Personal obligations and liabilities of managers in M&A
situations
M&A transactions involve managers - mainly managers of the
target, but also of the seller, the buyer, the other bidders, the
investment banks and other advisers. Managers have personal
obligations, and breaching those obligations creates personal
liability. This is relevant not only in private equity situations
(with management participations on either or both sides) but also
between the target and its managers. The target is part of the
seller's group before the transaction, and will be under the
buyer's control after the transaction. Today's bidder might be
tomorrow's owner, or might remain (or become) a market
competitor.
Sellers' or buyers' managers and their advisers might have their
own obligations and liabilities where they, for example, cause or
induce a breach by the target's managers, or where they otherwise
participate in that breach (which might constitute fraud, or
another tort or criminal offence) or because they fail to detect or
to disclose the breach. All of this and more can create sizeable
personal liabilities with potentially destructive consequences.
Below are a few examples of areas of concern, together with the
applicable principles of German law.
Areas of concern and risk
Management's regular due care obligations can have unexpected
consequences in an M&A situation when, for example, disclosure
or non-disclosure of information constitutes a breach of a
manager's obligations.
Due care in general: Do not only consider shareholders'
interests.
Whatever a manager does, abstains from, or tolerates, they must
apply due care. In general terms, the managers must identify and
weigh pros and cons and balance conflicting interests. In this
area, German law differs from English law and practice in two
distinct ways. First, the manager of a company (for example, the
target) is not the agent of a principal - that is, of that
company's shareholder. Instead, the target's manager is obligated
to the target itself, and must consider the legitimate interests of
the target and of all its stakeholders (not only the interests of
the shareholders) - that is, employees, creditors and the general
public.
Second, although managers have broad discretion, there is no
formal business judgement rule comprising criteria by which the
managers can be guided. Their power to exercise discretion simply
means that a judge cannot second-guess their conclusions. However,
a judge would consider whether a manager exercised appropriate
discretion, for instance, by considering all relevant interests
rather than being erroneously driven only by the shareholder's
interests (or, worse, by their own interests as a present or future
participation holder).
Five year forecast?
In a merger, these personal obligations can become far more
demanding. Take the simple example of a post-acquisition merger
between a target and an acquisition/financing vehicle, or another
post-acquisition restructuring such as a conventional
profit-and-loss transfer agreement. Before signing the merger or
other corporate agreement, the manager must again examine the pros
and cons from the point of view of the best interest of the
company.
At the very least, the manager must be convinced of the
viability of the merged business on the basis of a forecast for the
foreseeable future. Some commentators argue that this forecast
should extend over five years. Such an investigation needs
accountants' and other outside assistance. The investigation must
be appropriately documented and could apply to any corporate
acquisition, for instance, when a target's management decides to go
along with the project and allow and support a due diligence
process by bidders. It would appear quite logical to apply the due
care concepts to all decisions that the manager makes in an M&A
situation.
Financing: what happens when the bubble
bursts?
Today's abundant supply of cheap financing increases prices and
leverage. When the bubble bursts, the injured parties (such as
banks and investors) and the insolvency trustees will look for
damages, faulty credit requests and information packages produced
by, or with the assistance of, managers. Managers should be
particularly concerned about legal liability under tort or even
criminal law. There is extensive case law defining fairly stringent
standards of disclosure, whether or not expressly requested, and
proper documentation.
Corporate governance
In Germany, one should distinguish between shareholders
(sellers, buyers) and management (executive management board
members, non-executive supervisory board members, and non-board
employees). One should also distinguish between stock corporations
(AG), the far more common limited liability companies (GmbH), and
the even more common limited partnerships with a corporate general
partner (GmbH & Co KG) - the AG format being distinct and the
GmbH and GmbH & Co KG formats being more similar to each
other.
Within the AG format, listed AGs and their management are
subject to certain special rules, and co-determined GmbHs (or GmbH
& Co KGs) have a supervisory board similar (but not identical)
to an AG. Apart from some laws applicable to a listed AG, there are
only a few specialist pieces of legislation (such as the Tender
Offer Act) and some pieces of pending legislation. The Corporate
Governance Codex is not legislation, but a private,
government-supported set of recommendations containing little if
any special guidance for M&A situations (but requiring
disclosure of non-compliance).
The scarcity and narrowness of special rules should not deceive
companies, managers or their advisers. There is plenty of general
law applicable to them that imposes substantial obligations with
serious legal consequences in M&A transactions.
Breach by disclosure
A manager can breach their obligations by making disclosure (or
by not making it, as described below).
Confidentiality owed to the company
Any disclosure of a company's data or secrets to another person
might constitute a breach of confidentiality. Disclosure to a
competitor is certainly a breach, and even a financial investor
might be, or become, a competitor through another investee
company.
So, before any disclosure, the manager needs a release or
consent. How this would work in a public company is in dispute. In
a privately held company (GmbH), the release must come from the
shareholders, through a resolution passed in a shareholders'
meeting.
Who can challenge such a breach? The buyer might be prevented
from challenging a disclosure by the target. But the buyer can
certainly challenge the parallel disclosure to the other bidders.
The same is true for sellers if a deal fails, and it is certainly
true for opposing shareholders or for subsequent successor
shareholders.
Confidentiality owed by the company
Releasing information may be a breach of third party rights,
such as express or implied confidentiality obligations to
customers, suppliers or employees. If the third party derives
rights from the breach (such as termination of a contract, or
damage claims) the target can hold the manager liable.
Data protection
Disclosure can also constitute a breach of data protection laws
- either industry-specific ones such as those in the financial and
telecommunication industries, or general ones such as the Federal
Data Protection Act. The latter would apply, for instance, to many
or all customer or employee lists. Breaches of special data
protection laws can render the sale or acquisition invalid. It is
unclear whether, and how far, such invalidity could arguably be
extended to other M&A transactions.
If disclosure is limited or denied because of confidentiality or
data protection requirements, that again must be disclosed. It is
not enough to simply omit certain data.
Breach by non-disclosure
Non-disclosure can also constitute a breach of a manager's
obligations, and expose the manager to liability.
Management participations
If management participations are offered by a bidder to the
target's management, both the manager and the bidder must disclose
this to the target or the seller, respectively. Likewise, if the
seller finances the investment to be made by the target's managers
in a management participation scheme offered and expected by a
buyer, this must be disclosed to the bidder. A bonus promised to
the target's managers need not be disclosed to the bidder, however,
even if the bonus is directly related to the M&A transaction
and based on the transaction's success. However, if the buyer asks,
the seller must respond truthfully (possibly by openly refusing to
give the information), and most buyers would ask for a specific
warranty on this point.
A bonus paid to the target's managers by the seller might
constitute a breach - and it certainly does in the case of an AG. A
bonus paid by the target will become known to the buyer at some
stage, at the latest once the transaction has closed. Furthermore,
any exclusivity agreement between a bidder and a target's
management is a breach, and de facto exclusivity (for
example, a management's preference for one bidder, or for a type of
bidder such as private equity funds) may well be a breach too.
Contracts and other conflicts
Generally speaking, conflicts must be disclosed. For instance,
direct contacts between management and bidders (or contact without
the seller's representatives being present) are forbidden unless
they are disclosed to the target and the seller. A practical way
for sellers to make illicit contact and approach to target's
management more difficult is to make available to management an
adviser with whom the seller is comfortable, to help them identify
their obligations or to negotiate their management participation.
This adviser might be the seller's own lawyers, and the seller
should always prevent the buyer's lawyers from assisting the
managers.
If seller or buyer pays that lawyer's fees, this constitutes
remuneration and needs to be handled appropriately under corporate
and tax law.
Disclosure/non-disclosure
Limitations of disclosure may also have to be disclosed, as
mentioned above.
Management representations
By signing management representations, a target's managers
sometimes assume special obligations in connection with an M&A
transaction. They are not, however, obliged to sign them. If a
manager does sign them, though (or if such a representation is
found to be implied), any mistake probably constitutes fraud and
possibly a tort.
Protection and defence
How can managers protect themselves against a breach of their
obligations, and against incurring personal liability? And how can
sellers and buyers help their own and a target's management in this
respect? The victim's claim against a manager deriving from a
breach is attractive neither for the seller nor the buyer, so they
may genuinely want to help the managers avoid that liability.
Compliance and advice
The only straightforward (if a little trite) way of avoiding
liability is to comply with one's obligations.
Advice
For this purpose, managers need advice on identifying their
obligations in advance. Sellers and buyers will want this advice to
be provided by advisers on whom they can rely. The adviser should
not look for tricks, but instead should support compliance. This,
again, is an area of potential conflict, and these conflicts need
to be addressed openly and in advance.
Excuse
Advice might protect the manager, even if (and especially if)
the advice was incorrect and the manager, based on such advice,
breached his or her duties. A case in point was the criminal law
case against executive and non-executive board members of
Mannesmann, a public stock corporation, in connection with
Vodafone's tender offer for it and the bonuses granted to
Mannesmann managers after the transaction. The court held the
bonuses to be in breach of stock corporation law, but the managers
avoided penalties under criminal law because the court believed
they had taken appropriate, albeit incorrect, advice.
The earlier the better
Managers will need advice at some stage anyway, for example to
assess the appropriateness of a proposed management confirmation,
or to negotiate management participations. The earlier the manager
retains counsel the better, because risks can be reviewed and
handled and because a precautionary mandate will arouse less
attention and resistance on the part of other participants. In
contrast, a later mandate will raise questions and speculation as
to its immediate causes. Since the managers will want the company
to pay for the advice, an early mandate may be the only option,
because the company may well refuse to step in once a problem or
breach has already happened (or it is suspected it might have
happened).
Advisers
The main example of such an adviser would be a legal and tax
adviser. But in a big transaction, management might also seek
business, financial or M&A advice from a bank or similar
adviser.
Independent advice and remuneration
Traditionally, the advisers to management would be the advisers
of the company (as was the case in the Mannesmann/Vodafone
example). This is delicate, if not impossible, from the advisers'
perspective, and it is at least undesirable from the manager's
perspective, because these advisers will have to look after their
client's interest. Special counsel can be hired by the company but
made available solely to the managers. Then, all participants
should make sure that it is expressly stipulated that the advisers
owe their duties only to the managers, including confidentiality,
also with regard to the company itself. Alternatively, and perhaps
in a clearer and safer manner, the mandate can be awarded by the
managers (as the client), with the company undertaking to bear the
fees. Managers will want this undertaking to extend to subsequent
disputes or even litigation, and the company will not want to make
an open-ended financial undertaking.
A fee undertaking such as this constitutes remuneration to the
manager, and requires corporate action, tax compliance and other
substantive and formal measures. A simple promise by one
shareholder is certainly not enough, and a promise by the chairman
of the supervisory board might also not be enough. In general, this
is an area where it is worth paying full attention to corporate
governance issues.
Release and indemnity
Can a manager be released from a personal liability on a
prospective or a retrospective basis?
Wilful?
A prospective release from potential future liabilities is
subject to additional restrictions. In particular, such a release
does not cover intentional breaches. Under case law, the line of
distinction between intentional and gross negligence is fine and
fairly unpredictable. A manager not seeking advice in a special
situation (such as an M&A transaction) might easily be seen to
have acted wilfully if he is found to be mistaken after the
fact.
Ex ante/ex post?
An AG cannot release managers in advance, and not even before
several years (usually three) have elapsed, and even then, can only
do so by shareholders' resolution where not more than 10% of the
shareholders object. In a GmbH, a release from liability is
generally possible and valid, but would be after the fact and
requires at least a shareholders' resolution. A majority
shareholder, outside of a shareholders' resolution, can only
provide an indemnity. But unless the granting of an indemnity is
unanimous among all shareholders, a conflict is implied, and it may
indeed be forbidden for the indemnifier to give an indemnification,
and for the indemnified to receive one. The indemnity can therefore
turn out to be invalid and counter-productive.
Indemnity in the M&A agreement
Warranties in an M&A agreement are usually stipulated to be
conclusive and to exclude other implied warranties and remedies. As
such, they exclude any other liability of the seller. But managers
(whether or not they are also sellers) remain liable for whatever
liability they may have incurred with respect to the target (which
will then be under the buyer's control) or directly to the buyer or
other parties. So, in a sense, the more limited the representations
and warranties, the higher the exposure for managers (including
those sellers who were managers). One early case (involving missing
inventory in an M&A target) went to the German Supreme Court
twice - once on the basis of a claim by the buyer against the
seller under representations (which the buyer lost), and a second
time on the basis of a claim by the target against its manager
(which the target won).
Therefore, sellers (and managers, even if they are not sellers)
should insist on a clause in the M&A agreement, under which the
buyer undertakes to ensure that the target releases its managers
from any liability (or from any liability exceeding the scope of
the representations and warranties) or, failing that, to indemnify
the managers from that liability.
Directors' and officers' insurance is insufficient, but
useful
These issues do not become moot by directors' & officers'
(D&O) insurance, which has become rather widespread in Germany
(although less so among private companies - that is, GmbHs and GmbH
& Co KGs). Furthermore, its coverage is often limited to
regular business, and does not cover large, one-off events such as
an M&A transaction. Obviously, it excludes intentional
mistakes. Where it is useful, and where it may be a good idea to
take it out specifically for an M&A event, is in its coverage
of legal fees. But there too, it is incomplete, because these fees
are often only financed by insurance, but not definitively covered.
The D&O insurer may also have recourse for the fees if the
manager eventually loses his or her case. For this, recourse would
need to be excluded, possibly by a separate legal defence insurance
policy.
Author
biography
Reinhard
Pöllath
P+P Pöllath &
Partners
Reinhard Pöllath, 57, has practised as a lawyer for 30 years. He
has worked on hundreds of transactions and assisted in structuring
and reviewing more than 100 private equity funds. He has been an
adviser to family offices, investors, trusts, and foundations and
has been selected annually as a leading tax adviser and M&A
lawyer.
Pöllath obtained an LLM at Harvard in 1974 and was a partner of
law firms in Munich, Frankfurt, and Berlin from 1980 to 1997. He
was an executive director of a client, a hotel and real estate
group, from 1993 to 1996, and CEO of a major consumer goods group
2002-2003. He is author or co-author of numerous publications
(including M&A Handbook, eleventh edition) and chair or member
of several boards of public and private companies. He is involved
in pro bono work (for example, micro-loans; protection of
jurists and foreigners; private equity education). He has two nice
children.
P+P is an independent corporate and tax firm with 60 lawyers and
tax advisers specializing in M&A, tax, private equity/venture
capital, funds, asset management and real estate. The firm has 18
partners (Michael Best, Dieter Birk, Matthias Bruse, Andrea von
Drygalski, Matthias Durst, Carsten Führling, Otto Haberstock,
Wolfgang Hohensee, Reinhard Pöllath, Andreas Rodin, Andres
Schollmeier, Thomas Töben, Philipp von Braunschweig, Ralph Wagner,
Andreas Wilhelm, Margot Gräfin von Westerholt, Wolfgang Tischbirek,
Uwe Bärenz). It has offices in Berlin, Frankfurt and Munich. It is
fully independent and not affiliated with any other firm or
group.
P+P Pöllath + Partners
Kardinal-Faulhaber-Strasse
10
D-80333 München
Tel: +49 (0) 89-24 24 0-220
Fax: +49 (0) 89-24 24 0-997
Email: muc@pplaw.com
Linkstrasse 2
D-10785 Berlin
Tel: +49 (0) 30 253 53-0
Fax: +49 (0) 30 253 53-999
Email: ber@pplaw.com
Zeil 127
D-60313 Frankfurt/Main
Tel: +49 (0) 69 24 70 47-0
Fax: +49 (0) 69 24 70 47-30
Email: fra@pplaw.com