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Impacts of the Contracts and Torts Act on M&A agreements

27.06.2002

On 26 September 2001, the Estonian Parliament (Riigikogu) passed the Contracts and Torts Act. The Act is expected to take effect between 1 July 2002 and 1 January 2003, along with a separate implementing act. The Act repeals the only part of the Soviet-imposed Civil Code still in force.

Previously, contractual deviations from the Soviet Civil Code were permitted only in certain cases (although this interpretation shifted towards freedom of contract in 1991 when Estonia regained its independence). The principle of freedom of contract prevails in the Contracts and Torts Act.

Therefore, parties to a debt relationship or contract may agree to deviate from the provisions of the Act, provided that: the Act does not directly stipulate, or that it does not derive from the essence of a provision of the Act, that such a deviation is prohibited; and provided that such a deviation is not contrary to public policy or to accepted principles of morality and does not prejudice the fundamental rights of a person.

The principle of freedom of contract is closely connected with that of reasonableness. The definition of 'reasonableness' in the Act pertains to anything that an individual in the same situation and acting in good faith would ordinarily consider to be reasonable.

The evaluation of reasonableness shall take into account the essence of the debt relationship and the purpose of the transaction, the customs and practice prevailing in the given field of activity or profession, and other circumstances.

This may seem controversial, but the absolute recognition of the freedom of contract combined with the obligation to obey the principle of reasonableness can lead to a situation where, at least initially, an increase in the activity of courts and the role of the judiciary can be anticipated, whereby the autonomy of contractual parties would diminish to some extent. In other words, the freedom of contract is transferred from legislative restrictions to the factual control exercised by courts because contractual parties may resort to a court for altering the nature or scope of their contractual obligations.

Thus, parties are substantially free to agree upon the terms and conditions of the contract between them, but it might eventually result that their agreement is not enforceable because the performance of the contractual obligations may have become unreasonably burdensome for one of the parties.

The implementation of the Contracts and Torts Act should also provide security with respect to the legitimacy of shareholders' agreements, considering that the Soviet-era Civil Code does not provide for a common understanding regarding the admissibility of entry into such agreements.

The acknowledgment of such a form of agreement is included also in the bill of the new General Principles of the Civil Code Act, which is currently in the legislative process in the Riigikogu. The provisions of the Act that concern the adoption of resolutions by a body of a legal entity establish that it is permitted to enter into an agreement on the giving of one's vote unless otherwise established by law, but a violation of such an agreement will not affect the operation of the vote given.

Hence, entry into such agreements and accordingly, into shareholders' agreements, is permissible but, in terms of company law, the failure of a party to vote as was agreed in advance will not void the vote given by that party in the adoption of a resolution of the legal entity's body.

It is intended to enact the General Principles bill concurrently with the Contracts and Torts Act.

It emerges from the Contracts and Torts Act that the general provisions of purchase and sale contracts will be applied to contracts for the sale and purchase of shares. So in principle the situation is the same as under the Civil Code.

The differences, though, emerge from the regulation of purchase and sale contracts being much more thorough than that contained in the present Civil Code, since the intention is to regulate a remarkably varied sphere of contracts. To some extent the problem remains of having the same regulation apply with regard to the sale of shoes as well as sale of shares, but this is a European-wide issue for M&A lawyers.

This may cause certain problems, however, concerning share purchase and sale contracts, as they are a relatively specific type of agreement. Considering the context of the Contracts and Torts Act, the explicit recognition of the freedom of contract should certainly be of help, enabling parties to deviate from the provisions of the law by mutual agreement.

Therefore, owing to the unequivocal recognition of the freedom of contract, the general legal situation should become clearer and contractual parties will increasingly be able to agree upon circumstances that are essential to a particular transaction.

As mentioned above, the Contracts and Torts Act aims to achieve contractual justice by making legal regulation and, accordingly, the ensuring of legal certainty, the responsibility of the judiciary, i.e., courts.

One therefore cannot figuratively trace the stipulations of the law by finger and be certain that an initial agreement reached by the parties will remain invariably effective later.

Initially, this situation will lead to certain inefficiency, since contractual parties would lack an unambiguous awareness of the security of their rights, and it will take some time to develop the relevant practice of assessing such circumstances through Supreme Court rulings.

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