of pre-contractual liability under Czech law.

As suggested by its name, pre-contractual liability usually arises as a result of actions taken by a party before entering into a (formal) contract. In the case of M&A deals, this usually happens before the execution of a share purchase agreement or a similar contract. Until then, the mutual rights and obligations of the parties are often onlygoverned by a simple letter of intent or a non-disclosure agreement. As a result, important aspects of the relationship between the parties prior to the signing of the share purchase agreement (or its equivalent) may end up being governed by applicable statutory provisions on pre-contractual liability. Given the significance of this phase of M&A deals, as well as the expenses incurred by the parties (for example, in connection with due diligence audits, negotiation of a transfer documentation or procurement of financing), it is important that the parties understand the potential implications of pre-contractual liability law and, if necessary, exclude or limit its application.

Czech law distinguishes the following types of pre-contractual liability:

– Negotiations without the intent to conclude the agreement

– Termination of negotiations without a valid reason

– Obligation to disclose information

– Protection of confidential information

1)  Negotiations Without the Intent to Conclude the Agreement

This type of pre-contractual liability addresses situations when a party commences or continues in negotiations without the intent to conclude the agreement. This often happens when one of the parties is trying to acquire certain confidential information from the other party or purports to frustrate an ongoing negotiation with a third party. Note, however, that claims based on this type of liability are rather rare, since Czech law requires that the injured contractual party shows intent of its counterpart. In most cases this can be difficult to prove.

2)  Termination of Negotiations Without a Valid Reason

The second type of pre-contractual liability protects parties in situations where one of the parties terminates the negotiations without a valid reason – for example, merely because of a better offer from another bidder. This, however, applies only in cases where the negotiations between the parties have reached a sufficiently advanced stage for one party to believe (in good faith) that the relevant contract will be entered into.

Recent case law, however, suggests that a seller could try to avoid or limit its pre-contractual liability, even if it terminates the negation at an advanced stage, by reserving the right to do so at the outset of the negotiation – for example, by informing the potential bidders in an auction process that it reserves the right to refuse all bids or terminate the negotiation at any time.

3) Obligation to Disclose Information

The contracting parties have the obligation to notify each other of all the factual and legal circumstances of which they know or must know, so that each of the parties can make sure that it is possible to enter into a valid contract and that the interest of the other party to enter into the contract is clear.

After determining the information to be disclosed by the sellers and buyer’s knowledge for the purposes of the M&A negotiations, the parties must carefully considered the statutory disclosure rules and ensure that they will not interfere with any contractual disclosure obligations.

4) Protection of Confidential Information

Finally, Czech law requires each party to ensure that confidential information obtained in the course of negotiation is not misused or disclosed. While this rule is a simplified statutory version of the non-disclosure arrangements that have become a market standard, Czech law also provides parties with a right to keep records of confidential information and communications exchanged during the negotiations. Such provision, in most cases, goes against the intent of the parties (and the sellers in particular).

Conclusion

Parties to M&A deals – particularly those where the mutual pre-contractual rights of the parties are based on simplified letters of intent or other limited contractual arrangements – should carefully consider the potential impact of statutory provisions regulating pre-contractual liability.