A condition sometimes enables one party a relatively great discretionary freedom to decide whether or not it is satisfied. If such liberty essentially means that a party freely can walk away from the transaction or postpone the moment on which it decides to enter into the transaction, such condition is referred to as a ‘potestative condition‘. That is an unenforceable condition. This blog is on the particularities of such 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.