In Germany, arbitration tribunals settle most disputes resulting from mergers and acquisitions. Parties often fear that German state courts are inexperienced and therefore ill-placed to adjudicate complex, high-value mergers and acquisitions disputes. Parties prefer arbitration because it allows them to choose arbitrators who either have experience negotiating complex settlement agreements or handling mergers and acquisitions disputes. The downside of this preference for arbitration over litigation is that there is not much case law available in Germany on typical litigation arising from M&A transactions, as arbitral awards are often confidential.
In January 2022, North Rhine-Westphalia, the German federal state with the largest population and the German powerhouse with the largest economy among the German states, took a big step to change the situation just described. Among other things, North Rhine-Westphalia has established a specialized court in Düsseldorf for M&A disputes (“M&A Chamber”). All regional courts in the Land of North Rhine-Westphalia must now refer all large M&A disputes (> EUR 500,000) to the special court in Düsseldorf. The judge presiding over the Mergers and Acquisitions Chamber is a former lawyer who worked for many years in international law firms in London and Düsseldorf.
Today, the first major judgment of the Mergers and Acquisitions Chamber has been published (file number 24 S 1/221, available here). The dispute concerned a share purchase agreement containing an arbitration clause. The Buyer claimed damages from the Seller, alleging that the EBITDA of the target company had been manipulated and that this had caused harm in the amount of said amount to the Buyer.
The buyer was concerned that once the arbitration proceedings were successfully concluded, the seller no longer had sufficient assets to enforce the arbitration award and therefore requested a preliminary attachment order from the local court (Amtsgericht) Düsseldorf. According to German law, this is possible. According to sec. 1033 of the German Code of Civil Procedure (ZPO), a court may grant, before or during arbitration proceedings, an interim measure of protection relating to the subject matter of the arbitration at the request of a party. As a general rule, the competent court to pronounce an attachment is either the court before which the principal action is in progress, or the court of first instance in whose jurisdiction the object to be seized is located or the person whose personal freedom is limited, either resident, sec. 919 ZPO. Since the state courts did not have jurisdiction for the main action due to the arbitration agreement, the local court in Düsseldorf was responsible for the seizure. She rejected the Buyer’s request.
The buyer appealed against this decision to the regional court in Düsseldorf. The question arose as to which chamber of the regional court was competent for the appeal procedure. The Presidium of the Düsseldorf Regional Court decided that the Mergers and Acquisitions Chamber should hear the appeal, because the subject of the appeal was a dispute “resulting from the purchase or sale of companies, parties businesses or interests in businesses or contract negotiations preceding such purchase or sale”.
The Mergers and Acquisitions Chamber dismissed the appeal and refused to grant the seizure on the grounds that the acquirer could not prove At first glance intentional breach of SPA warranties or fraudulent misrepresentation (which was necessary to overcome the limitation of liability provided in the share purchase agreement).
The buyer was an Austrian, the seller was an American private equity firm. The Buyer claimed that the Seller/the management of the target company intentionally manipulated the EBITDA of the target company and thereby caused damage in the amount of EUR 258.4 million to the Buyer.
The terms of the SPA have not been published. However, according to the judgment, the buyer’s claim for damages was excluded by a limitation of liability clause in the share purchase agreement. However, this clause was not applicable in the event of “intentional misrepresentation, intentional violation or criminal act committed by Sellers or a representative of Seller“.
The Buyer claimed that the target company’s EBITDA had been manipulated in 22 cases and argued that without these manipulations, the Buyer would have paid a lower purchase price. According to the Acquirer, the former management of the target company had inflated the EBITDA by false entries that did not comply with the applicable accounting rules. The Buyer claimed that these wrong bookings were made intentionally. In this regard, the Buyer produced various emails from the management/employees of the target company. The court cited two emails which read as follows:if we don’t generate money, but burn it, we can’t tell the truth” and “everyone thinks EBITDA is true“. According to the Buyer, these e-mails proved that all the erroneous entries had been made intentionally. In addition, the Buyer presented a statistical argument. The Buyer claimed that there were 22 erroneous entries. All had led to – erroneous – EBITDA inflation. The buyer argued that there was a 1 in 4.2 million chance that these 22 erroneous entries were made through negligence. Had they been done negligently, one would also have expected bad bookings which – wrongly – deflated EBITDA. However, such erroneous entries would not have existed.
Seller disputed the accuracy of Buyer’s factual claims, in particular that Buyer made a fraudulent misrepresentation or intentional violation of the SPA.
The decision of the regional court
The court ruled in favor of the seller and found that the buyer had not demonstrated At first glance fraudulent misrepresentation or intentional violation of the SPA. Accordingly, the court concluded that the buyer’s claims were excluded by the limitation of liability clause.
According to the consistent case law of the German Federal Court of Justice (BGH), a seller is acting fraudulently within the meaning of fraudulent misrepresentation if he indiscriminately answers the buyer’s questions with misrepresentations devoid of any factual basis if these questions are obviously material to the buyer. In this case, this meant that the seller would have acted fraudulently had he accepted the possibility that an accounting statement was in error.
The regional court held that it was not necessary to determine whether the financial statements of the target company actually contained 22 “wrong bookings” because the Buyer failed to prove fraudulent misrepresentation with respect to the 22 alleged erroneous bookings.
First of allthe emails exchanged between management/employees of the target company did not prove intentional misconduct as the emails did not refer to a specific entry.
Secondly, the court did not follow the Buyer’s argument that the erroneous entries could not be the result of simple negligence. According to the Buyer, if the erroneous entries had been the result of simple negligent conduct, some erroneous entries might have been expected to reduce EBITDA and others to increase EBITDA. However, any wrong bookings would have increased EBITDA. Buyer’s statistical argument that the probability of this being the result of simple negligence was 1:4.2 million did not convince the court. He said the mere number of erroneous bookings inflating EBITDA was not evidence of seller intent. The court also said that a seller could be expected to apply accounting rules in a way that allows it to increase the EBITDA of the target company. Therefore, the court was not surprised that allegedly erroneous entries rather inflated EBITDA than deflated it.
Thirdly, the court held that there could be cases where the accounting was so flawed that it could be assumed that the EBITDA had been intentionally manipulated. However, the court concluded that this threshold was not met in this case. Consequently, the court dismissed the request for seizure of the assets of the Buyer. The dispute may not yet be closed. The Regional Court of Düsseldorf having rendered its judgment in the context of preliminary seizure proceedings on a At first glance Buyer can always claim damages in arbitration proceedings.