Corporate Compliance @ Tech Deals in Germany – The Compliance Guarantee

Even though the Association Sanctions Act (Verbandssanktionengesetz) will no longer be passed in this legislative period, compliance issues remain clearly in focus. The Supply Chain Act and the implementation of the EU Whistleblower Directive play an important role alongside the “classics” from the areas of corruption and money laundering. In addition, compliance is also becoming increasingly important in M&A practice. Based on the results of compliance due diligence, the compliance guarantee is at the centre of M&A negotiations.

Not least due to the increased legal requirements, in particular the FCPA and the UK Bribery Act, compliance guarantees in SPAs are becoming more and more extensive and differentiated. The buyer thereby hopes to be able to exonerate itself or the target company in the event of the discovery of a continuing compliance violation, which had already begun in the target company prior to the transaction, or alternatively to have a right of recourse against the seller.

Is this at all achievable with a compliance guarantee? The basic answer is in the affirmative. However, it is recommended that it is a specific compliance guarantee that states that the company always complies and has complied with the law.

Such a compliance guarantee could, for example, read briefly as follows:

“The target company conducts and has conducted its business in compliance with all domestic or foreign laws and regulations to the extent applicable to the target company or its business partners; in particular, there are and have been no compliance matters occurred in the last three years to this day, except for those listed in the Schedule, no is the seller not aware of any official investigations  for any compliance matter, except for those listed in the Schedule.

Compliance matters include an objective breach or, to the seller’s knowledge, the suspicion of a breach by employees, freelancers or officers of the target company in the name and on behalf of the target company, whether as offenders or accessories, of Sec. 299 StGB [German Criminal Code] (taking and giving bribes in commercial practice), …”

The catalogue of prohibitions to be included in the definition is then usually very extensive, and should separately list any special laws relevant to the company.

Such a clause at least leads to the fact that in the event of a compliance violation that was committed prior to the takeover of the company, there may be a right of recourse against the seller if there is damage to the buyer. The question of whether the claim then actually exists and its quantum depends on how well the buyer has negotiated the clause.

In contract negotiations, the seller will regularly seek to provide the warranty only to the best of its knowledge and to limit it to what is substantial. The buyer, in turn, will seek to exempt the compliance guarantee from a de minimis rule and a maximum liability limit and to agree on a longer limitation period. The question of whether and in what way reputational damage should be compensable as consequential damage can also be the subject of several rounds of negotiations, much to the irritation of the non-lawyers involved. However, this can often be worthwhile for the buyer if compliance violations are discovered after the transaction.

For another reason, the buyer should always be interested in including a specific compliance guarantee in the SPA. If a general, meaningless compliance guarantee is used, it can be assumed that the buyer has not placed any particular emphasis on compliance issues in the context of the transaction. If the buyer is also unable prove that it has carefully conducted compliance due diligence, it will lack arguments for mitigation of liability if it or the target company is held liable for past compliance violations. The buyer will have to accept the accusation that it did not even try to uncover compliance violations in the past and to remedy them if they continue. However, if it has carried out compliance due diligence and this is also reflected in the compliance guarantee, it can at least argue that it has seriously attempted to uncover compliance breaches. This can then have the effect of mitigating liability.

However, it will often be difficult to uncover actual compliance violations in the course of compliance due diligence, as these often remain hidden. Instead, the compliance due diligence will serve to give the buyer an impression of whether compliance is actively practised in the target company and whether compliance structures exist. Of course, there is also the possibility that the seller unconsciously or consciously conceals compliance issues – especially if it is not even asked about them because no compliance due diligence is carried out.

Then the dispute is usually pre-programmed, especially if the damages exceeds the purchase price and a liability limitation in the amount of the purchase price (or lower) was agreed for the compliance guarantee. In order to undermine the negotiated liability regime in the purchase agreement, the buyer will regularly invoke fraudulent misrepresentation and claim damages in the full amount. In order to avoid disputes, the seller and the buyer have a common interest in addressing relevant compliance issues during the due diligence process.

What happens however if compliance issues are identified during due diligence?

In this case, the seller will attempt to exonerate itself by including the facts in an schedule to the compliance guarantee. By describing the facts as precisely as possible, the buyer is then clear about what risks it is buying into and thus has various options for action. If the buyer decides to buy the target anyway, it can cover any financial liability by an indemnity from the seller, under which the seller has unlimited liability for any claims arising from the facts. Another option is to price in any monetary risks as part of the purchase price determination. Alternatively, the seller may decide to fully bear the compliance risk without discounting the purchase price in the hope that the risk will not be fully realized. In any case, the buyer should stop the violations for the future.

Lessons learned: During due diligence and contract negotiations in the M&A process, special attention should also be paid to legal violations in the target company, as any compliance violation can develop into an existential risk, especially due to the liability risk under foreign regulations.