Michael Rohls, Freshfields Bruckhaus Deringer LLP
This is an extract from the second edition of GAR’s The Guide to M&A Arbitration. The whole publication is available here.
Frequency of M&A disputes
The frequency of M&A disputes in Germany is difficult to determine with any certainty.
Reviewing the number of transactions and disputes in Germany in which the author’s firm participated over the past decade, and having cross-checked these findings with warranty and indemnity insurance brokers, an estimate would be that fewer than 10 per cent of all M&A transactions in Germany result in an M&A dispute (including mediation, contractual settlements or ad hoc settlements) that go beyond dealing with general post-closing issues.
Of all M&A transactions in Germany, 3 per cent or less result in arbitration (or more rarely litigation).
Form of dispute resolution
The ratio of arbitration to litigation is rather clear. In our experience, 1 per cent, or maybe 2 per cent, of all M&A disputes end up in litigation at German courts, the rest that have not been settled beforehand go to arbitration.
This experience is backed up by the fact that German courts have rendered very few decisions on M&A disputes and most of them concern relatively small businesses and transactions, such as a beverage wholesaler, a fitness studio, a jewellery store, an advertising agency, and so on. Accordingly, concerns are regularly voiced that the number of court decisions in this area of law is too low to allow for the continuous development of case law specific to M&A disputes governed by German law.
Another way to determine the frequency of arbitration over litigation is to look at the ratio of M&A deals with and without arbitration clauses. Again, in our experience, the result would be around 98 per cent or more in favour of arbitration. This assessment obviously very much depends on the kind of M&A deals examined. When, however, some sources report that only about a third of M&A deals in Germany have an arbitration clause and, hence, could potentially go to arbitration, this statement seems hard to believe. Such a low ratio in favour of arbitration would also be difficult to reconcile with the small number of decisions of German courts in this area of law.
Again, these findings seem to be supported by warranty and indemnity insurance brokers who ‘almost never’ see a litigation clause in the M&A deals for which they arrange insurance coverage in Germany.
Grounds for M&A arbitrations
An educated guess regarding the relevant frequency of types of M&A arbitrations is that claims for breach of warranties and for indemnification are frequent; as are, to a lesser extent, purchase price adjustments and earn-out disputes.
Disputes in connection with material adverse change clauses are very rare because MAC clauses are very rarely included in M&A contracts governed by German law.
Disputes arising out of the failure to complete the transaction are also rare as such failure does not happen often.
Under German substantive law, in the specific case of arbitration the categories of claims mentioned above – and others not mentioned – are very frequently overlaid by claims for intentional misinformation, as explained in detail in the Section below.
Sometimes the sole type of claim in an M&A arbitration is intentional misinformation.
Fraud and failure to disclose
In Germany, the threshold for liability due to intentional misinformation is comparably low and such liability cannot be contractually excluded. It is the main tool used in the attempt to overcome any and all contractual limitations of liability.
Culpa in contrahendo
Generally, M&A transactions under German law are subject to the German provisions on the sale of goods, applied by (statutory) analogy to M&A transactions. In practice, the parties exclude the application of said rules and replace it with contractual provisions. However, the parties might not effectively exclude, or validly change, direct liability for intentional misinformation. Such liability is commonly referred to as culpa in contrahendo.
However, the parties may contractually exclude, or limit, liability for gross negligence.
Intention – a shot in the dark
The threshold for intention is lower than one might expect. Dolus eventualis is sufficient, and the intention generally only needs to cover the misinformation as such but not the consequences (damage) caused by that misinformation.
A common phrase that is used in court decisions, is that the threshold might be already met if a statement was a shot in the dark. It might be sufficient that the party deems it possible that a statement is not correct and the party makes the statement anyway.
General duty to disclose relevant information
Under German law, a party to an M&A transaction has a general obligation to disclose information relevant to the other party. A party must disclose information about the target to the other party that might defeat the other party’s intended purpose of the transaction and of which the other party might reasonably expect disclosure.
For example, a seller might be held liable if it provided information on current and expected turnover, if it obtains new information on turnover, and the buyer would have had a reasonable interest in that new information. The seller might, in that example, be able to contractually exclude its liability if the parties agreed on a cut-off date for such information, namely if the buyer knew it would not get new information after a specific agreed date.
General duty to only state correct information
The duty to state correct information is broader than the duty to disclose relevant information. Any information provided must be correct. Any information specifically requested must be accurate, or the request must be denied.
A party breaches its obligation to make correct statements if the party intentionally (dolus eventualis) provides incorrect information to the other party, no matter whether the information is provided voluntarily, owing to a disclosure obligation, on one’s own initiative, or on request. This also includes the duty to provide complete information.
Burden of proof
German law has a number of substantive law rules governing the burden of proof. While one might question the reasonableness of these rules in arbitration where a tribunal has more discretion to come to a decision than a (German) state court has, some significant rules as regards M&A claims are the following.
Under German statutory law, if a breach of duty is established, the burden of proof is shifted to the breaching party to demonstrate that liability for the breach should not be attributed to it.
However, this rule does not apply if the level of attribution is intention. Thus, a buyer making a claim for culpa in contrahendo needs to prove that the seller committed the breach intentionally.
Causation and quantum of claims for culpa in contrahendo
Under general rules of burden of proof, a seller making a claim for culpa in contrahendo would need to demonstrate a causal link between the breach and the damages, and the quantum of damages.
However, German case law provides for an assumption that, if a buyer had been informed correctly, then the buyer would have been successful in concluding the transaction at a lower purchase price reflecting the influence of the misinformation on the overall purchase price. These reliance damages are calculated as the difference between the agreed and the lower purchase price. The buyer does not need to demonstrate that the seller would have agreed to the lower price.
General procedural rules for the taking of evidence
A tribunal with its seat of arbitration in Germany generally has discretion to determine the rules of procedure for its arbitration unless mandatory provisions, or provisions agreed between the parties, apply. Obviously, the parties have to be treated equally, and the parties’ right to be heard must be upheld. Other than for such fundamental principles, it is commonly accepted that a tribunals’ discretion is rather wide. German case law suggests that said discretion is, in any case, exercised properly if a tribunal, at the least, follows the rules laid down in the Code of Civil Procedure (ZPO) for state court proceedings. As a result, tribunals might take guidance from the German procedural rules for state courts even though they are not, at least not fully, compatible with arbitration proceedings, and those rules, unsurprisingly, are different from what is, or is evolving into, the international standard for conducting commercial (and M&A) arbitrations.
As expressly stipulated in the same ZPO provision, a tribunal may – again at its discretion – determine if evidence is admissible, if it will be taken, and what the result of the taking of evidence is. This provision makes it clear that it is not the parties who decide what evidence is presented and taken, as in state court proceedings under common law, but the tribunal decides. The rule does, however, not per se exclude the taking of evidence by way of, for example, pretrial discovery or extensive disclosure.
In Germany, most arbitral tribunals tend to take a cautious approach towards document disclosure. Much in line with the procedural principle that a party needs to rely on, and only on, documents in its possession, tribunals may grant limited document disclosure for a specific document that is relevant and material (also taking into account which party bears the burden of proof in relation to the facts to be established by the document).
While extensive disclosure, as mentioned above, is not prohibited, it will quite likely only be used under special circumstances.
Estimating the causation of damages and amount of damages
German procedural law has a provision that, once a breach of duty is established, a court might estimate the causation of damage, and quantum, resulting from the breach if the court is provided with sufficient facts to make causation and quantum probable. The question whether this provision is procedural or substantive law is rather academic. As explained above, applying this provision is considered to be at the tribunal’s discretion, as confirmed by German case law.
A seller is liable for the actions and knowledge of its legal representatives. However, the liability for other individuals involved in the transaction may be contractually excluded, even if such persons act with intention.
Generally, a seller is liable for actions of individuals who perform any of the seller’s obligations in the course of a transaction, for example the duty to disclose relevant information. The group of individuals is determined case by case. The members of a seller’s transaction team as well as third-party consultants, such as legal counsel, tax counsel or M&A advisors, might fall into this category.
Whether even actions of target representatives may be attributed to a seller, mainly depends on the actual involvement of the target company in the overall transaction process. The more, for example, a target representative is actively involved in negotiating and managing the transaction, the more likely that its actions would be attributed to the seller.
Any and all attribution of actions (of performance agents) can be contractually limited or excluded. Also, the seller (or the individual) may make it clear to the buyer that actions of the individual shall not be relied on and, thus, prevent the attribution of actions of that individual to the company. A unilateral statement of the seller would be sufficient to exclude reliance; the buyer does not need to accept, or agree to, it.
Similarly, the knowledge of an individual may be attributed to the seller if the individual can be deemed to be a representative of the seller in connection with the transaction. Whether an individual qualifies a ‘knowledge representative’ of the seller might, again, depend on the individual’s involvement in the overall transaction. Likewise, the attribution of knowledge can be contractually limited or excluded.
Unwinding – in theory yes, in practice less
In principle, a claim based on intention might result in the right to unwind the contract. However, the unwinding of an M&A transaction is factually, at least, difficult, if not impossible, and becomes even more difficult over time. As a result, unwinding is rarely requested.
Avoidance – but generally only one year after knowledge
Like liability under intentional culpa in contrahendo, the right of avoidance owing to intentional misinformation may not be contractually limited.
Avoidance has a strict time limit of one year after the party became aware of the intentional misinformation. Avoidance makes the M&A transaction invalid ex tunc and gives both parties claims for unjust enrichment to re-transfer anything exchanged under the contract.
Avoidance of M&A transactions is rare in practice, even while claims for culpa in contrahendo are quite common in arbitration and both legal concepts have many of the same legal prerequisites. Culpa in contrahendo might generally be more attractive because of the longer time limits (a time-bar of three years at year end, or contractual time-bar provisions) and because its legal effect of award of damages is often more desirable (and easier to achieve) than a re-transfer of anything exchanged under the rules of unjust enrichment.
Damages are, by far, the most common form of remedy requested in M&A arbitrations (see ‘Measure of damages’ below).
In case of contractual indemnifications (generally against known risks), a party may request not only the compensation for damage already suffered but also to be held harmless and to be indemnified.
Measure of damages
The common remedy for intentional culpa in contrahendo is the payment of reliance damages. The seller would have to put the buyer into the position the buyer would have been in if the buyer had not relied on the misinformation. Effectively, the buyer can claim a reduction of the purchase price (see ‘Causation and quantum of claims for culpa in contrahendo’, above).
In the case of contractual warranties, which under German law are treated as independent guarantees, the usual remedy – if not contractually altered – is the payment of expectation damages. The seller puts the buyer in the position the buyer would have been in if the guarantee had been observed.
Special substantive issues
A few specific substantive law issues are addressed in the following.
Culpa in contrahendo
Culpa in contrahendo in the context of German law is already discussed above in detail.
M&A deals and restrictions on general terms and conditions
German law has a peculiar, and often criticised, feature: it applies the limits, and the review of, general terms and conditions, as enshrined in EU consumer directives, not only to contracts with consumers but also to contracts between businesses.
Against this background, a discussion exists as to whether an M&A contract could be seen as general terms and conditions, as defined under German law, because the contract has not been negotiated between the parties but simply determined by one party. If that were the case, one could, for example, not validly exclude the liability for gross negligence and even for some lesser degrees of negligence. However, as far as typical M&A transactions are concerned, this discussion is purely academic. In practice, it seems perfectly clear, and arbitral tribunals agree, that an M&A transaction is not subject to the limits governing general terms and conditions under German law.
Data protection in Germany and the EU
Germany has, for some time, had relatively strict data protection rules. For example, when doing fact-finding, email accounts may not necessarily be reviewed without the consent of an employee.
The German data protection rules have to a large extent been overridden by the EU General Data Protection Regulation since 28 May 2018.
Special procedural issues
There are, depending on the definition and depth of review, any number of issues that might be considered special procedural issues when an arbitration has its seat in Germany. Some are described in the following.
An arbitration clause per se does not limit the possibility to request interim relief from German state courts, for arbitration whether its seat is in or outside Germany. However, German courts need to have international jurisdiction for interim relief, and such international jurisdiction can be contractually derogated.
It is widely assumed, but not uncontested, that the parties may not – not even by way of an express agreement that goes beyond a standard arbitration clause – exclude the right of the parties to request interim relief from German courts that have international jurisdiction.
Request to the court of appeal to confirm validity of an arbitration clause
Even when the seat of arbitration is outside Germany or when another domestic law might exclude the arbitrability of certain claims, a party to an arbitration agreement may request that a German court (specifically the court of appeal that has international jurisdiction in Germany) examines and determines the validity of an arbitration agreement.
Court assistance in the taking of evidence and confirmation by oath
Again for an arbitration with its seat in or outside Germany, German courts may provide assistance to arbitral tribunals. For example, the competent district court may be requested to have a witness confirm under oath statements made in an arbitral hearing when the tribunal has doubts about their correctness.
M&A transactions often make reference to the findings of an expert. German law provides that the findings of an expert (in that sense) might be binding on a tribunal in a later arbitration and may only be overruled by the tribunal if the assessment is significantly incorrect.
The use of an expert might result in various legal issues, for example: is it really an expert that the parties meant (Schiedsgutachter) or an arbitrator (Schiedsrichter)? Does instructing an expert (without arbitration) suspend the time-bar? If arbitration is commenced without the expert having been instructed, what happens in the arbitration? And then in the course of arbitration, who might instruct an expert to determine the findings? The issue presents too many questions for the author to answer in this chapter, but the reader should bear them in mind.
Review of awards by two instances
In contrast to some legal systems, the (limited) court review of awards rendered in Germany is not subject to one instance, but, in principle, to two: the competent court of appeal and the Federal Court of Justice.
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