Conditions precedent (cp’s) and conditions subsquent are of great importance because their effect can be drakonic. If a condition is not satisfied, the related rights or obligations either fall away or, depending on the formulation, become effective. This may even apply to the enforceability of the entire agreement.
Examples of conditions are a financing clause for the sale of a house, financial credibility (solvency) conditions for (revolving) credit facilities, a required shareholder approval for major (M&A) transactions or clearance by competition law authorities.
The law. Many national laws address the effects of a condition being satisfied, as does the DCFR:
III. – 1:106: Conditional rights and obligations
The terms regulating a right, obligation or contractual relationship may provide that it is conditional upon the occurrence of an uncertain future event, so that it takes effect only if the event occurs (suspensive condition) or comes to an end if the event occurs (resolutive condition).
Upon fulfilment of a suspensive condition, the relevant right, obligation or relationship takes effect.
Upon fulfilment of a resolutive condition, the relevant right, obligation or relationship comes to an end.
When a party, contrary to the duty of good faith and fair dealing or the obligation to co-operate, interferes with events so as to bring about the fulfilment or non-fulfilment of a condition to that party’s advantage, the other party may treat the condition as not having been fulfilled or as having been fulfilled as the case may be.
When a contractual obligation or relationship comes to an end on the fulfilment of a resolutive condition any restitutionary effects are regulated by the rules in Chapter 3, Section 5, Sub-section 4 (Restitution) with appropriate adaptations.
VIII. – 2:203: Transfer subject to condition
Where the parties agreed on a transfer subject to a resolutive condition, ownership is re-transferred immediately upon the fulfilment of that condition, subject to the limits of the re-transferor’s right or authority to dispose at that time. A retroactive proprietary effect of the re-transfer cannot be achieved by party agreement.
Where the contract or other juridical act entitling to the transfer of ownership is subject to a suspensive condition, ownership passes when the condition is fulfilled.
One may bear in mind, that a lawyer may have two roles relating to conditions precedent: negotiating them and making sure that they are satisfied.
Conditions as an exit. In many cases, the contracting parties may believe that the execution of an agreement concludes the deal, whereas in many cases there is still a lot of work to be done before the transaction is completed.
The negotiations of conditions precedent sometimes bring key interests of the parties to light. One party may have a great interest in the quick closure of the deal, whilst the other will probably need to receive more information on the object of the transaction. This is why conditions often serve as a leverage to renegotiate key deal terms (i.e., in such case, despite the drakonic effect, a condition precedent is not intended as an exit but rather as a protection of one party against ‘hidden defects’).
For example, if an ‘unsatisfied’ condition requires that the acquired company has a certain minimum amount of cash flow during, the purchaser may insist that the purchase price be reduced. At the same time, arguments to object to a proposed condition may be that satisfying such condition is onerous, expensive or not customary. In all cases, a condition should not permit a party a discretionary freedom to walk away from the deal after signing the agreement. (Explained in legal concepts: the ‘free will’ of a party or the ‘mutual consent’ of both parties should not in fact mean that one party may effectively still freely make up its mind.)
Terminology and cp’s versus conditions precedent. In somewhat unusual terms, the DCFR distinguishes between ‘suspensive conditions’ and ‘resolutive conditions’. More common is a distinction between conditions precedent (also called cp‘s) and conditions subsequent: conditions precedent, on the one hand, address conditions that should be satisfied before a right, obligation or contractual relationship comes into existence. On the other hand, conditions subsequent describe facts or events pursuant to which a right, obligation or contractual relationship may be terminated. Nevertheless, the term condition subsequent is not common parlance (if known at all); therefore, it strongly recommended that simple conditional wording is used such that “if ABC occurs, Party 1 may terminate this agreement”.
Conditions relate to future or uncertain facts or events. The DCFR on conditions requires that a condition refers to a future or uncertain fact or event. This distinguishes conditions from the legal concept of mistake (Irrtum, erreur, dwaling). The concept of mistake implies that an agreement, entered into on the basis of an incorrect assumption, is voidable (or otherwise subject to termination) if the agreement had not been entered into but for that assumption being incorrect (subject to tests of reasonableness and proportionality of termination).
To include a condition that refers to an unknown but existent fact or event (or to a fact or event that is uncertain for the parties but certain for others) is therefore not so much a question of conditionality of the agreement but rather an agreement between the parties that the referenced fact or event is important enough to trigger a termination. Nevertheless, if a straightforward condition is satisfied but for some apparently insignificant facts or events, the rights or obligations that are the subject of the condition will not come into force.
Potestative conditions. Effectively, such ‘subjective condition’ implies that the party has never been truly bound to the ‘agreed’ transaction (since that party has always been free to terminate ‘at will’); in fact it is questionable whether there was mutual consent or a meeting of offer and acceptance as regards the object of the agreement).
On the European continent, potestative conditions are invalid or ineffective. Depending on the contents of the condion, the principle of good faith would impose legal consequences that may for instance range from complete ineffectiveness of the condition, to a more objective (and reasonable) test whether the condition is satisfied, or even to an obligation on a party to make best efforts in order to ascertain that the condition be satisfied.
The potestative nature of a condition is not always apparent. For example, the following conditions contain a prevailing subjective element:
…Borrower has delivered its financial statements, in form and substance satisfactory to Lender.
…Purchasers having completed a due diligence review of the business, assets, contracts, tax and financial condition of Acquired Companies, being satisfied in all respects with the outcome of the review.
…The Parties having entered into a joint development agreement, allocating each Party’s entitlement to intellectual property rights in a mutually satisfactory manner.
The questionability of overly subjective conditions can be remedied in several ways. The inclusion of a standard of reasonableness in each of those conditions would mean that the beneficiary of the condition cannot avoid a closing by a simple statement that the condition is not satisfied (timely). The standard of reasonableness implies an objective test or at least a duty to explain (on reasonably understandable grounds) why the condition is not satisfied. Similarly, the conditions could be phrased more objectively.
For example, the condition could refer to market standards or customs of the market or even to the internal policies generally used by the beneficiary in similar circumstances. Alternatively, it is a good option to leave the determination whether the condition is satisfied open. Finally, the condition related to the joint development agreement could be elaborated by attaching an agreed framework or the main terms of such agreement. Obviously, time restraints or other circumstances may make this approach impractical.