In a January 2003 letter to the Federal Association of German Industry, the Ministry of Justice clarified an issue which has caused a great deal of uncertainty since the amended German Civil Code came into force on January 1 2002. The reform of the law of obligations introduced a new Section 444 of the Civil Code. According to this provision, a seller may not limit the statutory consequences of breach of a guarantee. This raised the question of whether the parties to a purchase agreement in a typical M&A transaction could no longer freely stipulate the scope of the seller's representations and warranties - for example through caps and thresholds for the amount of warranty claims (for further details please see "Representations and Warranties in M&A Agreements").
The Ministry of Justice has now ended the discussion on the effects of Section 444. It has pointed out that limitations of the seller's warranty obligation are not excluded by the new rule. The purpose of Section 444 is solely to prevent contradictory conduct on the part of the seller, which would have to be assumed if an express guarantee is excluded or limited in other parts of the agreement in a surprising or untransparent manner. Section 444 could not be applied to an agreement in which the scope and contents of a guarantee are limited from the outset, so that no element of confidence is created which might subsequently be frustrated. The validity of such a guarantee, according to the ministry, could not be questioned in the light of Section 444. A seller must be in a position to limit its liability, which is not mandatory under the law, within reasonable economic scope.
The ministry further emphasized that the interpretation of Section 444 is in line with the legislative process leading to the new rule. During the entire process, no consideration was given to changing the previous practice of limitable guarantees in privately negotiated agreements. No change was required in this respect, as the existing legal situation and practice were regarded as neither inappropriate nor inadequate.
Clarification on the proper interpretation of Section 444 must be warmly welcomed. Although most M&A lawyers anticipated this development, some uncertainty still existed and counsel to the seller always had to warn the client accordingly. Without intervention by the Ministry of Justice, the parties concerned would have had to wait for clarification by the courts. However, that seemed highly unlikely for the foreseeable future, not only due to the lengthy duration of litigation carried through three instances up to the Federal Supreme Court, but also given that most purchase agreements in M&A transactions provide for arbitration. Thus, M&A lawyers in Germany may breathe a sigh of relief.
For further information please contact Oleg de Lousanoff at Hengeler Mueller by telephone (+49 69 17 09 50) or by fax (+49 69 72 57 73) or by email ([email protected]). The Hengeler Mueller website can be accessed at www.hengeler.com.