Corporate │ M&A

Transfer of profit as compensation of damages, or asset forfeiture under civil law – Blog Edo Smid

By november 30, 2015No Comments

Section 6:104 Civil Code concerns unusual legislation that is as yet underdeveloped in terms of case law. What does it concern?

The text of the section is the following: “If an individual who is liable towards another individual on the basis of tort as a result of non-compliance with an obligation, has made a profit because of such tort or non-compliance the court may, upon the request of the injured person, appraise  the damage incurred by him to the amount of such profit or part thereof.” (“Indien iemand die op grond van een onrechtmatige daad of een tekortkoming in de nakoming van een verbintenis jegens een ander aansprakelijk is, door die daad of tekortkoming winst heeft genoten, kan de rechter op vordering van die ander de schade begroten op het bedrag van die winst of op een gedeelte daarvan.”)

In case law, the article was applied to tenancy law. In 2010, the Supreme Court ruled in a case involving the subletting of social housing by a tenant, which was in contravention of his rental contract. In doing so, the tenant charged a higher amount in rent than he himself would have to pay to the landlord, a housing corporation. The latter terminated the contract. As compensation of damages, the tenant was forced to surrender the profit he had made on the subletting – approximately EUR 13,000 – to the landlord.

In itself, the ruling does not involve a substantial financial interest, and could easily be overlooked in corporate law practice, where usually there is no case law alert for tenancy law.

In my opinion, however, the legal relevance of the ruling should not be underestimated. The following case was reviewed at a work meeting at our law firm. It is customary for a purchase contract to state that the seller of a business may not compete with the business the buyer purchased. It is with good reason that the buyer paid a good price. What, however, if the buyer operates in a growing, emerging market, and the seller ignores the non-compete clause agreed on and sets up a new, (unlawful) competing  business in the growth market he just exited. It will be quite difficult for the buyer to calculate the extent of the damage sustained in such a growth market, as it will be hard to determine to what extent his sales or revenue have declined at the hand of the seller. Nevertheless, the judge may be willing to accept that the buyer has sustained damage. Based on that assumption, the judge may award any profit seller made on contractually prohibited activities to the buyer. Taking into account the considerations of the subletting situation, it is irrelevant whether the buyer of the business would himself have gained the same revenue. In other words: the principle of determination of actual loss of profit is shifting.

It is advisable to take Section 6:104 Civil Code into account in the strategic analyses of recourse actions. It is difficult, however, to predict the development of case law. This is due to the fact that Dutch legislation on damages is based on the principle that only actually sustained damage can be compensated, despite the fact that such transfer of profit may, in certain circumstances, exceed the specific damage or loss sustained by a third party. Furthermore, compensation of damage may not be considered a form of punitive payment, as Dutch legislation permits punitive damages only to a very limited extent. Case law will have to determine the extent to which Section 6:104 Civil Code may be applied. Nevertheless, it is an interesting section to put to the test in practice: take away any ill-gotten gains or, or civil law terms, apply asset forfeiture.