1. Recent developments
Due to sellers’ continuing strong negotiating position in M&A transactions in many sectors, seller-friendly purchase agreements have become more common, particularly in auction processes and also in the German market. This trend is associated with an allocation of risks from the seller to the buyer, which is conceptually referred to as a clean exit for the seller. Consistently implemented, a clean exit can achieve a far-reaching limitation of the seller’s liability (zero recourse), up to a comprehensive exclusion and avoidance of subsequent liabilities of the seller, in each case only subject to mandatory legal requirements. In the competitive environment of an auction process, the buyer can generally oppose these efforts only to a very limited extent, if the buyer does not want to burden its final and binding offer with a heavy mark-up of the vendor SPA draft in the auction process. In this case, the buyer can only attempt to address the risks to be assumed pursuant to the seller-friendly purchase agreement outside of the contract, e.g., in the course of due diligence.
Historically, corporate sellers and private equity investors reduced their liability risks by excluding the attribution of fault by vicarious agents (Erfüllungsgehilfen) pursuant to section 278 of the German Civil Code (BGB), and regularly limited the imputation of knowledge (Wissenszurechnung) to the seller regarding representatives of the target company. Since the end of the 2000s, warranty and indemnity (W&I) insurance also has been increasingly used and further developed. Originally, W&I insurance policies were used to cover the seller’s warranties in the purchase agreement. Today, W&I insurance can cover unknown tax risks, and even certain known tax and other risks (contingent risk insurance, or CRI). Accordingly, the seller’s liability for breach of its warranties and under the tax indemnity in the purchase agreement can be reduced to zero (i.e., zero liability concept).
More recently, sellers have been attempting to reduce the remaining statutory liability to an absolute minimum and to include liability exclusions in the purchase agreement to the widest extent possible, including for wilful misconduct (Vorsatz) and constructive fraud (Arglist) by the management of the target company’s management. The seller does not assume any liability, as far as possible under mandatory law, beyond the contractual liability regime in the purchase agreement. In order to achieve this objective, certain precedents can be found in practice to date. It remains to be seen which of these, if any, will be able to develop into best practice, and whether and to what extent they will find the courts’ blessing in any subsequent M&A post-closing arbitration or litigation.
2. Contractual arrangements in the purchase agreement
In order to achieve a clean exit for the seller, a combination of the following contractual provisions in the purchase agreement and adequate disclosure strategy are required in the due diligence.
2.1 Exclusion of statutory buyer’s rights
In order to ensure that the contractual liability regime in the purchase agreement prevails, all statutory rights of the buyer under German civil law are regularly excluded by default unless they are subject to mandatory law. Liability for wilful misconduct by the seller’s managing directors cannot be excluded in advance under German civil law (section 276 para. 3 BGB), nor can claims for constructive fraud be excluded in advance (section 444 BGB). Exclusions regarding vicarious agents (Erfüllungsgehilfen) of the seller should be addressed separately in the purchase agreement.
2.2 Seller’s warranties
Instead of applying the statutory liability regime, it is market practice in German M&A transactions to agree on a particular set of seller’s warranties regarding the condition of the target company. In order to limit the risks and avoid disputes, the parties typically agree on certain liability caps, de minimis rules and the scope of the relevant damages to be compensated (direct damages, indirect damages, etc.). In addition, indemnification claims are often agreed for known risks, which are regularly excluded in the purchase agreement from the seller’s liability due to the buyer’s knowledge.
In M&A deals without W&I insurance, buyers usually try to impose certain duties of inquiry on the seller as part of the definition of the seller’s knowledge (so-called due inquiry concept). For the due inquiry, the seller’s management assumes a contractual obligation to interview certain members of the management of the target company regarding the sellers’ warranties and the disclosures made in this respect. Provided such inquiries to the relevant (agreed upon) managers are diligently carried out, the seller will usually aim to exclude any further obligations and liabilities from any knowledge attribution, organization and further inquiry obligations. The results of the due inquiry can be documented in writing and attached to the purchase agreement, e.g., in the form of so-called due inquiry certificates.
2.3 Risk regarding imputation of knowledge and how it can be addressed
In order to reduce the seller’s liability risks under German civil law (i.e., outside the purchase agreement), it is also necessary to exclude or limit as far as possible the attribution or imputation of knowledge (Wissenszurechnung) to the seller regarding knowledge generally available at the seller and/or the target. In the event of an intentional breach of duty or constructive fraud on the part of the seller in connection with its disclosure obligations, the contractual exclusions of the seller’s liability in the purchase agreement are ineffective, void and consequently do not apply at all. In these cases, the buyer has all statutory rights under German civil law and tort at its disposal, without any contractual limitations. According to applicable case law, the seller is already acting with constructive fraud if he makes statements based on insufficient or inadequate inquiries (Angaben ins Blaue hinein), which then prove to be incorrect. In this case, W&I insurance will no longer be available as protection for the seller. For M&A transactions, it is critical to understand whose knowledge is imputed to the seller and whose wilful misconduct and/or constructive fraud is relevant for the seller. The relevant group of persons to whom the attribution of knowledge applies are, first of all, a legal entity’s managing directors. However, on the grounds that a contracting party should not suffer any disadvantage because it contracts with a legal entity consisting of a large number of representatives and employees, the relevant knowledge concept, according to the case law of the German Federal Court of Justice (Bundesgerichtshof, or BGH), goes beyond the actual knowledge of the relevant managing directors. The German Federal Court of Justice considers it necessary to attribute all information that is “typically recorded in the files” as known by the seller. In addition, the knowledge of so-called “knowledge representatives” (Wissensvertreter) is attributed to the seller under German case law. As such, any person qualifies who the seller retains to act on its behalf and as its representative in connection with the respective M&A transaction.
The German Federal Court of Justice has not yet decided whether knowledge of the managing directors or other representatives or employees of the target company is attributed to the seller. The German Federal Court of Justice seems to be inclined to accept such attribution under certain conditions. There are different views on this question in the literature and in practice. In some cases, such an imputation is rejected outright, while in others, an imputation is assumed under special conditions, but rejected solely based on group law affiliation. It is also often questioned whether a seller should be able to rely on the fact that it was unaware of the knowledge available at the target company.
Regardless, it is established case law in Germany that a seller has a general duty to organize knowledge when selling a company (Wissensorganisationspflicht). Accordingly, any risk allocation for a broad clean exit (including an exclusion of wilful misconduct or constructive fraud by the target’s management) should be only justifiable, provided the seller comprehensively fulfils its duty to organize knowledge and makes it available to the buyer in the course of the due diligence in order to eliminate any information asymmetry between the seller and the buyer. Without recognition of a seller’s duty of this kind, any far-reaching limitation and shifting of liability, as in the context of a broad clean exit, should be difficult, if not impossible, to justify.
On the other hand, the German Federal Court of Justice has ruled that imputed knowledge can be sufficient for constructive fraud. In this context, the German Federal Court has already taken the step from the imputation of knowledge to a fiction of intent (Wollensfiktion). Accordingly, under German mandatory law (i.e., section 123 para. 1 BGB), a seller is not able to exclude any liability for constructive fraud by any of its representatives (including the management of the target company if assigned by the seller with the due diligence or the disclosures regarding the warranties in the purchase agreement).
The seller’s aim in the purchase agreement must therefore be to exclude the imputation of knowledge as far as possible in order to avoid a breach of duty within the scope of the knowledge organization constituting a constructive fraud misrepresentation due to the comprehensive imputation of knowledge. Generally, the seller can achieve this by waiving its liability for wilful misconduct by its vicarious agents pursuant to section 278 sentence 2 BGB. Furthermore, the direct or analogous application of the attribution standard pursuant to section 166 BGB regarding so-called knowledge representatives must be excluded.
With respect to the scope of excluded persons or knowledge representatives (e.g., managing directors, team leaders of the seller and/or management of the target company), it remains to be seen which market standards will develop in purchase agreements in the future, and also whether and to what extent case law will recognize corresponding limitations or reject them based on mandatory law. It is usually argued in these cases that in M&A processes both parties are often professionally advised, and it is not a matter of mandatory liability for wilful misconduct or constructive fraud under the law, but rather a contractual allocation and determination of the imputation of knowledge, which in some views is not regulated by mandatory German law for these cases. Whether this argumentation can prevail will certainly depend on the circumstances of the individual case.
3. Practical recommendations for M&A transactions
3.1 Sell side
The seller should comprehensively fulfil its duty to organize knowledge, including in due diligence, if it does not want to put its clean exit concept into question. In addition to a typical vendor data room with information on the target and its business, as well as a question-and-answer process and expert sessions in relevant areas, this can be further supported by providing (for example) vendor commercial, financial, tax, ESG and legal fact books. The seller should also offer adequate seller’s warranties for the target business in the vendor draft of the purchase agreement that the seller’s representatives feel comfortable with based on their knowledge of the target and its business. An insurance broker and insurance providers should be asked to review such seller’s warranties, and the seller should obtain non-binding indications of insurance coverage for the buyer (i.e., soft-stapled W&I insurance). Respective liability limitations also must be included in the purchase agreements (in particular, caps and liability exclusions for claims covered under the W&I insurance, i.e., no recourse to the seller). Last but not least, the due inquiry by the seller regarding the seller’s warranties and disclosures should be done with utmost diligence and documented in any event in order to reduce the seller’s risk of giving a warranty due to insufficient or inadequate inquiries.
3.2 Buy side
For the buyer, comprehensive due diligence is still the first choice to identify and address risks related to the target. This is the only way for buyers to eliminate or at least substantially reduce information asymmetry between seller and buyer, and to create transparency regarding the risks to be allocated and assumed. In addition, adequate seller’s W&I coverage for unknown and known risks, if any, as well as enhancements under the W&I insurance cover sheet (e.g., knowledge scrap) and policy should be negotiated with the seller and the W&I insurance provider. When negotiating liability limitations in the purchase agreement, no general, broad or blanket exclusions should be accepted despite a strong seller position for good assets. Instead, emphasis should be placed on a liability regime that is tailored, appropriate and balanced under the circumstances. With regard to the definition of seller’s knowledge regarding the seller’s warranties, particular care should be taken to ensure that the group of relevant knowledge representatives includes appropriate key management functions of the seller and the target. When determining the relevant persons for the due inquiry, both management and employees of the seller and of the target company should be carefully selected in order to exclude, as far as possible, the risk of any kind of collusive interaction among the relevant groups. Last but not least, the opportunities and future strategy of the target, but also the material risks of the transaction at hand, should be discussed by the buyer with the management of the target company.
3.3 Synthetic W&I insurance
So-called synthetic W&I insurance policies are also being discussed in Germany and in some cases used. In these instances, the representations and warranties are attached to the insurance policy and not anchored in the purchase agreement. The seller is normally not involved in the contractual relationship between the buyer and the insurer, which is more advantageous from the seller’s point of view for several reasons. Nevertheless, there can also be advantages for the buyer. The buyer does not have to negotiate warranties with the seller and can base the agreement with the insurer on a more buyer-friendly warranty scheme. There are still certain uncertainties and ambiguities for synthetic W&I insurance, however. It remains to be seen how this tool will developed and received in the market for other use cases.
A totally clean exit without any remaining seller liability is not entirely possible due to certain mandatory liability risks under German civil law. However, a clean exit can be achieved in individual cases under certain conditions. General and blanket provisions are not advisable in the purchase agreement (including for the sell side). Instead, the contractual provisions should be tailored for each individual case and aligned with the seller’s disclosure strategy as well as the buyer’s due diligence findings. This does not mean that a clean exit must be a nightmare scenario for the buyer with the assumption of risks, including in connection with wilful misconduct or constructive fraud by the management of the target company. Provided the buyer takes into account the practical recommendations described above, the best practice could develop into a clean exit concept that is neither wishful thinking nor a buyer’s nightmare.
1 With thanks for the continued and valuable exchange on the topic inter alia with esteemed former colleagues Matthias Luettges (Aon) and Philipp Heer (HWF Partners) as well as Philipp Gießen (Marsh).
2 Cf. esp. Findeisen, BB 2021, 1607; BB 2015, 2700 with further sources in the legal literature on the matter.
3 On W&I insurance cf. esp. Boche/Luettges, BB 2020, 2764; Ratz/Tachezy, BB 2020, 219; Deubert/Lewe, BB 2020, 235; Hoenig/Klingen, NZG 2016, 1244; Hensel/Namislo, BB 2018, 1475; on the tax treatment of W&I insurances esp. Ratz/Steffens, BB 2018, 2396.
4 Cf. Boche/Luettges, BB 2020, 2764.
5 Mellert, BB 2011, 1667, 1672; Metz, NJW 2010, 813, 815; cf. to Section 123 BGB: German Federal Court (BGH), decision (Beschluss) dated 21.9.2011 – IV ZR 38/09 – „Heros II“= NJW 2012, 296; judgement (Urteil) dated 17.1.2007 – VIII ZR 37/06 = NJW 2007, 1058.
6 More recently, W&I insurance providers became prepared to ignore the exclusion of liability for wilful misconduct on the part of vicarious agents and to compensate the buyer for the damage incurred in these cases as well. This is increasingly being used by sellers to enforce the exclusion in the purchase agreement.
7 Cf. to de Minimis: Hoger/Baumann, NZG 2017, 811, 815, with further sources in the legal literature on the matter.
8 Hoenig/Klingen, NZG 2016, 1244, 1247, with further sources in the legal literature on the matter.
9 Schudlo/Kersten, BB 2021, 1154, 1156, with further sources in the legal literature on the matter.
10 BGH, decision (Urteil) dated 26.9.1997 – V ZR 29/96 = NJW 1998, 302, 303; BGH, decision (Urteil) dated 16.3.2012 – V ZR 18/11= NJW-RR 2012, 1078, 1080.
11 Section 86 para. 1 German Insurance Contract Act (Versicherungsvertragsgesetz, VVG); BGH, decision (Urteil) dated 8. 12. 1989 – V ZR 246/87 = NJW 1990, 975, 976; generally, on the matter MüKoBGB/Schubert, § 166 BGB, ref. 8 et seq.
12 BGH, decision (Urteil) dated 8.12.1989 – V ZR 246/87 = NJW 1990, 975,
976 = NJW-RR 1990, 488; Risse, NZG 2020, 856, 858.
13 BGH, decision (Urteil) dated 2.2.1996 – V ZR 239/94 = NJW 1996, 1339, 1340 et seq.
14 BGH, decision (Urteil) dated 24. 1. 1992 – V ZR 262/90 = NJW 1992, 1099, 1100.
15 Overview in MüKo BGB/Schubert, § 166 BGB, ref. 64 et seq.
16 Von Woedtke, GmbHR 2017, 505, 508; Hoenig/Klingen, NZG 2013, 1046, 1049.
17 Koppmann, BB 2014, 1673, 1676 with further sources in the legal literature on the matter.
18 Risse, NZG 2020, 856, 860; Jaques in Beck’sches Handbuch Unternehmenskauf im Mittelstand, Ettinger/Jaques, 3. Aufl., 2021, C.I.3., ref. 68; Hartung, NZG 1999, 524, 529; Jaques, BB 2002, 417, 420.
19 BGH decision (Urteil) dated 2.2.1996 – V ZR 239/94 =NJW 1996, 1339, 1341 = BGHZ 132, 30; Risse, NZG 2020, 856, 863; MüKoBGB/ Schubert § 166 ref 47; Schwab, JuS 2017, 481.
20 BGH, decision (Urteil) dated 8.12.1989 – V ZR 246/87 = NJW 1990, 975, 976.
21 On the matter see, inter alia, Koppmann, BB 2014, 1673, 1675; Weißhaupt, WM 2013, 782, 787.
22 Generally, also on this aspect, Findeisen, BB 2021, 1607, 1610.
23 The concept of hard-stapled W&I insurance can be found in some cases in German M&A transactions. However, this type of W&I insurance offering is not (yet) common practice as for instance in some Scandinavian M&A markets.
24 Schudlo/Kersten, BB 2021, 1154, 1156.
25 So far, synthetic W&I insurance has been predominantly used for straightforward targets such as in certain real estate transactions concerning single tenant or single object targets and in some cases in distressed M&A transactions. Generally on the subject: Ratz/Tachezy, BB 2020, 219, 222; Findeisen BB 2021, 1607, 1608.