An M&A process is ultimately nothing more than finding a compromise between the conflicting interests of buyer and seller. Typically, the main interests of the seller can be summarised as follows: (i) the highest possible purchase price, (ii) the highest possible transaction security and (iii) the lowest possible liability risk. The interests of the buyer are often not so far removed. He also has an interest in transaction security (he just does not want to bear the sole responsibility for it). The buyer may also agree to a "zero liability" concept if a Warranty & Indemnity (W&I) insurance policy is available to him as the liability addressee instead of the seller. All a matter of negotiation? Yes, almost. Particularly with regard to the important issue of limitation of liability, there seems to be one aspect that the parties find difficult to get to grips with: The liability trap of "making a statement in the blue".
Statement in the blue
The term "making a statement in the dark" refers to a situation in which a seller makes incorrect statements about an object of purchase without sufficient factual basis. A highly simplified example is the used car seller who falsely claims that the car is accident-free without having made any effort to verify this statement in advance.
The consequence of this is the assumption of fraudulent misrepresentation by the seller and the associated fulfilment of the relevant liability requirements.
Ultimately, fraudulent intent is a subset of intentional behaviour and therefore requires at least dolus eventualis (conditional intent or contingent intent). This is not the case if the declaring party is firmly convinced of the accuracy of his statement.
However, even good faith does not save the seller if the buyer obviously expects the seller to be able to properly assess the situation. If this is not the case and the seller conceals this, the conditions for fraudulent misrepresentation are nevertheless met (see OLG Frankfurt am Main, decision of 24 July 2008 - 3 U 68/08).
Applicability to the M&A process
For many, the question already arises as to whether the construct of the statement in the blue can be applied to M&A processes at all. The sale of a used car is ultimately difficult to compare with a complex company sale, which is preceded by a months-long process including due diligence on the part of the buyer.
The M&A process is indeed more complex and due diligence on the part of the buyer may even lead to the buyer having sovereignty of knowledge with regard to one or other aspect of the target company. However, this is no reason to categorically deny the validity of the principle of making a statement in the blue. The question of fraudulent misrepresentation will not have to be examined across the board for the M&A process, but rather in relation to the specific statements made by the seller. There may well be constellations that fulfil the requirements of fraudulent misrepresentation due to statements made in the blue.
Unlimited liability of the seller in the event of a company sale
If the principle of the statement in the blue is transferred to the M&A process, this results in serious disadvantages for the seller.
With regard to the liability regime, the purchase agreement in the context of a company acquisition is characterised above all by the fact that it deviates as far as possible from the statutory provisions of warranty law and establishes its own, individually negotiated liability regime.
Such a liability regime contains so-called independent guarantee promises (in short: guarantees) of the seller, i.e. statements for the correctness of which the seller is liable to the buyer irrespective of any fault. Furthermore, the purchase contract contains detailed provisions on the legal consequences of the inaccuracy of a guarantee.
As part of these legal consequences, the seller and buyer regularly agree maximum liability limits in favour of the seller. For material guarantees (so-called fundamental guarantees), a limit of 100% of the purchase price is regularly agreed. For guarantees relating to the company's operating business, the maximum liability limit is usually significantly lower (often between 10 and 30% of the purchase price). In addition, the seller and buyer typically agree a de minimis amount and other thresholds in the form of exemption limits or allowances aimed at excluding claims below a certain materiality threshold. W&I insurance is also frequently used. Here, the seller's liability (with a few exceptions) is even limited to EUR 1. In addition, there are shorter limitation periods compared to the legal framework. All these regulations are of great importance to the seller for understandable reasons.
However, in the case of a statement in the blue, they are all invalid.
The statement in the blue fulfils the offence of fraudulent misrepresentation. This is a sub-category of intent and, in accordance with Section 276 (3) BGB, liability for intent cannot be waived in advance. In other words, liability for fraudulent misrepresentation cannot be excluded or limited. The seller is liable for the inaccuracy of the guarantees without any limitation of liability. This also applies if the guarantees are covered by W&I insurance. In the context of purchase prices in the mid three-digit million range, this is a risk that certainly has an impact on the M&A process.
Current solutions
In practice, various instruments are currently in circulation that attempt to exclude or at least limit the liability risk.
1. avoid statements in the blue
The first solution is obvious. The seller is well advised to verify his statements sufficiently before guaranteeing them to the buyer regardless of fault. Especially when large sums are involved. In this case, however, it is easier said than done!
It is simply impossible for a seller to have first-hand knowledge of all the details relating to the entire warranty catalogue. The warranty catalogues of typical company purchase agreements today are far too comprehensive and granular for that. They cover all areas of the company's operations (sometimes including areas that are completely foreign to the company). Reviewing the warranty catalogue requires expert knowledge, so the seller must rely to a certain extent on the statements of his employees.
The process of interviewing employees is also known as the "due enquiry" process in the context of the purchase agreement. The earlier and more carefully the due enquiry process is prepared, the more reliable the statements of the interviewees will be. As a rule, it is also helpful for the negotiation of the warranty catalogue if the due inquiry persons on the seller's side are involved. They are often in a good position to judge whether the content of a guarantee can be meaningfully reviewed in full within the specified time.
However, even after a thorough due diligence process has been carried out, it is possible that the right people with knowledge have not been interviewed or that the relevant people are simply mistaken. It is also possible that the persons interviewed have not fully understood the requirements of the warranty catalogue and its annexes. A seller will often find himself confronted with the situation that he cannot say with absolute certainty whether the guarantee he has given is completely correct.
2. guarantees as pure risk allocation
For some time now, there has been an increasing attempt to give warranties the character of "pure risk allocation" in sales contracts. The aim of the guarantee catalogue should be to allocate the risk of incorrectness of the guarantees exclusively to the parties (namely to the seller). However, the issue of the guarantee should not be linked to the seller's assertion that the guarantee statement is correct. If the seller does not claim that a statement is correct, the buyer cannot be deceived either with regard to the correctness or with regard to the basis of the seller's proper assessment of the correctness. Ultimately, it is only a matter of regulating the legal consequences.
Whether this legally "works" has not yet been clarified by the courts. In particular, there are doubts that the qualification as pure risk allocation seems to contradict the way in which the guarantee catalogue is created. The seller will only provide guarantees for pure risk allocation if he is convinced that they are correct. He will not accept liability according to the principle of chance.
The buyer is also aware of this, so that the issue of a guarantee naturally always contains a declaration as to how the seller stands by the accuracy of the guarantee.
This applies all the more in view of the preceding Q&A process and any expert calls. Ultimately, this is where precisely those topics are addressed that will ultimately become the subject of the warranties. The buyer requires the seller to stand behind the accuracy of the answers when answering the questions. In any case, the answers are not given for the purpose of risk allocation, but are the basis for the purchase decision and will continue to serve as the basis for the warranty catalogue.
However, where this variant has been chosen in practice, the technical implementation often does not appear to have been solved consistently. Typically, the introductory sentence of the guarantees reads something like this:
The seller declares to the buyer in the form of an independent guarantee promise in accordance with § 311 Para. 1 BGB that the statements in accordance with Clause [...] are correct.
This introductory sentence seems to have become ingrained in company contracts like an insurmountable standard, making lawyers extremely reluctant to touch it. As a result, it simply remains untouched and is supplemented by the risk allocation clause. The result is two contradictory statements: the buyer declares that the statements are accurate and at the same time the parties agree that no statement should be made with regard to the accuracy of the warranties.
As a result, the formulation of "pure risk allocation" often seems to be just that: a new formulation for an old, unchanged concept. If this is the case, however, it appears to be a formulation that attempts to exclude liability for intent in advance. However, this is probably not compatible with the law (Section 276 (3) BGB).
3. definition of the recipient horizon
The better approach is based on the legal requirements for liability for fraudulent intent.
On the basis of a sensible due enquiry process, the seller satisfies himself that the guarantees to be given are correct. He makes himself bona fide. Unless there are insignificant residual doubts, the wording of the guarantee should be adapted and any contingent intent regarding the inaccuracy of the guarantee should be excluded.
If the seller is acting in good faith, the conditions for liability for fraudulent misrepresentation can only be met if, despite his good faith, he is wrong and he disappoints an obvious expectation on the part of the buyer regarding the seller's ability to properly assess the matter of the relevant warranty. This will therefore not be the case if the buyer is always aware of the basis on which the seller came to the conclusion that the warranties as given are correct.
It is therefore advisable for both parties to document in the contract how the seller arrived at his assessment of the accuracy of the guarantees in order to clearly exclude any disappointment of the buyer's expectations. The buyer's recipient horizon is defined by the contract.
A corresponding clause could include the following statements:
- The seller does not have first-hand knowledge of any warranty.
- The seller must rely on the information provided by employees for the purpose of verifying the warranties.
- Neither the seller nor the employees are obliged to carry out special enquiries or research of any kind.
- The lack of this first-hand knowledge and the need to rely on the information provided by employees should under no circumstances be interpreted as fraudulent behaviour based on information provided "in the blue".
- The Buyer waives all claims against the Seller on the same legal grounds to the extent permitted by law.
Admittedly, the compatibility of a clause in the sense of the last two bullets with Section 276 (3) BGB would have to be examined more closely in an emergency. They alone should not be relied upon in this context. However, they certainly outline the thrust of this provision. Ultimately, the purpose is to exclude the conditions for liability for fraudulent intent at the factual level. The intention of the parties to bring about this legal consequence is in any case documented by the last two bullets.
The implementation of a meaningful due diligence process, together with clarity as to the seller's factual basis for assessing the accuracy of the warranties, should remove the scope for fraudulent liability based on statements made in the dark.
Possible consequences for the dynamics of the M&A process
The endeavours to exclude liability for statements made in the blue are understandable. Nevertheless, the potential atmospheric effects on the M&A process should not be completely disregarded.
The buyer derives a certain comfort from the theoretical unlimited liability of the seller. He can assume that the seller has verified his statements as best he can. Overall, this means that the buyer can rely on the guarantees. The buyer's due diligence and a balanced warranty catalogue with substantial weight gives the buyer a good feeling with his purchase decision.
For the seller, the theoretical risk of fraudulent liability is always an argument for rejecting the buyer's demand for more extensive guarantees. After all, the seller cannot be expected to make statements in the blue.
This dynamic has often provided a healthy framework for the negotiations, within which an appropriate compromise could be found.
However, if the liability for fraudulent misrepresentation is off the table, this could lead to the buyer wanting to convince himself even more thoroughly of the accuracy of the guarantee. The due diligence process will be intensified. In addition, the seller lacks a well-functioning argument for rejecting further-reaching guarantees. The catalogue of guarantees could expand as a result.
In the end, however, both parties have an interest in a balanced and reasonable warranty catalogue - with or without the liability trap of making statements in the blue. The buyer wants to be able to rely on the guarantees for his purchase decision and is not interested in claiming damages afterwards when the contract is concluded. For the seller, "normal" contractual liability is also incentive enough to agree a reasonable catalogue of guarantees and to ensure that the guarantees are correct.
Avoiding liability for fraudulent misrepresentation should therefore not have any particular negative effects on the negotiation dynamics. Especially if the means of choice is a thorough due diligence process in combination with more clarity and transparency about the seller's ability to assess the accuracy of the warranties.
Conclusion
From the seller's point of view, it only makes sense to take the due diligence process seriously and to explain to the buyer in the contract how the seller came to assess the warranties. In particular, it should be made clear to the buyer what knowledge is not available and what efforts have not been made to verify the warranties. Liability for intent cannot be waived in advance, but it is certainly possible to ensure that the requirements at the factual level are not met. The avoidance of liability for fraudulent misrepresentation is also consistent in view of the fact that the statutory provisions regarding the seller's liability are also largely replaced by a separate regime.
In the end, however, it should be clear: With or without liability for fraudulent misrepresentation, the requirement for a good warranty catalogue is in any case that it is comprehensible, verifiable and therefore (hopefully) also correct.