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Direct and indirect losses in Swedish share purchase agreements
Background
When calculating losses in contractual relationships, Swedish law distinguishes between what
is referred to as direct and indirect losses (cf. the Swedish Sale of Goods Act (Sw. Köplagen
1990:931; “the Act”)). This distinction is commonly repeated in Swedish share purchase
agreements. As regards warranty breaches in such agreements, the prevailing market practice
is that the seller is allowed to disclaim liability for indirect losses. However, in the absolute
majority of cases, the parties will not have explicitly defined in the agreement what is to be
understood by the terms direct and indirect loss. Instead, the distinction between direct and
indirect loss set out in the Act will apply to interpret this issue. A conflict of interest arises in
these situations, as a buyer will endeavour to classify a loss as a direct loss, in order to be
entitled to compensation, whilst the seller will claim the opposite, i.e. the loss should be
regarded as a non-recoverable indirect loss.
This article intends to pinpoint the issue regarding mitigating damages which arises from the
statutory distinction between direct and indirect loss pursuant to the Act in relation to Swedish
share purchase agreements.
The statutory distinction between direct and indirect losses
Section 67 of the Act
According to Section 67 paragraph 2 of the Act, an indirect loss is a loss resulting from
reduction or loss of production or turnover, other loss resulting from the goods being unfit for
use in the intended manner, loss of profit resulting from a contract with a third party lapsing or
not being properly performed and other similar loss, if such loss was difficult to foresee.
Pursuant to Section 67 of the Act, a loss needs to be classified as being either a direct or an
indirect loss as soon as a breach occurs.
Under Section 67 paragraph 3 of the Act, an indirect loss pursuant to the second paragraph,
does not, however, include loss which the injured party has suffered in order to mitigate loss
of a type not referred to in the second paragraph. According to the preparatory work to the
Act, this includes losses arising from, inter alia, purchase of replacement goods, leasing of a
replacement machine or hiring of outside labor.
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Section 70 of the Act
Pursuant to Section 70 of the Act, an injured party shall take reasonable measures to mitigate
his or her damage. If the party neglects to do so, he or she shall bear a corresponding share of
the loss.
Mitigation of damages
As stated above, losses incurred by a party in order to mitigate direct losses are considered
direct loss, and, as such, entitle the buyer to compensation. This is the case when the costs for
taking active mitigating measures are lower than, or equal to, the indirect losses arising from
not taking any measures to mitigate the damage. However, on the opposite, when the costs
for mitigation exceed such indirect losses, it could be argued that the injured party should be
obligated to refrain from taking mitigating measures pursuant to Section 70 of the Act. If the
injured party chooses not to refrain from such measures he or she shall bear a corresponding
share of the loss. The question is whether losses incurred by the injured party when staying
passive should be regarded as direct or indirect losses? In the legal literature, it has been
argued that such losses should be converted into direct losses pursuant to Section 67
paragraph 3 of the Act, entitling the buyer to compensation for indirect losses as if they were
direct losses.
The following example can be used to illustrate the above. A machine used for production in a
target company is defective in a manner which constitutes a warranty breach, resulting in loss
arising from reduction or loss of production amounting to SEK500 000 and the cost for leasing
a replacement machine amounts to SEK700 000. In this case, if the buyer refrains from leasing
such replacement machine (i.e. in order to comply with his or her obligation to mitigate
damages pursuant to Section 70 of the Act), the buyer is entitled to compensation as for direct
loss amounting to SEK500 000. In other words, Section 67 paragraph 3 of the Act allows the
possibility to convert an indirect loss (i.e. the loss resulting from reduction or loss of
production) into a direct loss by refraining from actively mitigating damages under certain
circumstances.
One reason for this argument is that the injured party should not suffer from refraining from a
measure that theoretically would entitle the party to compensation for direct loss. According
to the preparatory work of the Act, an injured party should not be put in a worse position
when he or she chooses a course of action in order to mitigate a direct loss, even when such
actions result in indirect losses. Hence, the injured party’s indirect losses shall be compensated
for as direct losses, despite the fact that the injured party has not taken any (active) measures
to mitigate its damage.
Conclusions
In conclusion, Section 67 paragraph 3 of the Act could extend a seller’s liability in an
unpredictable way. Many of the losses initially considered indirect can be converted into direct
losses and therefore be subject to the seller’s liability, notwithstanding that the seller has
disclaimed all liability for indirect losses in the purchase agreement. In other words, the seller’s
liability for warranty breaches is seldom significantly limited by the fact that the seller has
disclaimed liability for indirect losses in the share purchase agreement.
As a result of the above, when drafting liability limitation clauses in Swedish share purchase
agreements, contracting parties are advised to make an effort to define precisely what types of
losses should be excluded from the seller’s scope of liability arising from warranty breaches,
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rather than to rely upon the distinction between direct and indirect losses set out in Section 67
of the Act.
Stockholm, 7 January 2015
ADVOKATFIRMAN TÖRNGREN MAGNELL KB
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