Structure and process, legal regulation and consentsStructure
How are acquisitions and disposals of privately owned companies, businesses or assets structured in your jurisdiction? What might a typical transaction process involve and how long does it usually take?
The vast majority of acquisitions of privately owned companies in Germany are structured as share deals because a share deal structure is usually far more straightforward and less complex than an asset deal. Details of the share deal structure vary depending on whether the target company is structured as a limited liability company (GmbH), as an unlisted stock corporation (AG) or as a limited partnership with a limited liability company as sole general partner (GmbH & Co KG), a frequently used legal form for entities in particular in the famous German Mittelstand (mid-sized manufacturers). A share deal provides the buyer with the certainty that it acquires basically everything that constitutes the business it intends to acquire. In an asset deal scenario, this is much more complex because there are generally no provisions on a transfer of a business as a whole under Germany law. To the contrary, the business to be transferred by means of an asset deal needs to be identified very carefully asset by asset. A transfer by operation of law applies only with respect to related employment agreements under the EU Transfer of Undertakings (Protection of Employment) (TUPE) regime.
Auction processes are frequent for mid- and large-cap acquisitions. They are usually very well structured by the investment banks involved and follow international market standards. On the other hand, when looking at one-on-one negotiations on the acquisition of one of the numerous family-owned Mittelstand companies, the transaction processes may deviate from international standards to some extent. In such transactions, the psychological element of convincing a family to sell a business that often was founded by its ancestors is always very important. An international buyer needs to learn that these sellers are usually not only interested in achieving the best overall package of purchase price and favourable terms of the purchase agreement. Instead, they demand that their business is transferred to a reliable owner with a clear perspective for future growth. Therefore, it is always valuable to seek German legal advice, as a German counsel will also function as a kind of translator between the interests of his or her international client and the German entrepreneur.Legal regulation
Which laws regulate private acquisitions and disposals in your jurisdiction? Must the acquisition of shares in a company, a business or assets be governed by local law?
There is no specific law regulating private acquisitions and disposals in Germany. Instead, the general provisions of German civil law on the purchase of goods apply in addition to the corporate laws that apply depending on the legal form of the target entity and other provisions applicable depending on the business the target operates in. As most of the applicable provisions of German civil law are not mandatory, the parties are free to tailor the purchase agreement in accordance with the result of their negotiations. As a result, German-style purchase agreements follow the Anglo-American market standards to a large extent, at least in an international context.
Regarding the governing law, against the background of the applicable ‘two step approach’ under German civil law, one has to distinguish between the purchase agreement governing the sale of the shares or assets and the transfer agreement to be executed upon completion. While the parties may choose a law of their choice to govern the former, the latter must be governed by German law.Legal title
What legal title to shares in a company, a business or assets does a buyer acquire? Is this legal title prescribed by law or can the level of assurance be negotiated by a buyer? Does legal title to shares in a company, a business or assets transfer automatically by operation of law? Is there a difference between legal and beneficial title?
Under a share purchase agreement, a buyer acquires the ownership over the shares as well as the membership in the target company and, indirectly, over the assets and liabilities constituting the business conducted by the target company. In an asset deal, the buyer acquires direct title to the assets.
The rights and obligations resulting from the acquisition of the legal title are indeed prescribed by law as regards third parties.
Apart from certain measures under German transformation law, there is generally no automatic transfer of shares, a business or assets by operation of law.
Regarding legal and beneficial title, there is no distinction under German law in setting aside trustee relationships. However, parties are free to negotiate that the transfer of the shares is effected with a retroactive economic effect, although the legal ownership will be transferred later and only upon completion of the transaction contemplated by the purchase agreement.Multiple sellers
Specifically in relation to the acquisition or disposal of shares in a company, where there are multiple sellers, must everyone agree to sell for the buyer to acquire all shares? If not, how can minority sellers that refuse to sell be squeezed out or dragged along by a buyer?
Generally, under German law, every shareholder needs to agree to sell his or her shares if the buyer wants to acquire 100 per cent of the shares. Moreover, there is no means to force a shareholder to sell his or her shares other than a squeeze out, which is, however, applicable with regard to stock corporations only. An exception to this principle applies only in cases where the articles of association or a shareholders’ agreement provide for drag-along rights for the majority of the shareholders. While this is the case for most joint ventures or start-up companies, the articles of association of old family-owned companies that have been inherited by the second or third generation following the founder usually lack such provisions.Exclusion of assets or liabilities
Specifically in relation to the acquisition or disposal of a business, are there any assets or liabilities that cannot be excluded from the transaction by agreement between the parties? Are there any consents commonly required to be obtained or notifications to be made in order to effect the transfer of assets or liabilities in a business transfer?
There is no specific provision regulating the acquisition or disposal of a business as a whole in Germany. Therefore, the reference object of an asset deal is not the business itself, but every single asset and liability constituting the business. The general principle is that the parties are free to negotiate which assets and liabilities shall form part of the transaction and which shall remain with the seller. The two most important exceptions to this principle are the transfer of employment agreements and the transfer of other agreements. While the latter requires in any event the consent of the counterparty without which the transfer may not be effected, the transfer of the employment relationships to the buyer occurs by operation of law unless the transferring employees object to the transfer.Consents
Are there any legal, regulatory or governmental restrictions on the transfer of shares in a company, a business or assets in your jurisdiction? Do transactions in particular industries require consent from specific regulators or a governmental body? Are transactions commonly subject to any public or national interest considerations?
Under the German Foreign Trade and Payments Act and the pertaining ordinance, foreign investments of formerly 25 per cent, now 10 per cent or more of the voting rights in German businesses active in the defence or encryption sectors require prior approval by the Federal Ministry for Economic Affairs and Energy (BMWi). In addition, the BMWi has the power to review, veto or stipulate conditions for acquisitions (direct or indirect ones) of 25 per cent or more of the voting rights in any Germany business by a non-EU and non-European Free Trade Association (EFTA) investor if the ‘public order and security’ of Germany is affected. Upon application, the BMWi may issue a compliance certificate, ideally at an early stage of the transaction. Recent amendments of the Foreign Trade and Payments Ordinance in July 2017 and December 2018 have extended the BMWi’s review deadlines considerably, so that, as a result, the BMWi may decide to review an investment as late as three months after gaining knowledge of the publication of the decision to issue the takeover offer or of the publication of assumption of control. In addition, the recent legislative reforms have also introduced a duty to notify investments in certain sensitive civilian sectors (especially in critical infrastructure, for example in the sectors energy, water, banking, insurance, transport, traffic, health or food) to the BMWi and have reduced the threshold for the BMWi’s foreign investment control powers in relation to such sensitive civilian sectors to 10 per cent of the voting rights. Besides the described legislative changes, administrative practice of the BMWi is showing a growing governmental willingness to interfere in foreign investments in Germany, particularly in the area of critical infrastructures and security-related technologies. In the summer of 2018 this willingness was evidenced by two cases in private M&A, namely by the federal government’s resolution to prohibit the acquisition of the German machine tool manufacturer for automotive, aviation, aerospace and nuclear industries Leifeld Metal Spinning by a Chinese investor and by the acquisition of a 20 per cent stake in the power transmission system operator 50Hertz by the state-owned development bank KfW in order to pre-empt an investment by State Grid Corporation of China. The legislative amendments and the tightened administrative practice are resulting in increasing numbers of applications for foreign investment compliance certificates and have slowed down many cross-border transactions.
Except for antitrust reasons and foreign investment control as well as supervision of banks, insurance, aviation and media companies, government agencies cannot influence or restrict the completion of business combinations based upon legal considerations.
Are any other third-party consents commonly required?
For a share deal, there are usually no third-party consents other than from the shareholders required. As to whether a shareholder’s consent is required depends on the articles of association of the seller. They frequently provide for restrictions on the sale of shares in subsidiaries, in larger groups setting out a threshold so that not each and every transaction requires a shareholder’s consent. When it comes to an asset deal, basically the same applies. In addition, the consent of the relevant counterparties is required if agreements shall be transferred together with the assets constituting the business. A general exception from the above applies to agreements under which the seller undertakes to transfer its entire or almost its entire assets. Entering into such agreements always requires an affirmative shareholders’ resolution.Regulatory filings
Must regulatory filings be made or registration (or other official) fees paid to acquire shares in a company, a business or assets in your jurisdiction?
Apart from merger control clearance, no registration or regulatory filing has to be made to acquire shares in German limited liability companies validly. However, in German market practice, the buyer usually has to bear the fees of the notarisation, which in most cases totals up to a higher five-figure amount.
Advisers, negotiation and documentationAppointed advisers
In addition to external lawyers, which advisers might a buyer or a seller customarily appoint to assist with a transaction? Are there any typical terms of appointment of such advisers?
In accordance with international practice, the buyer and the seller typically appoint financial advisers, accountants and tax consultants. Depending on the size of the transaction and its own capability and experience, the seller may additionally appoint an investment bank or an M&A adviser to run the transaction process. Both parties may also engage communication advisers if the transaction requires professional public relations activities.
As the major international firms of the relevant professions are active in the German market, the terms of engagement of such firms as well as of the top German players follow international standards.Duty of good faith
Is there a duty to negotiate in good faith? Are the parties subject to any other duties when negotiating a transaction?
Through the commencement of negotiations between the seller and the buyer, a pre-contractual relationship comes into existence with the obligation to show mutual consideration and loyalty, and to take account of the rights and legal interests of the negotiating partner. Any culpable breach of these obligations by any party may cause a liability of the breaching party (culpa in contrahendo). As regards contract negotiations, pre-contractual obligations comprise the duty to negotiate in good faith but in general not a duty to enter into the transaction. However, a break-up of negotiations without good cause may entail the liability of the terminating party if the other party reasonably relied on a successful conclusion of the negotiations (eg, because the parties have agreed upon all essential open issues in the purchase agreement and explicitly agreed upon a signing on this basis within a few couple of days). Having said all that, it is noteworthy that the aforementioned obligation will of course influence the parties’ manner during the negotiations, while claims for breaches of these obligations are very rarely enforced.
Other than that, the seller is under a rather strict obligation to disclose all information that is reasonably material for a buyer prior to signing at the latest. If the seller fails to do so intentionally, the purchase agreement is subject to challenge by the buyer for up to 10 years following signing.Documentation
What documentation do buyers and sellers customarily enter into when acquiring shares or a business or assets? Are there differences between the documents used for acquiring shares as opposed to a business or assets?
The legal documentation in most cases consists of a purchase agreement governing the sale of the shares or assets, a transfer deed executed at closing, and a number of ancillary agreements such as an interim service agreement, licence agreement or lease agreement. The purchase agreement sets out the terms and conditions for the entire transaction, and contains provisions dealing with the object of the sale, signing and closing, purchase price, reps and warranties, indemnities, covenants of the parties and dispute resolution. The most notable difference between a share purchase agreement and an asset purchase agreement is the description of the object of sale, which comprises very detailed provisions in an asset purchase agreement and even more detailed exhibits thereto. A separate transfer deed may be avoided if the seller already assigns the shares in the share purchase agreement subject to the relevant conditions precedent (eg, merger control clearance or payment of the purchase price at closing).
Are there formalities for executing documents? Are digital signatures enforceable?
Purchase agreements governing the sale of shares in a stock corporation or interests in a limited partnership are not subject to any legal formalities. The same applies with regard to asset purchase agreements unless real property is among the assets to be transferred or the entire or almost the entire property portfolio of the seller is to be sold, in which case a notarisation is required. This is also always the case for purchase agreements concerning shares in limited liability companies. As the majority of target companies in Germany are limited liability companies, the notarisation of all relevant documents is a standard procedure in German M&A transactions. A legal or authorised representative of each contractual party has to personally attend the signing before a notary during which the entire purchase agreement needs to be read out aloud by the notary. German practitioners are very well aware that this is uncommon in most other jurisdictions. It is, on the other hand, surprising how many misunderstandings between parties are detected and solved during the notarisation.
While there are provisions in statutory law regarding the use of digital signatures, the proper and lawful implementation of this technology is so complex and costly that it is little practised. Moreover, even with a digital signature in accordance with German law, the parties cannot bypass the requirement to personally appear before the notary.
Due diligence and disclosureScope of due diligence
What is the typical scope of due diligence in your jurisdiction? Do sellers usually provide due diligence reports to prospective buyers? Can buyers usually rely on due diligence reports produced for the seller?
Typically, the scope of due diligence on a German entity comprises corporate matters (including corporate history and chain of title), financing agreements, commercial agreements, employment, pensions, real estate, intellectual property, data protection and public law (permits, regulatory, environmental, subsidies).
Vendor due diligence reports are usually not provided in typical German mid-cap transactions, but are frequently available in large-cap transactions or when the organisation of the target group is complex so that the seller deems it helpful to educate the bidders by means of the vendor due diligence report or fact book. If a vendor due diligence report is available, it is more or less common to offer reliance by the seller’s legal advisers.Liability for statements
Can a seller be liable for pre-contractual or misleading statements? Can any such liability be excluded by agreement between the parties?
In the context of the potential liability of a seller for culpa in contrahendo (see question 10), it could of course be liable for misleading statements under statutory law. Against this background, the parties usually explicitly exclude any liability of the seller for certain information such as projections, business plans or forecasts. A seller’s liability for fraud, however, cannot be excluded.Publicly available information
What information is publicly available on private companies and their assets? What searches of such information might a buyer customarily carry out before entering into an agreement?
A buyer will customarily perform research of the commercial register, which contains information about a company’s legal form, authorised representatives, share capital, capital measures and transformation measures in the past. The financial statements, as well as limited other information, are available from the federal gazette.
Before acquiring real estate, a buyer reviews excerpts from the land register disclosed by the seller, in which the owner and the most important in rem encumbrances are registered. Other than, for example, in jurisdictions such as the US, there are no further publicly accessible registers such as litigation or debt registers. Here, the buyer needs to rely on the disclosure of the seller and protect itself by agreeing with the seller on reasonable representations and warranties.Impact of deemed or actual knowledge
What impact might a buyer’s actual or deemed knowledge have on claims it may seek to bring against a seller relating to a transaction?
Under statutory law, if a buyer has actual knowledge of circumstances that constitute a claim before signing, the seller is not liable in regard to this claim. However, the parties usually agree upon a deviating compromise in this regard that only facts and circumstances that are either fairly disclosed in the data room or that are explicitly referred to in the disclosure exhibits to the purchase agreements exclude claims for a breach of representations and warranties.
Pricing, consideration and financingDeterming pricing
How is pricing customarily determined? Is the use of closing accounts or a locked-box structure more common?
Pricing is usually based on the enterprise value of the target that may be determined by using established accounting methods or transaction multiples, or both. The actual purchase price is usually determined on a cash and debt-free basis (ie, an equity bridge leads from the enterprise value to the equity value that is paid as the purchase price).
The equity value can be determined as of an economic effective date in the past (locked-box structure) or as of the closing date by way of closing accounts that are set up to determine cash, debt and working capital. Both closing accounts and locked-box structures are frequently used in German M&A practice. Generally, locked-box mechanisms are often proposed by sellers as they give more certainty as to the final amount of the consideration received. Particularly in structured auction processes, locked-box mechanisms are prevailing to ensure that the offers of different bidders are as comparable as possible. In a rather seller-friendly market such as Germany’s market is today, locked-box structures are often proposed by the seller and are also often accepted.Form of consideration
What form does consideration normally take? Is there any overriding obligation to pay multiple sellers the same consideration?
In the majority of private M&A transactions, a cash consideration is paid by the buyer. Non-cash offers (eg, shares) are generally possible, but are more common where public companies are involved so that the seller gets liquid shares in exchange. Share-for-share transactions are typical in constellations where a listed buyer (often younger technology companies) acquires larger businesses in exchange for issuing shares to the seller who can then - after a certain lock-up period - liquidate the shares and participate in the overall economic success of the buyer reflected in the stock price of the buyer’s shares.
Vendor loans are granted in some transactions to support the buyer’s financing. It is often not so much the lack of the buyer’s ability to finance the transaction, but rather the weakness of the target and the intention of the buyer to bridge a valuation gap and share the risk with the seller by using a vendor loan. From a legal perspective, the focus is on reviewing whether the vendor loan is in compliance with mandatory banking laws (in a nutshell: as soon as loans are granted in a professional manner and several times by the same vendor, a bank licence may be required).
In private M&A transactions, there is no obligation on a buyer to pay the same consideration to all sellers (either as regards the kind of consideration or the amount). This is different in the case of public takeovers, where the German Takeover Act provides for pricing rules that lead to the result that the same consideration that has been agreed with certain shareholders (eg, in a package deal) has to be offered to the outstanding shareholders as well.Earn-outs, deposits and escrows
Are earn-outs, deposits and escrows used?
Earn-outs are a common tool to bridge a valuation gap between the seller and the buyer. The basis for the earn-out varies and depends on the specific circumstances. Earnings before interest, taxes, depreciation, and amortisation targets are often used. In particular in cases of carve-outs where the future success of the carved-out business depends on the continuation of commercial relationships with the seller, the fulfilment of certain turnover targets with companies of the seller’s group may be the right basis.
Escrow structures are frequently used as a tool to secure potential buyer claims arising from representations and warranties or indemnities in cases where there is no seller or seller guarantor that is financially strong enough. The amount of such an escrow obviously depends on the specifics of the transaction: 5 per cent to 15 per cent of the purchase price (equity value) may be a good approximation in the current market.
Escrows may also be used to secure the purchase price. In particular in restructuring scenarios with multiple stakeholders, trustees or insolvency administrators who are in charge of selling the company will ask for a security deposit up to an amount of the purchase price.Financing
How are acquisitions financed? How is assurance provided that financing will be available?
The financing of the transaction mainly depends on the type of buyer. Whereas acquisitions by strategic buyers are typically financed with a high portion of equity, private equity investors tend to utilise a higher debt financing.
The typical way to secure payment of the purchase price to be paid by a strategic investor is a parent guarantee if there is a parent company with sufficient financial capacity and the parent company is located in a country in which claims under the guarantee can be easily enforced. In some transactions, the purchase price or parts thereof are secured by a bank guarantee on first demand; in such constellations, the question of who bears the cost of the bank guarantee is typically a discussion point.
In a private equity set-up, equity and debt commitment letters are the typical means to secure the financing of the transaction. The equity commitment letter usually provides that the seller may directly assert a claim for funding of the investment vehicle against the fund.
In particular, in the case of acquisitions by investors where transaction certainty is critical, a deposit of a portion of the purchase price on an escrow account at signing is customary; such deposit would be forfeited as a break fee if closing subsequently does not occur.Limitations on financing structure
Are there any limitations that impact the financing structure? Is a seller restricted from giving financial assistance to a buyer in connection with a transaction?
Subject to the applicable regulatory banking laws (see question 18), the seller is generally permitted to fund the acquisition by the purchaser - practically, only a smaller portion of the purchase price will be financed by the seller by way of a vendor loan.
However, it is very difficult for the target to provide collateral to the seller for such a loan; if at all subject to very limited exceptions, this is permissible only on the basis of a limitation language that limits the ability of the seller to enforce the security at the time of enforcement.
A stock corporation is, in general, not permitted to grant security in respect of the obligations of its shareholders with regard to its acquisition unless the stock corporation is the dominated entity under a domination agreement or the subsidiary under a profit and loss transfer agreement with the shareholders, or the granting of collateral is covered by a full-value recourse claim against the shareholders. Moreover, German corporate law prohibits the rendering of financial assistance by a target in the legal form of a stock corporation to another person for the purpose of acquiring shares in that target; again, this does not apply in the event of a domination agreement or a profit and loss transfer agreement.
In the case of a GmbH, the management needs to comply with its fiduciary duties when supporting the buyer in connection with the financing of its acquisition. German corporate law also restricts the ability of a GmbH to provide collateral to secure the indebtedness of its shareholders. The company must not grant collateral (subject to the same exceptions mentioned above for the stock corporation) for the obligations of its shareholders if this would result in the net assets of the company being lower than its registered share capital.
A violation of these rules may lead to the personal liability of the managing directors or members of the board.
Conditions, pre-closing covenants and termination rightsClosing conditions
Are transactions normally subject to closing conditions? Describe those closing conditions that are customarily acceptable to a seller and any other conditions a buyer may seek to include in the agreement.
Typically, there is only a smaller number of closing conditions in German M&A transactions. Such closing conditions mainly cover objective requirements to consummate the deal, such as merger control or clearance under foreign investment regulations.
In the case of carve-out transactions, the completion of certain clearly defined carve-out measures by the seller may also be a closing condition.
Closing conditions in the sphere of the buyer (eg, completion of financing or obtaining of corporate approvals) are usually not accepted by the seller.
Material adverse change clauses and bring-down concepts (eg, concerning the accuracy of representations and warranties or the fulfilment of pre-closing covenants) as closing conditions are often not accepted by German sellers.
What typical obligations are placed on a buyer or a seller to satisfy closing conditions? Does the strength of these obligations customarily vary depending on the subject matter of the condition?
The buyer is typically responsible for obtaining merger control clearances and clearances under foreign trade laws. With regard to such obligations, the purchase agreement typically contains provisions governing the cooperation between the parties and obligations of the buyer in this regard, in particular obligations to make commitments towards merger control authorities. If the transaction involves a higher merger control risk, the seller will usually ask for a ‘hell or high water’ clause, pursuant to which the buyer has to offer those commitments and obligations that are required to get clearance. In such constellations, complex clauses allocating the merger control risk in detail may be the result.Pre-closing covenants
Are pre-closing covenants normally agreed by parties? If so, what is the usual scope of those covenants and the remedy for any breach?
The purchase agreement typically contains an obligation of the seller to cause the target business to be conducted in the ordinary course, supported by a catalogue of measures that require the buyer’s approval between signing and closing. The extent of such catalogue depends on the specifics of the transaction. In particular, if the period between signing and closing is expected to be longer, a seller will be careful not to agree to a too-narrow scope of covenants that may negatively impact the business going forward (in particular if the buyer is a competitor). From a legal perspective, it needs to be taken into account that the transaction may not be consummated prior to merger control clearances being granted; this usually also has an impact on the scope and quality of pre-closing covenants.
In the case of locked-box transactions, no leakage covenants are required to secure the value of the target company, the usual remedy being a euro-for-euro payment claim for every leakage.Termination rights
Can the parties typically terminate the transaction after signing? If so, in what circumstances?
Typically, there is a termination right of the parties only if not all closing conditions are fulfilled or waived until a certain long-stop date agreed by the parties. The likelihood of whether a transaction can be terminated after signing therefore mainly depends on the number and quality of closing conditions agreed between the parties. Apart from that, the parties usually remain bound to the agreement after signing and rights to terminate the agreement are widely excluded.
Are break-up fees and reverse break-up fees common in your jurisdiction? If so, what are the typical terms? Are there any applicable restrictions on paying break-up fees?
Break-up fee agreements are often concluded between the seller and the buyer in the pre-signing phase, in particular in exclusivity agreements or letters of intent (LOIs). Such pre-signing break-up fees may be agreed in favour of the seller and the buyer. This means that the seller has to pay the break-up fee to the buyer if the seller enters into a transaction with a third party even though the buyer did not change the offered deal terms; and the buyer has to pay the break-up fee to the seller if the buyer requests a deviation from the terms set forth in the LOI and, as a result, no transaction is entered into between the seller and the buyer.
In structured M&A processes, pre-signing break fees are agreed only in rare cases. In more advanced stages of the process (eg, after binding offers have been submitted), cost cover may be offered to certain bidders. Cost cover is, in particular, requested by private equity investors that wish to avoid frustrated expenses.
In the share purchase agreement, break-up fees in favour of the seller are agreed upon in a number of transactions, in particular in the case of structured M&A processes or in transactions involving buyers that are deemed to be critical regarding transaction certainty.
Depending on the size of the transaction, the amount of the break-up fee may, as a rule of thumb, range between 10 and 30 per cent of the purchase price. Excessive break-up fees may be adjusted by a court to an ‘adequate amount’.
Representations, warranties, indemnities and post-closing covenantsScope of representations, warranties and indemnities
Does a seller typically give representations, warranties and indemnities to a buyer? If so, what is the usual scope of those representations, warranties and indemnities? Are there legal distinctions between representations, warranties and indemnities?
In general, it is still typical for the seller to give representations and warranties to a buyer in a ‘normal’ German M&A transaction (except for private equity and sellers in distressed scenarios that would start with a ‘no reps and warranties approach’). However, owing to the very seller-friendly market environment of the past few years, the standards have shifted a bit towards shorter catalogues of representations and warranties, and the use of warranty and indemnity (W&I) insurance products.
In addition, representations and warranties in German-style M&A agreements are traditionally (significantly) shorter and more focused than typical US-style representations and warranties. Usual representations and warranties may cover basic corporate representations, unencumbered title to shares or assets, or both, the recent financial statements of the target group, ownership of relevant IP rights, material contracts and, at least to a certain extent, compliance with the applicable laws. Representations and warranties in German deals are often knowledge-qualified or contain materiality qualifiers, or both.
While representations and warranties cover unknown risks, indemnities are the typical tool to protect buyers against risks identified in the due diligence. Customary examples are environmental and litigation risks detected in a due diligence. Additionally, in a share deal, a tax indemnity is customary. If the risk is known and can be quantified, a buyer would usually choose a purchase price reduction instead of an indemnity.
The remedies for breaches of representations, warranties and indemnities are typically set forth in detail in the purchase agreement. Statutory rules are subrogated to the extent permissible by law.Limitations on liability
What are the customary limitations on a seller’s liability under a sale and purchase agreement?
Typically de minimis thresholds, (tipping or deductible) baskets and liability caps are agreed upon in German M&A transactions. The amount agreed as de minimis, baskets and liability cap depends on the circumstances of the deal. As a rule of thumb, the following figures could serve as a rough indication:
- de minimis: 0.1 to 0.2 per cent of the purchase price;
- basket: 1 to 2 per cent of the purchase price; and
- liability cap: 10 to 50 per cent of the purchase price.
Claims for breaches of fundamental representations and warranties (such as those relating to title to the shares) are often capped at the purchase price. The same is true for covenant breaches by the seller. It is a question of negotiation power whether the liability cap also applies to indemnities, in particular tax indemnification claims; separate caps are often agreed in this respect.
Beyond the maximum liability amounts, the purchase agreement typically contains additional limitations to the seller’s liability.
This includes a definition of losses to be compensated by the seller that usually narrows down the range of losses to be compensated under the statutory provisions. Typical discussion points include the compensation of indirect damages and lost profits, whereas the buyer coming to a too-high valuation of the target as such or multiplier-based damages are typically not to be compensated.
The purchase agreement furthermore contains a number of exclusions of liability, in particular if the buyer contributed to the damage, or the buyer or the target failed to mitigate the damage; in the case of recovery or potential recovery from a third party; or in the case of the knowledge of the buyer of the circumstances underlying the claim.
Typically, the knowledge of the buyer and its advisers (including of the content of the data room) is relevant in German M&A transactions, and ‘sandbagging’ clauses are rather uncustomary.Transaction insurance
Is transaction insurance in respect of representation, warranty and indemnity claims common in your jurisdiction? If so, does a buyer or a seller customarily put the insurance in place and what are the customary terms?
W&I insurance is frequently used at least in medium-sized and larger M&A transactions in Germany. In the current market environment, all kinds of sellers try to make use of the availability of W&I insurance.
Technically, insurance is typically taken up by the buyer, not by the seller. However, in particular in structured M&A processes, sellers often pre-discuss and arrange for insurance cover with a broker and W&I insurers prior to approaching potential bidders (‘stapled W&I insurance’). A limited number of bidders will be granted access to the insurance provider at a later stage of the process to finalise discussions with the provider.
Costs for W&I insurance have decreased in the past few months. The actual fees depend on the scope of insurance coverage and the deductible agreed with the insurance provider. As a general rule, 1 to 2 per cent of the enterprise value are customary fees.
Known risks are usually excluded from the insurance coverage. The same applies to representations and warranties relating to future events (eg, correctness of projections). Environmental risks may be covered by special risk insurance. Claims under tax indemnities are meanwhile also often covered by W&I insurance (unless it is already certain that a specific risk will materialise).Post-closing covenants
Do parties typically agree to post-closing covenants? If so, what is the usual scope of such covenants?
Post-closing covenants are often agreed in German M&A transactions. The actual scope depends on the identified post-closing issues. Typical provisions in favour of the seller include access rights to certain documents and information a seller may need post-closing and indemnity obligations of the buyer in cases where claims relating to the target are asserted against seller. Buyers often request a non-compete and non-solicitation undertaking from the seller.
Are transfer taxes payable on the transfers of shares in a company, a business or assets? If so, what is the rate of such transfer tax and which party customarily bears the cost?
In Germany, real estate transfer tax (RETT) is applied to certain transactions involving real estate located in Germany. If real estate (including buildings) is transferred as an asset (separately or as part of a transfer of a business) or if at least 95 per cent of the shares in a company owning real estate is transferred to an acquirer, in principal, RETT is due on such transaction. Depending on the federal state in which the real estate is located, the RETT rate ranges from 3.5 to 6.5 per cent, to be applied to the fair value of the real estate (whereby the fair value is to be determined based on specific rules laid down in German tax laws). It is market practice that RETT is borne by the buyer.Corporate and other taxes
Are corporate taxes or other taxes payable on transactions involving the transfers of shares in a company, a business or assets? If so, what is the rate of such transfer tax and which party customarily bears the cost?
Corporate taxes are generally due on any gains realised upon the disposition of shares in a company, a business or assets. The tax rate is approximately 30 per cent (including German trade tax), assuming the seller is a German corporation. However, in the case of a transfer of shares by a German corporate in another corporation, 95 per cent of the gain are, in principle, exempt from tax. Such corporate taxes (including trade tax) have to be borne by the seller.
While the transfer of shares or a business (qualifying as a going concern) generally does not attract value added tax (VAT), the transfer of single assets generally would. The VAT rate in Germany is 19 per cent, and such tax typically has to be borne by the buyer. However, the buyer would be entitled to deduct at the same time input VAT, subject to certain limitations.
Employees, pensions and benefitsTransfer of employees
Are the employees of a target company automatically transferred when a buyer acquires the shares in the target company? Is the same true when a buyer acquires a business or assets from the target company?
If a buyer acquires shares in the target company (share deal), the only change at the target company will be at shareholder level. The company as such, though, will remain legally unchanged, meaning that for the employees, there will be no change in employer either. Following the consummation of the share deal, the employment relationships will continue to exist between the employees and the target company. There will be no ‘transfer’ of the employees to the buyer in that regard. The employment relationships will continue to exist unchanged at the target company, the shares of which have been acquired by the buyer. In the case of a share deal, therefore, a buyer indirectly acquires all the employment relationships with employees along with the contractual relationships with directors and members of the management board.
The situation is different where material assets of the target company are acquired (asset deal). Where a business or part of a business passes to a new owner while preserving the economic unit, and is continued by the buyer, this is referred to as a transfer of business. The existence of a transfer of business needs to be determined by way of an evaluative overall assessment taking the following aspects into account: the transfer of tangible assets (such as buildings, movable goods), the transfer of key customer relationships, the degree of similarity between activities performed before and after the asset deal, and the duration of any interruption of these activities. A transfer of business will have the consequence that upon execution of the asset purchase agreement, the buyer will automatically become the employer of the employees attributed to the business or the part of the business that has been sold unless the employees object to the transfer after having been notified of the transfer of business (see question 34). The buyer furthermore succeeds to existing employee rights in relation to the seller. The contractual relationships of directors and members of the management board are not covered by a transfer of business. An asset deal does not provide for these contractual relationships to be automatically transferred to the buyer.Notification and consultation of employees
Are there obligations to notify or consult with employees or employee representatives in connection with an acquisition of shares in a company, a business or assets?
Should a change in the composition of the group of shareholders entail a change of control within the company, the ‘economic committee’ will need to be informed of the proposed transaction at an early stage. An economic committee is required in companies that regularly employ more than 100 employees. It is tasked with advising the company on economic matters and informing the works council. The economic committee serves to provide advice and exchange information. The members of the economic committee are company employees, at least one of whom must belong to a works council of the company. Depending on the size of the company, the economic committee consists of three to seven members. The works council appoints the members of the economic committee.
Information that the economic committee fails to provide or does not provide in good time does not, however, mean that the economic committee or the works council will prevent, block or delay an asset purchase agreement. Any failure of the economic committee to provide information in good time may entail consequences under the law on administrative offences that can affect the management or HR management personally. The economic committee needs to be informed in the case of an asset deal as well.
Should an asset deal lead to a transfer of business (see question 33), the employees affected thereby need to be informed in writing of the legal, economic and social consequences thereof for the employees and the measures envisaged for the employees in this regard. The employees affected by the transfer of business have the option of objecting to the transfer of their employment relationships within one month of receiving the letter of notification. If the objection is lodged in good time, the employment relationship with the seller will continue to exist, but if the seller can no longer continue to employ the employee, the employee will run the risk of being dismissed by the seller for operational reasons. The Federal Labour Court places very strict requirements on the content of such letter of notification. The required information needs to be provided in great detail. Should only one point of the letter of notification be incorrect or a key piece of information be omitted, then the time limit for objecting to the transfer of business will not start to run. In this case, the employees affected will be able to object to the transfer of business up to the limit of being forfeited, which will cause considerable legal uncertainty among the companies involved in the transaction.
Should it come to an ‘operational change’ in the course of the transaction, the works council needs to be notified in that regard. If necessary, a reconciliation of interests and a social plan need to be negotiated with the works council.
An operational change in this context exists, for example, if the business is relocated or part of it is closed before or after consummation of the transaction, giving rise to a detrimental impact on many parts of the workforce.Transfer of pensions and benefits
Do pensions and other benefits automatically transfer with the employees of a target company? Must filings be made or consent obtained relating to employee benefits where there is the acquisition of a company or business?
A share deal merely entails a change at shareholder level, so all pension obligations of the target company are preserved even after the transaction. The same applies to employee claims to other benefits in relation to the target company.
The buyer acquires the target company, including all pension obligations in relation to active employees, former employees with pension entitlements and pensioners. Upon consummation of the transaction, employee claims to other benefits likewise continue to be addressed in relation to the target company and hence, in turn, in relation to the buyer in economic terms.
In the case of an asset deal, the buyer only enters into the obligations towards such employees as are affected by the transfer of the business. Insofar, the buyer automatically only enters into the pension obligations of the active employees of the seller on the date of the transfer of business. Nor are obligations from pension commitments towards directors and board members transferred, as they do not concern employees and therefore cannot be covered by a transfer of business (see question 33).
With the transfer of business, the buyer automatically becomes the employer of the employees affected and hence the debtor of all liabilities from the earlier employment relationship with the seller. Employee claims to other benefits consequently pass to the buyer with the transfer of business.
Should the company pension scheme in the seller’s company be executed by external institutions such as a benevolent fund or pension fund, in the case of share deals or asset deals further steps may, however, be required to ensure the continuation of the pension commitments by the buyer. Pension funds or benevolent funds are frequently open only to such companies or employees as belong to a specific group. Should the buyer fail to satisfy the requirements for membership under the articles of association, membership may need to be acquired by way of trilateral agreements or the consent to or amendment of the articles of association of such external pension fund institution, failing which the employer will be obliged to ensure appropriate pension provision via a different pension fund or benevolent fund.
Update and trendsKey developments
What are the most significant legal, regulatory and market practice developments and trends in private M&A transactions during the past 12 months in your jurisdiction?Key developments36 What are the most significant legal, regulatory and market practice developments and trends in private M&A transactions during the past 12 months in your jurisdiction?
Owing to the implementation of the General Data Protection Regulation in early 2018, data protection in the due diligence process is becoming increasingly important. The lowering of the thresholds for German foreign investment control has brought this even more into focus in cross-border transactions.