In Germany, arbitral tribunals decide most disputes arising from M&A transactions. Parties often are concerned that German state courts are not experienced and therefore in no good position to decide complex and high-value M&A disputes. Parties favor arbitration because it allows them to choose arbitrators who have either experience in negotiating complex transactional agreements or in handling M&A disputes. The downside of this preference for arbitration over litigation is that not much case law is available in Germany on typical disputes arising from M&A transactions because arbitral awards are often confidential.
In January 2022, North-Rhine-Westphalia, Germany’s federal state with the largest population and Germany’s powerhouse with the largest economy among the German states, has made a big step to change the situation just described. Amongst others, North-Rhine-Westphalia has created a specialized court in Düsseldorf for M&A Disputes (“M&A Chamber”).[1] All regional courts in the state of North-Rhine-Westphalia must now refer all large (> EUR 500,000) M&A Disputes to the special court in Düsseldorf. The judge chairing the M&A Chamber is a former lawyer who had worked in international law firms in London and Düsseldorf for many years.
Now, the first important judgment of the M&A Chamber has been published (docket number 24 S 1/221, available here). The dispute concerned a share purchase agreement containing an arbitration clause. The Purchaser claimed damages against the Seller, alleging that the EBITDA of the target company had been manipulated and that this had caused damage to the Purchaser.
The Purchaser was concerned that upon the successful conclusion of the arbitration proceedings, the Seller would no longer have sufficient assets into which the arbitral award could be enforced and therefore applied for a preliminary attachment order with the Local Court (Amtsgericht) Düsseldorf. Under German law, this is possible. According to sec. 1033 of the German Code of Civil Procedure (ZPO), a court may grant, before or during arbitral proceedings, an interim measure of protection relating to the subject matter of the arbitration upon request of a party. Under general rules, the court responsible for granting an attachment is either the court before which the main action is being pursued or the local court in the district of which the object to be seized or the person whose personal liberty is to be limited are situated or resident, sec. 919 ZPO. As the state courts had no jurisdiction for the main action due to the arbitration agreement, the Local Court Düsseldorf was responsible for the attachment. It dismissed the application of the Purchaser.
The Purchaser filed an appeal against this decision with the Regional Court Düsseldorf. The question arose which chamber of the regional court had jurisdiction for the appeal proceedings. The presidium of the Regional Court Düsseldorf decided that the M&A Chamber had to handle the appeal, as the subject matter of the appeal was a dispute “arising from the purchase or sale of enterprises, parts of enterprises or interests in enterprises or from contractual negotiations preceding such a purchase or sale”.[2]
The M&A Chamber dismissed the appeal and refused to grant the attachment on the basis that the Purchaser could not show a prima facie case of an intentional breach of the warranties under the SPA or of a fraudulent misrepresentation (which was necessary in order to overcome the limitation of liability provided for in the share purchase agreement).
Factual Background
The Purchaser was an Austrian, the Seller was a US Private Equity Company. The Purchaser claimed that the Seller/the Management of the target company intentionally had manipulated the EBITDA of the target company and thereby had caused damage in an amount of EUR 258.4 million to the Purchaser.
The terms of the SPA were not published. However, according to the judgment, the Purchaser’s claim for damages was excluded by a limitation of liability clause in the share purchase agreement. This clause, however, was not applicable in case of “intentional misrepresentations, intentional breach or a criminal act committed by the Sellers or a Seller’s Representative“.
The Purchaser claimed that the EBITDA of the target company had been manipulated in 22 instances and argued that without such manipulations, the Purchaser would have paid a lower purchase price. According to the Purchaser, the former management of the target company had inflated the EBITDA through false entries that did not comply with the applicable accounting rules. The Purchaser argued that these wrong bookings had been made intentionally. In that regard, the Purchaser produced various emails of the management/employees of the target company. The court quoted two emails which read: “if one does not generate money, but burns it, one cannot say the truth” and “everyone thinks that the EBITDA is true“. According to the Purchaser, these emails proved that all wrong entries had been made intentionally. In addition, the Purchaser presented a statistical argument. The Purchaser argued that there were 22 wrong entries. All of them had resulted in an – erroneous – inflation of the EBITDA. The Purchaser argued that the probability was 1:4.2 million that these 22 wrong entries were done negligently. If they had been done negligently, one would also have expected wrong bookings that – erroneously – deflated the EBITDA. However, such wrong entries allegedly did not exist.
The Seller contested the correctness of the Purchaser’s factual allegations, in particular that the Purchaser had shown any fraudulent misrepresentation or intentional breach of the SPA.
The Regional Court’s Decision
The court found in favour of the Seller and held that the Purchaser had not shown a prima facie case of fraudulent misrepresentation or intentional breach of the SPA. As a consequence, the court found that the Purchaser’s claims were excluded by the Limitation of Liability Clause.
According to settled case law of the German Federal Court of Justice (BGH), a seller acts fraudulent in the sense of a fraudulent misrepresentation if it haphazardly answers questions of the buyer with incorrect statements lacking any factual basis if such questions are obviously decisive for the buyer. In the case at hand, that meant that the Seller would have acted fraudulently if it had accepted the possibility that an accounting statement was incorrect.
The Regional Court found that there was no need to determine whether the target company’s financial statements did in fact contain 22 “wrong bookings” because the Purchaser had not proven fraudulent misrepresentations with respect to the 22 alleged wrong bookings.
Firstly, the emails exchanged between the management/employees of the target company did not prove intentional misconduct because the emails did not refer to a specific entry.
Secondly, the court did not follow the Purchaser’s argument that the wrong entries could not have been the result of mere negligence. According to the Purchaser, if the wrong entries had been the result of mere negligent conduct, one would have expected some wrong entries reducing the EBITDA and others increasing the EBITDA. However, all wrong bookings allegedly had increased the EBITDA. The Purchaser’s statistical argument that the probability that this was the result of mere negligence was 1:4.2 million did not convince the court. It stated that the mere number of wrong bookings inflating the EBITDA was no proof of the intention of the Seller. The court also stated that a Seller could be expected to apply the accounting rules in a way that allows the Seller to increase the EBITDA of the target company. Therefore, it did not surprise the court that allegedly wrong entries would rather inflate the EBITDA than deflate it.
Thirdly, the court held that there might be cases where the accounting is so wrong that it can be assumed that the EBITDA was manipulated with intent. The court, however, found that this threshold was not met in the case at hand.
As a result, the court denied the Purchaser’s request for a seizure of assets. The dispute may, however, not be over yet. As the Regional Court Düsseldorf rendered its judgment in preliminary attachment proceedings on a prima facie basis without taking evidence, the Purchaser may still claim damages in arbitration proceedings.
[1] Regulation on jurisdiction for disputes arising from corporate transactions (mergers & acquisitions), information technology and media technology, and renewable energies, Gazette of Laws and Ordinances of the State of North Rhine-Westphalia (GV. NRW.), 2021 No. 83 of December 9, 2021, page 1340.
[2] This is the definition of M&A disputes in sec. 1 of the Regulation.
