MUNICH HIGHER REGIONAL COURT: DECEPTION ABOUT SIGNS OF CRISIS IN THE PURCHASE OF A COMPANY ENTITLES TO REVERSE TRANSACTION
In a recent judgment (judgment dated 3.12.2020 – 23 U 5742/19), the Munich Higher Regional Court (Oberlandesgericht – OLG) dealt with the duty of disclosure of the seller of a company with regard to the economic situation of the company to be sold, which is in crisis. General principles for the duty of disclosure in the acquisition of a company can be derived from the decision beyond the specific case.
I. Facts of the case
In the case decided by the OLG Munich, the defendants as purchasers acquired from the claimant his limited partner’s share in a GmbH & Co. KG (limited partnership with a limited liability company as general partner – “KG”), which operated a discotheque. In an advertisement on ImmobilienScout24 relating to the discotheque for sale, the seller had held out the prospect of a “very quick return on investment”. In addition to the discotheque, the KG also operated a loss-making bar. During the contract negotiations, which lasted several months, there were several meetings between the parties. The seller’s tax advisor also attended one of these meetings to answer questions from the buyers. In the course of the negotiations, the purchasers were provided with business analyses (hereinafter referred to as “BA”) for the past financial year together with lists of totals and balances. The BAs marked “KG Diskothek” reported a significantly negative result for the same period of the previous year. However, the actual profit generated by the KG was even worse than reported in the BAs because the losses from the operation of the bar were not included in them. In fact, the KG had never generated a positive result. Whether the seller’s tax advisor had advised the defendants that the losses from the operation of the bar were not included in the BAs was in dispute between the parties. In an e-mail preceding the conclusion of the contract, the seller had stated that “the whole thing is now going back into the black considerably”.
Within the framework of the notarial contribution and sale agreement (“company purchase agreement”), the defendants had undertaken, among other things, to release the claimant from a guarantee debt, from which the claimant was later held liable after the defendants filed for insolvency for the KG just under a year after the conclusion of the agreement.
The claimant asserted a claim for damages against the purchasers of the KG for breach of their indemnification obligation in respect of the guarantee. For their part, the defendants counterclaimed for damages in the form of rescission of the company purchase agreement and reimbursement of the expenses incurred by them in connection with the acquisition.
II. The decision of the Munich Higher Regional Court
After the Munich Regional Court I had dismissed both the claim and the counterclaim in the first instance, the Munich Higher Regional Court held that the defendant’s counterclaim for rescission of the company purchase agreement was well-founded.
The company purchase agreement was invalid due to the defendant’s appeal on the grounds of fraudulent misrepresentation on the part of the seller. In the case of the sale of a company, the seller has an increased duty to provide information because it is difficult for the purchaser to assess the object of purchase correctly from the outside. The duty to provide information extends in particular to circumstances that seriously jeopardize the company’s ability to survive, namely to an imminent or already existing insolvency or overindebtedness. The seller would also have to provide comprehensive and truthful information, without being asked, about events that are weighty indications of a continuing crisis of the company. Accordingly, he would also have to point out to the purchaser the losses of the past years, which could jeopardize the purpose of the contract.
The seller of the KG had deceived the buyers by presenting them with an inaccurate economic situation. In addition, he had not sufficiently informed the purchasers about the signs of a permanent crisis of the company, which were already weighty at that time. With his statement that “the whole thing is going back into the black”, the seller had suggested that there had already been such a plus for the company once, whereas the KG had never actually made a profit. Against this background, the announcement of a “very fast return on investment” was also misleading and was made without any tangible evidence. The seller had not informed the purchasers “clearly and unambiguously” that and in what amount the KG had so far only achieved negative results. The seller’s deceptions had not been eliminated by the documents provided to the buyers during the negotiations. The buyers had not been obliged to check these documents as to whether and to what extent the explicit statements of the seller corresponded to the truth, but were allowed to trust in the correctness of these statements. The documents provided had also only inaccurately reflected the true loss situation of the KG, since the actual negative result of the KG had been more than twice as high as stated in the BA. The seller was also not exonerated by the fact that the buyers had the opportunity to ask questions to the seller’s tax advisor. The disclosure obligation on this particularly important point existed regardless of whether the purchasers asked about it. The tax advisor had also failed to provide sufficient information about the KG’s true loss situation in the discussion with the purchasers.
III. Tips for practice
Rulings by higher regional courts or the Federal Court of Justice (BGH) on issues relating to the acquisition of companies are rare. Most disputes in this area, especially where high-volume transactions are involved, are settled before non-public arbitration tribunals or end with a settlement. The rare rulings of the ordinary courts mostly concern smaller deals, which are often concluded by parties who are not familiar with the customs of the M&A business and even more so sometimes act without legal or tax advisors. Such a situation was probably also the basis of the decision of the OLG Munich. The company for sale was offered for sale on ImmobilienScout24, the buyers were not advised by a lawyer, only some BAs were handed over, but were apparently neither questioned nor understood by the buyers.
The decision of the OLG Munich, which considered the purchasers worthy of protection in this situation, is in line with the – also sparse – case law of the BGH. It has not been conclusively clarified whether even experienced and lawyer-advised buyers may rely on rather vague and generally promotional statements of the seller (“the whole thing is clearly in the black again”, “quick return of investment”) when conducting a due diligence as is customary in the market. In the event of a claim for damages due to pre-contractual duty of disclosure (cic), the purchaser is usually partly to blame if he does not carefully check the documents provided to him.
In general, it can be said that misrepresentations by the seller about material circumstances affecting the economic situation of the company being sold constitute fraudulent misrepresentation if they are made “in the dark” or deliberately. Concealing or suppressing signs of crisis also constitutes misrepresentation. Whether the buyers in this situation can successfully challenge the company purchase agreement or claim damages depends on whether the misrepresentation has become causal for the conclusion of the agreement. If such misrepresentations or signs of crisis are identified during due diligence or if the buyers did not rely on such information from the outset, such claims do not exist. However, there is a presumption of causality of the misrepresentation for the conclusion of the agreement. In this respect, doubts shall be borne by the misrepresenting seller.
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