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The sale of a company involves various stages of the process. It begins with the search for a buyer, followed by the buyer’s review of the company (due diligence) and the determination of the purchase price, and culminates in the negotiation and execution of a purchase agreement. In addition to the purchase price and accompanying safeguards, the liability provisions between the seller and the buyer are at the heart of most (professional) business purchase agreements.
In general, the sale of a company can take two forms: (1) the sale of shares in a company (a so-called “share deal”) or (2) the sale of all or a substantial portion of a company’s assets (a so-called “asset deal”). The share deal is often the preferred structure, as in this case “only” the shares are sold and transferred, whereas in an asset deal, every single asset and every single contract must be transferred (with the consent of the contracting party). Asset deals are therefore frequently used in insolvency (or near-insolvency) scenarios, in which the insolvent or near-insolvent company is not to be acquired precisely because of the associated risks. The following section focuses on the share deal.
Statutory Warranty Regime
From a legal perspective, the purchase of a company share constitutes the acquisition of a right. In principle, the general warranty provisions of the German Civil Code (BGB) governing the sale of tangible goods (such as a used car) apply to the purchase of a share. Herein lies the problem: The statutory warranty provisions do not apply to the acquisition of a company. This begins with the very concept of a defect. Among other things, an item or a right is considered free of defects if it has the agreed-upon quality or exhibits a quality that is customary for items of the same kind. When selling a share in a company, however, the object of the sale is the share itself and not the hybrid (virtual) entity of the company that is embodied in the share. This raises the question of what exactly constitutes the quality of the share: Is it merely a matter of the share being free from third-party rights, or does the company’s earning power also play a role? In addition, an assessment of defects based on the usual nature of the share might still be considered, though not in relation to the company itself, as these are usually completely different (even among companies in the same industry).
In addition to the difficulty of defining the absence of defects in a company, the statutory legal consequences are also generally not effective. One example is the right of rescission, the legal consequences of which cannot be readily invoked, since corporate (share) transfers that have been completed over a longer period of time can hardly be reversed.
Contractual Liability Regime
Instead of the statutory warranty rules, a contractual liability regime has therefore developed in practice that, upon express agreement by the parties, replaces the statutory warranty rules. This regime contains standards that are either identical or at least comparable across various business purchase agreements.
So-called warranty representations by the buyer form the core of contractual liability. In this context, the seller (depending on bargaining power and the nature of the business) provides a series of warranties regarding the condition of the business or the equity interest, some of which are identical or similar across all business purchase agreements (such as ownership of the equity interest, no over-indebtedness or indebtedness of the business, compliance with laws) or, depending on the company, very specific (such as ownership of certain intellectual property rights, customer and supplier relationships). In layman’s terms: Through the nature and scope of the warranties, the seller and buyer “tailor” the desired characteristics of the company.
If, in retrospect, a particular warranty proves to be false, the contractual regime of legal consequences comes into effect, which generally provides for strict liability for damages, accompanied in principle by a wide range of liability exclusions (such as no liability for known facts or those disclosed during due diligence) and limitations (liability caps, contractual statutes of limitations).
If the M&A agreement is professionally executed from the seller’s perspective, the result is a self-contained liability framework that, in principle, leaves no room for the buyer to raise claims outside the contractual provisions.
Side Note: Liability for Intentional Misrepresentation Based on a Speculative Statement
Since the liability framework is self-contained when properly implemented, if a buyer wishes to hold the seller liable beyond the scope of contractual liability (including contractual liability caps), the only recourse is through liability for willful misconduct or fraudulent misrepresentation, because in these cases, due to mandatory statutory provisions, the contractual liability limitations do not apply. The seller is fully liable.
Now, one might think that liability for intentional acts encompasses only knowing or deliberate conduct (such as intentional deception). However, this is not the case, because “intent” also includes “willingly accepting the risk” (Example: The seller does not intend to deceive, nor is he certain that he is deceiving, but he is aware—and accepts—that, for instance, a relevant piece of information he provides to the buyer could be incorrect).
In this case, there is a risk of unlimited liability on the part of the seller. This example shows that efforts to avoid liability begin even before the contract is concluded.
