Mergers and Acquisitions
by Marcus Baum
1. Subject matter
Mergers and acquisitions (M&A) is already a truly European topic insofar as the term M&A is used not only in English, but also in all other European languages. It is indeed a truly international term. That does not mean that the other European languages do not have their own terms for M&A. However, the English term is also dominant in these languages.
M&A is the subject of extensive literature and discussion both within and outside the legal sphere. Within the legal sphere, the term M&A is generally understood to be the legal process of the acquisition of a company or a company’s business (‘the target’).
All European jurisdictions fundamentally distinguish between M&A transactions in the form of an asset deal, ie the acquisition of the individual assets constituting a target business, and in the form of a share deal, ie the purchase of a target business by way of acquiring the shares in a company.
In an asset deal the target business is acquired by the purchase of a multitude of tangible and intangible assets, which can also be contracts, and by assuming all, some, or none of the target’s liabilities. Consequently the target business is separated from the legal entity which was previously its owner. While the target business is therefore the one acquisition object, the transfer of the assets is—technically—effected by way of an array of individual transfers which have to comply with the relevant transfer rules for such assets. Thus, although through an asset deal a whole company’s business can be transferred, it is also possible for the seller to retain certain assets or liabilities.
While an M&A transaction always has to be effected by way of an asset deal when an individual is the owner of a target business, it can also be effected by way of a share deal when a legal entity is the owner of the business. It is generally agreed that not each and every transfer of a shareholding which only represents a very small fraction of the whole shareholding in a company, eg the acquisition of a few shares in a listed company through the stock exchange, is considered to be an M&A transaction. Certainly, however, an M&A transaction is undertaken when the whole shareholding of a company is transferred. Further, it is generally assumed that there is an M&A transaction once a percentage in the shareholding is transferred which allows the new owner to exercise managerial influence; as a rule that is the case if more than 50 per cent of the shareholding is transferred.
Whether an M&A transaction is carried out as a share deal or an asset deal is often determined by tax preferences existing on the side of the seller and/or the buyer. The asset deal is also often opted for if the buyer either does not want to assume known risks of the target business or wants to make sure that he does not assume unknown risks.
M&A transactions in the form of share deals can either be private M&A transactions or public M&A transactions. In private M&A transactions the acquisition of the target business is effected by way of the conclusion of a share purchase agreement between the buyer and a usually limited number of seller-shareholders who—under all circumstances—are known by name. In contrast, a public M&A transaction is effected by way of a takeover bid carried out on the stock exchange.
2. Unification of law: reasons and form
If one considers that companies in Europe often have activities in the whole of Europe or even the whole of the world, it may at first be surprising that there is no European law on M&A, and particularly so that there are no acts of European legislation (for M&A and uniform law see 3. below). A small proviso has to be made in that there are European rules on merger control (anti-trust rules) which have to be considered for M&A transactions, but these belong to the legal framework for M&A transactions and do not deal with the substance of the M&A process as understood in this article. M&A are also not the subject of any European unification projects. One primary explanation given for these findings is that each and every company, even a globally active conglomerate, has its legal seat in one particular country and therefore belongs to one particular legal system. This argument has merit and ultimately is also accurate for the European company (Societas Europaea). Cross-border mergers which result in a combined company with legal seats in two countries are political rather than legal exceptions. This so-called nationality of companies is, however, as demonstrated by the European legislature in its handling of other issues, not a compelling reason for the legislature’s restraint. Rather, it appears European legislation would be superfluous as in practice, irrespective of the governing national law, M&A agreements across European jurisdictions already overwhelmingly follow harmonized American/English standards.
A variety of reasons are put forward for this dominance of common law standards. Each and every one of these reasons can be critically challenged, but as a composite of reasons they are compelling. It is argued that on the Continent there is no ‘culture’ of M&A. This is empirically supported by the fact that even in the late 1980s some four out of five takeovers in Europe still took place in the United Kingdom. The lack of such ‘culture’ on the Continent allowed the American/English model to spread. As a further reason, legal writers refer to the—at least until recently—dominance of the British and American capital markets together with the fact that M&A transactions are often highly leveraged. That dominance meant that finance volumes above a certain level could more easily be procured in either London or New York. It is further reflected in the creativity of such markets in the development and structuring of new financial products. The easiest way to make use of these possibilities is for the M&A agreement to comply with the standards of such markets, ie common law standards. Otherwise, the British and American financiers would first have to be convinced by extensive legal opinions that their—justified—(security) interests are safeguarded even if the legal standards are unknown to them. As the purchase agreement and the contract for financing are often negotiated simultaneously, timing issues make the parallel preparation and coordination of legal opinions impossible so that in practice the purchase agreement has to follow American/English standards.
Some practitioners from civil law countries consider it an advantage of common law that it lacks elaborate doctrine and therefore allows, more easily than civil law, for solutions which fit the practice. However, not everyone is convinced by the alleged antagonism of doctrine and practice. Further, it is argued that common law can show a history of successfully completed complex transactions and that this track record is an invaluable aid for new transactions. At the very least this track record has led to an enormous number of termini technici, which, just like the term M&A itself, are used as anglicisms in the other European languages and form the lingua franca of M&A.
There is a further important reason for the fact that M&A agreements follow American/English standards all over Europe, namely that M&A processes are carried out in an almost identical way in all European countries based on the ideas of English and American investment banks. Even in the case of comparatively small values, a seller will often contract one or several M&A advisers or one or several investment banks to coordinate the M&A process, this being done with the aim of obtaining the best possible price under the best possible conditions. Once the transaction exceeds a certain value, the seller will try to establish a bidding process so as to have, if possible, the chance to choose between several offers right up until the end of the actual contract negotiations.
With certain nuances, the processes all follow the same model. At a very early stage as a basis for the exchange of information on the target business, a ‘confidentiality or non-disclosure agreement’ is executed between the seller or his representatives and the potential buyer or buyers. The seller will usually try to ensure that breaches of confidentiality are sanctioned by penalty or liquidated damages clauses. Following the execution of such agreement there is, not infrequently in several stages, an exchange of further information, with the seller in many cases first providing an ‘offering memorandum’. This first round of information exchange usually results in a ‘letter of intent’ or ‘memorandum of understanding’ which, with great differences in the degree of detail, outlines at least the key economic features of the envisaged transaction, including timing issues and sometimes the basic legal issues of the transaction. It is the basis for a more thorough ‘due diligence’ investigation of the target. However, neither the letter of intent nor the memorandum of understanding gives either the seller or buyer an enforceable course of action if the other party fails to sign the purchase agreement. The potential buyer will usually try to reserve in the letter of intent the right for exclusive contract negotiations for a certain period of time. That interest is in direct conflict with the interest of the seller to initiate a bidding process.
Originally based on the common law principle of caveat emptor, due diligence is today a general standard in M&A processes in all European countries. The management of the potential buyer cannot do without it for the simple reason that otherwise it runs the risk of personal liability, that being so because the acquisition of a target business without a due diligence inquiry is considered to be negligence by the courts. During the due diligence investigation the potential buyer evaluates the target business thoroughly under technical, economic, financial, tax and legal aspects. The aim is to assess accurately the potential risks and rewards of the transaction and to validate the assumptions underlying the valuation. If, after performing due diligence, both the seller and the buyer still have mutually acceptable positions on the purchase price and the buyer has not identified insurmountable obstacles, the phase of actual contract negotiation ensues which, if successful, leads to the ‘signing’. The ‘closing’, ie the actual transfer, takes place a few weeks or possibly even months after signing, when either the financing has gone through and/or other conditions precedent, especially the merger control clearance, have occurred.
A standardized purchase agreement is a necessary part of such a standardized process. Such an agreement usually starts with a preamble of varying detail. Against the background of a civil law system such a preamble fits awkwardly with general drafting standards for contracts which concentrate on the stipulation of the strictly binding legal provisions rather than deliberating on the respective motives of the contracting parties.
The preamble is followed by a sometimes very detailed section of definitions of terms subsequently used in the contract. At least for a reader with a civil law background who is less trained in such extensive use of definitions, this makes the actual text of the contract very hard to understand. That is because without constantly being fully aware of each and every definition, the actual meanings of the various contract provisions are lost to the reader. A further hurdle for the reader is that—at least from the perspective of a lawyer trained in civil law—lawyers trained in common law do not find it difficult to define blue as green in the definitions.
At the beginning of the actual contract there is a description of the sale/purchase object, in the case of an asset deal substantiated by a long list of attachments, and the rules for the actual transfer of the object. Part of this is usually the stipulation of the purchase price. It is normally followed by the most detailed and, especially during the negotiations, the most problematic part of the contract, the representations and warranties to be given by the seller to the buyer in respect of the target. Catalogues of representations and warranties which run over several pages are very common in all European jurisdictions. In these representations and warranties the seller has to state a variety of facts concerning the target business which are relevant for the buyer either for the purchase itself or the validation of the target. These are often statements on the corporate structure of the target, important contracts, insurances, real property, intellectual property, customers and suppliers, compliance with the relevant public law provisions, employees, liabilities, financial statements and the target’s indebtedness. A good example of the influence of common law standards with its, at least historically, literal approach to the interpretation of contract clauses is that the individual representations and warranties are often worded in such a way that a variety of examples are given to describe one and the same thing. Against the background of a civil code and given that in civil law jurisdictions the interpretation of contract clauses as to what the parties actually agreed upon is not a last resort but a general principle, it would often be sufficient just to name the topic. From a civil law perspective, therefore, these representations and warranties are often full of pleonasms and esotericisms.
This clear reception of common law legal thinking in the civil law jurisdictions is further promoted by the leading international law firms which, based on their experiences with marred cases, continually update and add to their standard M&A agreements including the standard representations and warranties catalogues. In some cases this leads to the situation that the standard texts dominate the lawyers dealing with them rather than it being the other way around. Such extensive M&A agreements, especially extensive representations and warranties catalogues—irrespective of the actual material content—can prove to be real deal killers, especially if a seller who has only limited experience in M&A transactions is confronted with them. Consequently, it is sometimes necessary to deviate considerably from the general unified standards in order to complete a transaction successfully.
A standard M&A agreement further contains elaborate rules as to the consequences of breaches of representations and warranties. These rules concern the remedies available as well as applicable thresholds, caps and limitation periods.
The increasing presence of indemnity clauses in M&A agreements can again primarily be explained by the influence of the common law role model. By way of an indemnity the seller undertakes to indemnify the buyer and hold him harmless for any costs or risks arising out of certain issues which are of particular relevance to the buyer. Typical indemnity clauses cover tax issues and possible liability for damage to the environment. From the viewpoint of German law at least, such issues could easily and without lesser protection for the buyer be covered by representations and warranties, these given under German law in the form of so-called independent guarantees (guarantee, independent). Further unnecessary legal transplants from the viewpoint of many continental jurisdictions are the guarantees or representations and warranties given by the buyer in the M&A agreement, whereby the buyer declares, for example, that he exists and is duly represented when entering the agreement.
Overall, M&A agreements are standardized to a high degree in all European jurisdictions. That, however, does not mean that such standards are static. On the contrary, changes to the standards are spreading fast across all European jurisdictions.
Because M&A agreements based on the American/English model cover areas which are open to the autonomous decisions of the parties and attempt to form self-contained sets of rules which are at the same time independent of the individual rules under national laws, it is not surprising that in many cases the decision as to what law actually governs the purchase agreement is decided at the very last moment.
3. Mergers and acquisitions and uniform law
As mentioned earlier, despite their great economic importance, M&A are not the object of unification projects. Additionally, existing uniform law such as the CISG (sale of goods, international (uniform law)) only applies to a limited extent.
It is a common understanding that the CISG does not apply if a purchase of a target business is structured as a share deal. This is explained by the argument that a shareholding is not goods but a membership right or participation right and the CISG does not apply to the purchase of rights. If one considers that under German law, as far as warranty rights are concerned, the acquisition of goods includes the acquisition of a target business in the form of a share deal, that reasoning is by no means cogent.
If the acquisition of a target business is structured as an asset deal, the CISG can apply. Accordingly, if the sale of the actual goods and the sale of the remainder of the assets and liabilities constituting the target business are agreed upon in separate contracts, the CISG would then apply to the actual sale of goods. If, however, there is only one agreement, as is usually the case in practice, there is some ambiguity as to the legal position. The majority of legal writers, however, assume that the CISG does not then apply. It is not uncommon, therefore, to expressly clarify in the M&A agreement whether the CISG is intended to apply.
Gerhard Picot (ed), Unternehmenskauf und Restrukturierung (2004); Wolfgang Hölters (ed), Handbuch des Unternehmens- und Beteiligungskaufs (2005); Susan Singleton, in Simon Beswick and Humphrey Wine (eds) Buying and Selling Private Companies and Businesses (2008); Hermann Knott and Werner Mielke, Unternehmenskauf (2008), Franck Bancel and Jerome Duval-Hamel, Fusions d’entreprise (2008); Hans-Joachim Holzapfel and Reinhard Pöllath, Unternehmenskauf in Recht und Praxis (2010); Donald M DePamphilis, Mergers, Acquisitions and Other Restructuring Activities (2009); Franck Ceddaha, Fusions Acquisitions: Evaluation, négociation, ingénierie (2010); Hanno Merkt and Stephan Göthel, Internationaler Unternehmenskauf (2011).