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Typical transaction structures – public companies
What is the typical structure of a business combination involving a publicly traded real-estate owning entity?
In principle, there are no differences between a business combination that is a publicly traded entity that does not own real estate and one that does. Shares in a listed stock corporation can be acquired by way of a public takeover, through the stock exchange or by entering into a purchase-and-transfer agreement with the shareholders. Furthermore, a publicly traded entity can be merged with another company.
Typical transaction structures – private companies
Are there are any significant differences if the transaction involves a privately held real-estate owning entity?
Shares or assets in privately held real-estate owning entities may be acquired by entering into a purchase agreement with the target’s shareholders or the target (in case of an asset deal), or the target may be merged with another entity. Additionally, a common form of cooperation by the shareholders of a privately held real-estate owning entity is a joint venture (eg, cooperation through a joint project or a development agreement). Essentially, joint ventures are not regulated in Germany, which provides maximum flexibility to the joint venture’s potential partners when negotiating a shareholders’ agreement.
Typical transaction process
Describe the process by which public and private real-estate business combinations are typically initiated, negotiated and completed.
In general, this process is the same as in a non-real-estate-related business combination. Depending on whether the transaction involves a public (listed) or private company, there are the following scenarios.
Friendly and hostile takeovers
In the event of a friendly takeover, the target and the offeror enter into a non-disclosure agreement (NDA) before negotiating the offer documentation, (ie, the takeover terms and valuation of the target. Ultimately, the target’s management board and supervisory board will propose the target’s shareholders accept the offer).
In a hostile takeover, the offeror submits a draft offer to the Federal Financial Supervisory Authority (BaFin). Principally, this offer is subject acceptance by a controlling majority of the target’s shareholders and clearance of the merger by the competent cartel authorities. During a period of approximately two weeks, BaFin will review such an offer. If BaFin approves the offer, the offeror should publish the offer as soon as possible.
The target’s management board and the supervisory board will normally recommend shareholders refuse the offer. In this case, the offeror can adjust its offer and provide the shareholders with better conditions.
Bilateral transactions and mergers
In a bilateral transaction the parties will initially agree on an NDA and the purchaser will submit an indicative offer to the seller. The parties will then agree on a letter of intent (LoI) and the purchaser will start conducting a due diligence. At the end, the parties will enter into a share purchase-and-transfer agreement. Merger clearance by the competent antitrust authority (regularly the German Federal Cartel Office or the European Commission) may be necessary before closing the transaction.
For a merger to become effective, the process is essentially the same, except that due diligence will be conducted by both parties and the merger must be approved by both parties’ shareholders and registered with the commercial register.
An auction generally is subject to the same procedure as a bilateral transaction. However, the seller will receive several indicative offers and will ask the bidders with the best offers to conduct due diligence on the target. After due diligence, the potential buyers whose bids are still on will make binding offers. Concurrently, such buyers will submit a marked-up version of the seller’s draft share purchase-and-transfer agreement to the seller. Normally, the seller will choose the best offer and enter into a binding agreement with the bidder that makes it.
Law and regulation
Legislative and regulatory framework
What are some of the primary laws and regulations governing or implicated in real-estate business combinations? Are there any specific regulations or laws governing transfers of real estate that would be material in a typical transaction?
Apart from the German REIT Act, which provides a legal framework for listed stock corporations holding real estate, there are no specific regulations regarding the sale and transfer of real-estate business combinations. Depending on the structure and type of a real-estate deal, the following laws and regulations may also be relevant to non-real-estate-related business combinations:
- the Civil Code;
- the Commercial Code;
- the Limited Liability Companies Act (GmbHG);
- the Stock Corporation Act (AktG);
- the Reorganisation Act (UmwG);
- the Securities Trading Act;
- the Securities Acquisition and Takeover Act;
- the Insolvency Code;
- the Protection of Competition Act;
- the Stock Exchange Act;
- the Real Estate Transfer Tax Act; and
- the EU Market Abuse Regulation (MAR).
The Real Estate Transfer Tax Act does not only apply in an asset deal, but also in a share deal in case of an acquisition of at least 95 per cent of the shares in the real-estate owning entity. Currently, discussions on a legislative level are pending to extend the holding period to at least 10 years and reduce the participation thresholds to less than 90 per cent. For details see question 14.
Cross-border combinations and foreign investment
Are there any specific material regulations or structuring considerations relating to cross-border real-estate business combinations or foreign investors acquiring an interest in a real-estate business entity?
In general, there are no specific material regulations relating to cross-border real-estate business combinations. The purchaser must obtain merger clearance before the completion of the transaction if the transaction confers control. ‘Control’ is defined as the ability to exercise decisive influence - for example, an investor having the right or ability to determine or veto key strategic decisions or when certain thresholds have been exceeded.
German foreign investment rules generally consider the ultimate beneficial owner of an investment vehicle to determine whether a foreign investment filing is required (eg, under German rules direct or indirect participation of 25 per cent or more can render an investment reportable). Furthermore, foreign investment filings require notifying parties to disclose information for each level of the holding chain up to the ultimate business owner or entity exercising control and to describe it (eg, activities of the relevant entities, and future governance rights of such entities in the target business).
In addition, the German Federal Ministry of Economics usually requires foreign investors to disclose information around transaction financing and whether the financing arrangements provide third parties with any influence and information rights with respect to the target.
When there is a change of the ultimate beneficial owner of a company (ie, a natural person who holds more than 25 per cent of the capital interest, controls more than 25 per cent of the voting rights, or exercises control in a similar way), the information on the ultimate business owner must be made public in the transparency register. In Germany, this register is accessible online by public authorities and anybody who has a ‘legitimate interest’.
Choice of law and jurisdiction
What territory’s law typically governs the definitive agreements in the context of real-estate business combinations? Which courts typically have subject-matter jurisdiction over a real-estate-related business combination?
When the relevant real estate is in Germany, German law will typically govern the transaction documentation and German courts will have jurisdiction. However, foreign law might govern certain transaction documents (eg, securities for the purchaser, such as a letter of comfort issued by the target’s shareholders).
Approval and withdrawal
What information must be publicly disclosed in a public-company real-estate business combination?
The scope of the disclosure depends on the structure of the public-company real-estate business combination. The overall size of the transaction does not matter in this context.
In the first instance, a listed stock corporation is subject to ad hoc publicity obligations under MAR if the proposed real-estate business combination qualifies as insider information under MAR.
In the case of a merger, the merger agreement and reports from an auditor and the companies’ management board have to be filed with the commercial register, which publishes such documents electronically.
In a takeover scenario, the offer document that, among other things, includes information on the offeror, the target, the offer’s subject, the consideration and the structure, must be publicly disclosed. In case the consideration does not only consist of cash, the details of such non-cash consideration must also be set out in the offer. In addition, the offeror has to provide information on the financing of the takeover offer and the consequences of a successful offer for the offeror’s asset, financial and profit situation.
Duties towards shareholders
Give an overview of the material duties, if any, of the directors and officers of a public company towards shareholders in connection with a real-estate business combination. Do controlling shareholders have any similar duties?
The directors of a stock corporation must exercise the diligence of a prudent and conscientious businessperson when acting for the company. This means that they must act in the best interest of the company and its shareholders, the company’s employees and the public interest. The directors must ensure that shareholders are provided with all relevant information regarding their decision about the proposed transaction.
To comply with their fiduciary duties towards the company, the purchaser’s directors must ensure that it does not pay an unreasonably high purchase price for an acquisition. Similarly, in the case of a merger, the directors of both companies involved must agree on an adequate consideration for shareholders.
In a takeover, both the members of the management board and the members of the supervisory board of the target must not act in a way that might frustrate the success of the takeover offer at first. During a takeover, they might be instructed by the shareholders’ meeting (the majority of at least three-quarters of the share capital represented at the shareholders’ meeting) to implement countermeasures against the takeover. In contrast, the controlling shareholders do not have a similar duty to ensure the success of a takeover attempt.
What rights do shareholders have in a public-company real-estate business combination? Can parties structure around shareholder dissent or rejection of a real-estate business combination, and what structures are available?
The rights of shareholders in a public-company real-estate business combination vary depending on the transaction’s structure. In general, there are no differences in shareholders’ rights if the scenarios described below are performed as going-private transactions.
In mergers, the shareholders of the transferring entity receive shares in the transferee entity in return for the loss of their participation in the transferring entity.
A merger requires resolutions by both companies’ shareholders’ meetings and must be approved by a majority of at least three-quarters of the share capital represented at each shareholders’ meeting. The same applies to a change of the stock corporation’s legal form to a limited partnership. However, a unilateral shareholders’ resolution is required to approve the transformation of the public company to a general partnership or a civil law partnership.
Conversely, approval by shareholders’ resolution is not necessary for delisting in a going-private transaction. The consideration for all listed shares concerned must at least equal the six months volume-weighted average stock exchange price of the target’s shares prior to the announcement of the offer, and the highest price paid or agreed to be paid for acquisitions of target shares in the last six months’ prior to the announcement of the offer, or, for off-market purchases, within one year of the result announcement of the offer.
In comparison, generally a share or asset sale does not have to be approved by the target’s shareholders, unless the target’s articles of association provide specific approval requirements. However, when all or an essential part of a stock corporation’s assets are being sold, the shareholders have to approve the sale with a majority of at least three-quarters of the share capital represented in the shareholders’ meeting.
Parties usually cannot structure around shareholder dissent or rejection of a real-estate business combination.
Are termination fees typical in a real-estate business combination, and what is their typical size?
In Germany, termination or break-up fees are only relevant in bilateral real estate deals or mergers. If the target is a stock corporation or a limited liability company (LLC), the agreement on a break-up fee is subject to certain restrictions.
It follows from the GmbHG that the agreed break-up fee must only take sufficient account of the shareholders’ mutual fiduciary duties and the principle of equal treatment, the AktG provides for a more restrictive view in this regard. The amount of the break-up fee to be borne by the target must be ‘reasonable’, which means that it can be up to 1 per cent of the value of the company or deal value. The parties may also consider the complexity of the proposed transaction when agreeing on a certain amount: the more complex the intended agreement, the higher the break-up fee. The conditions under which the break-up fees incurred must be objective and not unilateral. Furthermore, capital protection provisions in the AktG, such as the prohibition of a repayment of contributions and of financial assistance for the acquisition of shares, might play an important role when assessing whether a break-up fee is legally admissible.
Are there any methods that targets in a real-estate business combination can employ to protect against an unsolicited acquisition? Are there any limitations on these methods?
There are a couple of methods a target in a real-estate business combination can employ to protect against an unsolicited acquisition. These are the same as the defences usually used in a non-real-estate-related business combination.
In the first instance, the target’s success may be increased, for example by realising additional profits, to convince the target’s shareholders of a positive future performance by the company’s management and to discourage them from agreeing to an acquisition offer or takeover bid. The target may also acquire or merge with another company to increase the transaction costs for a potential purchaser. In addition, the target’s ‘crown jewels’ (ie, its most interesting assets) may be sold or liquidated. Also, a stock corporation may issue registered shares with restricted transferability so they are only transferable with the issuing company’s consent.
How much advance notice must a public target give its shareholders in connection with approving a real-estate business combination, and what factors inform this analysis? How is shareholder approval typically sought in this context?
In general, the shareholders of a stock corporation must be informed at least 30 days before a shareholders’ meeting is to take place, but the target’s articles of association may also provide for a longer notice period for convening the shareholders’ meeting. For a takeover, shareholders must be given at least 14 days’ notice of a shareholders’ meeting being convened.
In the shareholders’ meeting, the management board must inform the shareholders of the transaction’s terms and answer the shareholders’ questions. Additionally, the shareholders must be provided with all relevant transaction documents. If the target is listed on a stock exchange, it has to publish this documentation on its website.
Taxation and acquisition vehicles
Typical tax issues and structuring
What are some of the typical tax issues involved in real-estate business combinations and to what extent do these typically drive structuring considerations? Are there certain considerations that stem from the tax status of a target?
Real-estate transfer tax at a rate of 3.5 to 6.5 per cent is always payable on asset deals. In case of a share deal, real-estate transfer tax will be triggered, if at least 95 per cent of the shares in a real-estate holding company (corporation or partnership) are directly or indirectly transferred to one purchaser or a group of affiliated purchasers. In addition, the direct or indirect transfer of at least 95 per cent of the partnership interests to new partners within a period of five years is subject to real-estate transfer tax.
Asset deals and share deals are generally VAT exempt. However, these exemptions may be waived. Purchasers should ensure that they can deduct the VAT triggered by the waiver before accepting such a waiver. An asset deal might not be subject to VAT if it qualifies as the transfer of a going concern. In this case, the purchaser will have to continue the input VAT adjustments triggered by the seller.
Corporate income tax (CIT), including a solidarity surcharge (15.825 per cent, is applicable on the capital gains due to exit and distributions. However, German tax law provides for a participation exemption of 95 or 100 per cent. Refinancing on the target’s level (including shareholder loans) is subject to the German interest ceiling rules, which apply if annual interest expenses exceed €3 million. Furthermore, trade tax (approximately 15 to 17 per cent) is applicable on the capital gains if the selling entity is subject to German trade tax.
In cases of asset deals, the purchaser will be held liable for specific taxes triggered by the purchaser.
When setting up the acquisition structure a tax-efficient exit scenario should be considered.
Mitigating tax risk
What measures are normally taken to mitigate typical tax risks in a real-estate business combination?
In cases of share deals, the real-estate transfer tax burden might be mitigated by a co-investment structure, with each independent investor not exceeding the respective participation threshold of 95 per cent. If the target is structured as a partnership, the seller could also be maintained as minimum shareholder; the remaining stake could be acquired via a call or put option to be exercised after the expiry of a holding period of five years. Currently, discussions on a legislative level are pending to extend the holding period to at least 10 years and reduce the participation thresholds to less than 90 per cent.
The liability for taxes, triggered by the seller, in asset deals, might only be addressed by indemnities in the sale and purchase agreement that are frequently supported by warranty and indemnity (W&I) insurance. The continuance of VAT corrections, in cases where the transfer qualifies as a transfer of a going concern, is normally considered by an indemnity or price reduction in the amount of the aggregated input VAT corrections.
With respect to trade tax on rental income, income tax and trade tax on capital gains in the case of an exit by way of a share deal, the purchaser might avoid having a permanent establishment in Germany, especially by ensuring that management decisions are not made in Germany. If such structuring is not available, with respect to trade tax, choosing a partnership as acquiring vehicle (structured as a non-trading business) could be considered.
Types of acquisition vehicle
What form of acquisition vehicle is typically used in connection with a real-estate business combination, and does the form vary depending on structuring alternatives or structure of the target company?
In Germany, selecting a certain form of entity for the acquisition cannot prevent the acquisition vehicle from incurring real-estate transfer tax when acquiring the target (provided that the purchaser acquires 95 per cent or more of the shares in the company). However, investors often choose a German LLC as an acquisition vehicle for a real-estate business combination. Since such LLCs are not tax transparent, they normally are integrated in a tax group. In such cases CIT and trade tax are only payable at group level.
Board considerations in take-private transactions
What issues typically face boards of real-estate public companies considering a take-private transaction? Do these considerations vary according to the structure of the target?
A take-private transaction of a public company generally requires the company to delist from a stock exchange. Normally, a controlling shareholder that wants to acquire the shares must make an offer to acquire all outstanding shares. Additionally, the management board and the supervisory board have to act in the company’s best interest. However, there are no specific obligations the board members must follow.
Furthermore, a listed stock corporation may be delisted by way of a merger into a non-listed company. Such a merger must be approved by a shareholders’ meeting of the listed company, with at least three-quarters of the share capital represented.
Time frame for take-private transactions
How long do take-private transactions typically take in the context of a public real-estate business? What are the major milestones in this process? What factors could expedite or extend the process?
A public company’s delisting from a stock exchange takes around three months. The company must file an application with BaFin and simultaneously submit an offer document prepared by its controlling shareholder. The controlling shareholder must publish the offer document without undue delay, if BaFin approves it.
Furthermore, it takes another eight weeks to exclude minority shareholders that do not accept the controlling shareholder’s offer from the company by way of a squeeze-out. Minority shareholders may take legal action against the squeeze-out; such proceedings take approximately three months.
Are non-binding preliminary agreements before the execution of a definitive agreement typical in real-estate- business combinations, and does this depend on the ownership structure of the target? Can such non-binding agreements be judicially enforced?
The use of preliminary agreements, such as LoIs, is standard practice in Germany and usually do not depend on the ownership structure of the target.
After reviewing the investment memorandum and before entering in-depth negotiations regarding the purchase of real estate, the potential buyer typically signs an exclusivity agreement with the seller. An estate agent often facilitates this. The exclusivity period usually lasts and between four weeks and three months, at the end of which the buyer needs to make a binding offer. Although the LoI is not binding and enforceable regarding the conclusion of a purchase agreement, the parties typically aim to agree on the framework conditions of the real-estate business combination.
The preliminary agreement should clearly state which provisions shall be binding to avoid leaving enforceability open to court interpretation. While terms covering commercial issues are usually non-enforceable, terms regarding the confidentiality, exclusivity and duration of the preliminary agreement are enforceable.
Describe some of the provisions contained in a purchase agreement that are specific to real-estate business combinations? Describe any standard provisions that are contained in such agreements.
A purchase agreement must contain at least the parties, the structure of the sale, the object of purchase and the purchase price. In relation to a real-estate business combination not only must the target company (as the direct object of purchase) be described precisely, but so must the real estate acquired indirectly via reference to its registration in the land register. Regarding the purchase price, the payment mechanism and due date must be agreed upon as well as the closing conditions. Frequently a preliminary purchase price is fixed, but is later adjusted as the calculation of the purchase price generally depends on the rental income of the property.
Essential provisions further include the date of transfer of possession, the deletion of encumbrances and repayment of loans secured by those encumbrances, representations and warranties (R&Ws) and remedies for breach of contract.
The standard R&Ws for the acquisition of real-estate cover leases and other third-party agreements, environmental matters, litigation, payment of taxes and other public fees and charges, compliance with building permits and zoning regulations.
Are there any limitations on a buyer’s ability to gradually acquire an interest in a public company in the context of a real-estate business combination? Are these limitations typically built into organisational documents or inherent in applicable state or regulatory related regimes?
There are no legal restrictions on a buyer’s ability to gradually acquire an interest in a public company in the context of a real-estate business combination in Germany. Furthermore, such limitations cannot be specified in the articles of association of the company. However, there might be tax consequences if certain shareholding thresholds are exceeded (eg, if a shareholder directly or indirectly acquires 95 per cent of the shares in a company that owns real estate).
In this case, real-estate transfer tax will, generally, be incurred.
Certainty of closing
Describe some of the key issues that typically arise between a seller and a buyer when negotiating the purchase agreement for a real-estate business combination, with an emphasis on building in certainty of closing? How are these issues typically resolved?
The parties to a purchase agreement typically agree on certain termination or rescission rights if closing conditions (eg a certain percentage of the property is leased) are not fulfilled by a fixed longstop date. Depending on the party’s negotiating power, contractual penalties might be negotiated. If a certain matter, for example, the granting of a building permit, is key to the transaction, the parties can agree for the matter to be a condition precedent for the entire agreement.
Additionally, provisions dealing with the transfer of the companies’ properties, securities, and potential warranty rights against contractors, should be incorporated in the agreement. The parties may also agree on the termination of maintenance, service and employment contracts to optimise the combined businesses.
Who typically bears responsibility for environmental remediation following the closing of a real-estate business combination? What contractual provisions regarding environmental liability do parties usually agree?
Under the German Federal Soil Protection Act, the polluter, the current owner, the current user, and all former owners and users of a property may be subject to mandatory decontamination measures for by order of the relevant authorities. Should any contamination of a property render decontamination measures necessary, the relevant authorities will not necessarily charge the polluter, but look for the most financially sound party that is, or has been the owner, or has been in any other way in possession of the property. The German Federal Soil Protection Act grants specific rights to any party that may be charged to recover payment from any other party whose liability for the particular contamination can be proven.
The local authorities maintain cadastres in which all available information on possible contamination of soil or ground water by existing or former use of the property or as a result of warfare is registered (the Cadastre for Contaminated Sites). These cadastres are an important source of information for any investigation prior to the acquisition of a property. However, if the property is not registered or no issues are referred to in cadastre, this does not necessarily mean that the property is free from contamination. So it is highly advisable to undertake an environmental investigation prior to any acquisition of property.
In standard sale-and-purchase agreements the term ‘environmental damage’ is defined to include not only contamination under the German Soil Protection Act, but also, for example, hazardous materials in the building, warfare agents and waste. In the market-standard provision, the seller states that it is not aware of any contamination and that the buyer will indemnify the seller in case authorities should request decontamination measures from the seller in the future, unless the seller is responsible for the environmental damage. If there is any suspicion of environmental damage, it is important that environmental experts investigate the matter further in order for the parties to be able to agree on liabilities.
Other typical liability issues
What other liability issues are typically major points of negotiation in the context of a real-estate business combination?
The parties will typically agree on a time of transfer regarding the risk associated with the property, for instance, ownership and right of use of the property, duties of care, accidental deterioration or impairment of the property. On one hand, the seller should keep in mind that by selling the property its liability is not automatically excluded; but on the other hand, the purchaser should note that he or she might need to fulfil duties connected to the property prior to its purchase.
It is market standard that the liability for defects of the property are limited or excluded.
Sellers’ representations regarding leases
In the context of a real-estate business combination, what are the typical representations and covenants made by a seller regarding existing and new leases?
Generally, the sale of a property does not affect existing leases, regardless of whether the transfer is made by share deal or an asset deal. The new owner is bound by the existing leases (including its benefits and liabilities) and enters into the lease as the legal successor of the seller.
Therefore, typical representations of the seller include the existence and validity of the lease agreements, rent payments, rent securities (including the transfer of these securities) and ongoing or pending legal disputes with tenants.
Market-standard covenants may concern a promise to perform outstanding repair and maintenance works, the obligation not to terminate or amend existing lease agreements without the prior approval of the other party or a commitment to enter into new lease agreements between closing and the final transaction.
Legal due diligence
Describe the legal due diligence required in the context of a real-estate business combination and any due diligence specific to a real-estate business combination. What specialists are typically involved and at what point in the transaction are the various teams typically brought in?
Prior to investing in property, buyers usually carry out due diligence on all aspects of the property. Such due diligence often covers all technical, commercial and legal aspects including title, easements, agreements with neighbouring owners, environmental regulations, zoning and building laws, lease agreements and planning permissions.
The due diligence prior to a share deal also covers all legal aspects regarding the shares in the target company such as pre-emption rights, encumbrances, whether the authorised share capital has been contributed completely and accurately, annual accounts of the company including debts and risks, employment contracts and existing or future liabilities and commercial risks.
How are title, lien, bankruptcy, litigation and tax searches typically conducted? On what levels are these searches typically run? What protection from bad title is available to buyers and does this depend on the nature of the underlying asset?
In Germany, title to real estate is registered with the land register; this also applies for liens encumbering the real estate. An extract of the land register regarding the relevant plots of land forming the real estate needs to be reviewed. As entries in the land registers constitute a ‘public faith’, it can be assumed that the registrations are correct and no additional title searches have to be carried out. The risk of applications having been filed, but not yet registered with the land registry, is typically covered in the acquisition document by R&Ws.
Bankruptcy filings may be reviewed online on the Insolvency Notices website.
Litigation and tax issues must be reviewed based on the information provided by the seller as there is no public register or source to be examined. A provision in the acquisition document may ensure that the seller is liable for incorrect or incomplete information.
The types of searches to be conducted do not depend on the nature of the underlying asset.
Representation and warranty insurance
Do sellers of non-public real-estate businesses typically purchase representation and warranty insurance to cover post-closing liability?
W&I insurance is becoming an increasingly popular method of securing the buyer’s claims arising from the R&Ws concluded in the acquisition agreement. However, this is not a market-standard practice, as the seller’s liability typically is very limited and time-barred to between several months up to a few years (depending on the parties’ agreement). However, some investors, particularly private equity funds, may try to achieve a ‘clean exit’ when selling a non-public real-estate business in order to quickly dissolve the seller entity and pay out the dividends.
Review of business contracts
What are some of the primary agreements that the legal teams customarily review in the context of a real-estate business combination, and does the scope vary with the structure of the transaction?
In addition to all the usual corporate documents, standard legal due diligence for the (indirect) acquisition of real estate in Germany covers the review of:
- land register extracts, acquisition agreements (if the acquisition has taken place recently);
- extracts from the register of public building charges;
- lease agreements;
- building permits;
- information on urban building particularities; and
- extracts from the register of contaminated sites.
Depending on the outcome of the review further documents, such as approvals for registrations or environmental reports, may be requested. Whether agreements that do not exceed certain thresholds or are terminable with relatively short notice periods are reviewed depends on their importance to the transaction and the scope agreed with the client.
Breach of contract
Remedies for breach of contract
What are the typical remedies for breach of a contract in the context of a real-estate business combination, and do they vary with the ownership of target or the structure of the transaction?
Typical remedies for breach of a contract are termination and rescission rights, the payment of damages, contractual penalties or the reduction of the purchase price.
A seller usually tries to exclude any liability as far as possible and to agree on high amounts and short expiration periods for any remaining liability.
The remedies and possible securities depend less on the structure of the transaction than on whether substance for forfeiture is left with the seller after the property-owning target has been transferred.
How does a buyer typically finance real-estate business combinations?
Not least due to the low interest rate environment, the majority of commercial property finance is still dominated by private debt, for instance loans granted by banks or, increasingly, other investors such as insurance companies and debt funds. In addition to the private debt, equity and in some instances intercompany loans will usually be injected into the structure to finance the acquisition of the property (by a share or by an asset deal).
Typically, the private debt financing will be asset-based and set up as a limited recourse transaction on the property level (either directly or by way of accession of the target and corresponding debt pushdown). Such a structuring is more advantageous for banks, facilitates the granting of security (considering discussions regarding capital maintenance rules and current case law) and so is commercially favourable for the buyer. In any case, the specifics of the relevant structure will need to be evaluated on a transaction-by-transaction basis taking tax law considerations into account.
What are the typical obligations of the seller in the financing?
Generally, the seller will have no other obligation other than to support the granting of a land charge as security for the financing party. Providing an authorisation to charge the property typically does this. Additionally, the seller should be obliged to assist in coordinating the release of security granted for the debt assumed for the development of the property or the acquisition of the property by the current seller.
However, broader obligations might apply for share deals, for instance, acquisition of the property-owning company or the parent of such company where the seller remains in control of the target until the shares are transferred. In these cases, the seller’s assistance is required to set up the security package prior to closing of the transaction.
What repayment guarantees do lenders typically require in the context of a property-level financing of a real-estate business combination? For what purposes are reserves usually required in the context of property-level indebtedness?
Usually, no repayment guarantees are provided, as the financing is limited recourse. Therefore, no reserves are required by the lenders from the outset, but are rather built in a scenario where financial covenants are breached and cash traps are implemented. However, other securities are typically granted, such as a land charge (in connection with a corresponding security purpose agreement), account pledges, share pledges over the shares in the property-owning company and further contractual obligations of third parties and group companies involved in the structure, such as duty-of-care agreements and subordination agreements.
What covenants do lenders usually insist on in the context of a property-level financing of a real-estate business combination?
The lenders will normally insist on certain financial covenants, such as a specific loan-to-value (LTV) ratio (the average LTV is 60 to 75 per cent, but can also be higher); interest-cover ratio, which can average 110 to 150 per cent); or debt-service-cover ratio, the average of which is 110 to 180 per cent.
Additionally, information undertakings in regard to the monitoring of the property and the provision of financial statements, as well as further property undertakings (eg, maintenance, management of the property itself and as an asset, and maintenance of appropriate insurance) all aiming to protect the cash flow and condition of the property that is essential to the lenders.
Typical equity financing provisions
What equity financing provisions are common in a transaction involving a real-estate business that is being taken private? Does it depend on the structure of the buyer?
The equity financing provisions depend on which portion the financing bank is willing to take, which, in turn, depends on the value of the property, as well as the remaining term of the lease - for instance, the longer the lease the more the lender will be willing to finance.
Collective investment schemes
Are real-estate investment trusts (REITs) that have tax-saving advantages available? Are there particular legal considerations that shape the formation and activities of REITs?
German REITs may only be structured in the legal form of a stock corporation. German REITs are tax-exempt on an entity level. Distributions are taxed on shareholder level, but no participation exemption applies. German REITs are subject to various regulatory restrictions, such as, immovable assets must account for at least 75 per cent of the REIT’s assets REITs need to distribute 90 per cent of the annual profits and maintain an equity ratio of at least 45 per cent. Furthermore, no shareholder must hold more than 10 per cent in a REIT and at least 15 per cent of the shares need to be in free float.
Private equity funds
Are there particular legal considerations that shape the formation and activities of real-estate-focused private equity funds? Does this vary depending on the target assets or investors?
Generally, real-estate-focused private equity funds qualify as alternative funds and are supervised by BaFin. Furthermore, they are regulated by the Investment Law Book, which defines the level of regulations according to the classification of the investors and the value of the assets under management, rather that the target asset.
The Investment Law Book also establishes a set of requirements for the management of funds. The fund manager must be registered with BaFin and alternative funds generally require a permit from BaFin. There are, however, exceptions for alternative funds that only manage alternative funds for semi-professional investors and whose managed assets do not exceed €100 million (with use of leverage) or €500 million (without use of leverage and further requirements).
Update and trends
Are there any other current developments or emerging trends that should be noted?
The hot topic is the pending legislative initiative regarding the new real-estate transfer tax (RETT) rules for share deals. It was expected in mid-September 2018, but has not yet been initiated. For details about this legislation see question 14.