- within Compliance, Strategy and Real Estate and Construction topic(s)
Ladies and Gentlemen,
I am pleased to present our second newsletter on M&A and Corporate law. This edition once more contains a series of current issues and rulings of the highest courts. At this point the much discussed Telekom judgment of the Federal Supreme Court ("third public offering") should be emphasized, in which the Federal Supreme Court had to rule on an impermissible repayment of contributions when a company assumed prospectus liability risks during a secondary placement of shares.
I would also like to draw your attention to the second "Exchange of Ideas on Corporate Law " that will take place in our Munich office on 22 November 2011 and in our Düsseldorf office on 28 November 2011. I would be delighted to welcome you to these events and hoping that this edition of our newsletter will be of interest to you,
I remain with best regards,
Your Hans Diekmann
EARN-OUT-CLAUSES IN DISTRESSED M&A
Against the backdrop of the global economic and financial crises the so-called Distressed M&A has won considerable importance. In order to avoid the failure of purchase price agreements due to an insecure future profitability of the target company, the parties often agree on so-called Earn-out clauses that provide for a future variable purchase price component that depends on achieving certain financial parameters within a pre-defined time period. As far as, in such factual constellations, guarantee claims of the purchaser against the seller exist or a sliding scale acquisition of assets or shares is agreed upon, the aspect of the seller's possible insolvency is of particular importance. In these cases, until payment of the Earn-out and/or until there is certainty that the requirements for the Earn-out will not take place with the purchaser's simultaneously existing guarantee claims or with the purchaser's not yet entirely completed asset or share acquisition, a mutual incomplete fulfillment of the agreement exists, which entitles the insolvency administrator according to Sec. 103 para. 1 German Insolvency Act (Insolvenzordnung – InsO) to refuse the performance of the agreement. The insolvency administrator will choose this path, for example, when the guarantee claims in favor of the purchaser are higher than the seller's claim from the Earn-out. It follows, therefore, that especially the purchaser can no longer enforce his (primary) claim (Primäranspruch) and is relegated to compensation, which he can only assert as an obligation incumbent on the assets (Masseverbindlichkeit). It appears that an (early) payment of the variable purchase price on a separate account of the seller with a simultaneous pledging of this account in favor of the acquirer with the aim of securing any (repayment) claims of the purchaser should the prerequisites for the Earn-out not be fulfilled, could be a way of possibly avoiding the insolvency administrator's right to vote – subject to non existing insolvency rescission with regard to the pledge right. The purchaser would then, as a creditor entitled to separate satisfaction, be entitled to a preferential settlement from the account.
TELEKOM JUDGMENT OF THE FEDERAL SUPREME COURT: IMPERMISSIBLE REPAYMENT OF CONTRIBUTIONS WHEN A COMPANY ASSUMES PROSPECTUS LIABILITY RISKS DURING A SECONDARY PLACEMENT OF SHARES
In its judgment of 31 May 2011 (Ref. No. II ZR 141/09) the Federal Supreme Court (Bundesgerichtshof – BGH) made an important decision concerning the distribution of liability during a secondary placement of shares. As a result, a selling shareholder must indemnify the company from all liability risks arising from the prospectus.
Factual Circumstances
After the replacement of 200 million shares in Deutsche Telekom AG that were held in trust by KfW (Kreditanstalt für Wiederaufbau – KfW) for the Federal Republic of Germany ("third public offering") U.S. buyers filed several class-action lawsuits on the basis of alleged misleading information in the prospectus. The lawsuits were ended by paying a settlement fee of around USD 120 million. Deutsche Telekom sued KfW and the Federal Republic of Germany for a refund of the settlement sum and the legal defense fees arising therefrom.
Basic Rulings of the Federal Supreme Court
The Federal Supreme Court assessed the assumption of prospectus liability risks through the company during a secondary placement of old shares as an impermissible repayment of contributions according to Sec. 57 German Stock Corporation Act (Aktiengesetz – AktG), that leads to a liability pursuant to Sec. 62 German Stock Corporation Act. A share secondary placement is carried out in the economic interest of the shareholders, who therefore have to bear the prospectus liability risks. According to the Federal Supreme Court, this is also notwithstanding the fact that the company itself is involved in preparing the prospectus and that, with exercising due care, it can reduce or avoid the liability risk. The company's own interests in a secondary placement of the shares, for example to obtain an increased free float of the shares, are a matter of financially immeasurable advantages that are not suitable as compensation for the contribution to shareholders. According to the Federal Supreme Court a corporate group obligation to compensate for shareholder disadvantages also comes into consideration. The selling shareholder can achieve a certain, but limited, protection only by securing the company's liability claims against its executive bodies.
Relevance for Future Share Placements
The latest decision of the Federal Supreme Court must be taken into account in future share placements. Hereby, a difference needs to be made between the secondary placement of old shares and the issuance of new shares. The guidelines of the Federal Supreme Court must especially be taken into account when configuring the internal distribution of liability, payment of costs and participation of the parties in preparing the prospectus. In principle, shareholders whose shares are placed on the stock exchange must assume the corresponding liability risk for the prospectus in the internal relationship to the company. It must be assumed that the judgment will have a considerable effect on the former market practice. In particular, the exit of investors from a company as part of a public offering could be made more difficult. Also with regard to old cases, a company may have claims for repayment.
RENUNCIATION OF LEICA JUDGEMENT: FEDERAL SUPREME COURT ON THE INVALIDITY OF RESOLUTIONS OF SHAREHOLDERS' MEETINGS DUE TO MISSTATEMENTS REGARDING REPRESENTATION IN THE INVITATION
The recent decision given by the Federal Supreme Court deals with the question of the invalidity of resolutions passed by the ordinary shareholders' meeting 2008 of Deutsche Bank. In this respect the Federal Supreme Court had to judge on the previously disputed question of whether the modalities of representation count as part of the conditions for participating in the shareholders' meeting or for exercising one's voting rights within the meaning of Sec. 121 para. 3 sentence 2 German Stock Corporation Act (Aktiengesetz – AktG) old version. However, it remains open under which conditions erroneous or misleading information concerning representation in the invitation to the shareholders' meeting present grounds for contestation in terms of Sec. 243 para. 1 German Stock Corporation Act.
Violation of Law Affirmed
In a first step, the Federal Supreme Court had to clarify whether the registration requirement for representatives laid down in the invitation presented a violation of the law. The question in this respect was whether the passage in the invitation was to be read in such a way that the voting right could only then be exercised by a representative in the shareholders' meeting when he was also registered in due time. This would have meant that a registration of a shareholder himself would not have been sufficient. The Federal Supreme Court confirmed such an understanding of the invitation and thus confirmed a violation of the law.
No Grounds for Annulment – Against the Leica Adjudication of the Higher Regional Court (OLG) of Frankfurt am Main
In a second step, the Federal Supreme Court, therefore, had to judge on the question as to whether the respective information counts as being part of the conditions for participating in the shareholders' meeting or exercising voting rights in terms of Sec. 121 para. 3 sentence 2 German Stock Corporation Act old version. The Higher Regional Court of Frankfurt had affirmed this as court of lower instance – fully along the lines of its Leica-decision – and thus seen in the erroneous information regarding authorization as grounds for annulment in terms of Sec. 241 No. 1 in connection with Sec. 121 para. 3 sentence 2 German Stock Corporation Act old version. In renunciation of this judgement the Federal Supreme Court now decided that this provision only covers the requirements for participating and exercising voting rights relating to the shareholder himself. In contrast, conditions relating to the participation and exercise of voting rights of a representative are not covered by this provision and thus do not lead to an annulment of the resolutions made during the shareholders' meeting. In conclusion, the Federal Supreme Court narrowly interprets Sec. 121 para. 3 sentence 2 German Stock Corporation Act old version.
All-Clear due to New Version of Sec. 241 No. 1 German Stock Corporation Act by ARUG1
The aforementioned problem was already defused by ARUG with regard to a threatened annulment. The new version of Sec. 241 No. 1 German Stock Corporation Act captures, according to the clear wording, only violations of the requirements listed in Sec. 121 para. 3 sentence 1 German Stock Corporation Act, i.e. providing the name and seat of the company as well as time and location of the shareholders' meeting.
No All-Clear With Regard to Grounds for Contestation
The decision, however, does not lead to an increase in legal certainty with regard to the question of whether erroneous or misleading information regarding representation in an invitation to a shareholders' meeting presents grounds for contestation in terms of Sec. 243 para. 1 German Stock Corporation Act. Although the Federal Supreme Court in consonance with the court of lower instance assumes that there is a violation of the law it did not need to comment on the relevance for contestation as the defects in the invitation were not asserted within the deadline for contestation. The judgment of the Federal Supreme Court discussed here makes it clear that simple trifling mistakes (as stated according to the press by the defendant's lawyer in the oral proceedings) in the preparations for the shareholders' meeting imply a not inconsiderable potential for attack on resolutions passed by shareholders' meetings of (listed) companies.
Further information is included in the publication from the lawyers Dr. Andreas Merkner and Dr. Rüdiger Schmidt-Bendun, No Invalidity of Resolutions of Shareholders' Meetings due to Erroneous Information concerning Authorizations in Invitations, NZG 2011, 1097.
CONTESTABILITY OF DISCHARGE RESOLUTIONS AS WELL AS NEW CAPITAL MEASURES DUE TO INFRINGEMENT OF REPORTING OBLIGATIONS AFTER UTILIZATION OF AUTHORIZED CAPITAL – JUDGMENT FROM HIGHER REGIONAL COURT OF FRANKFURT
In its decision (Ref. No. 5 U 104/10) of 5 July 2011 the Higher Regional Court of Frankfurt had to decide on the extent of reporting obligations of the management board towards the shareholders' meeting (Deutsche Bank 2009) concerning the effected utilization of authorized capital.
Factual Circumstances
In the underlying case the management board, with the aim of financing an acquisition of shares, carried out two capital increases from authorized capital, each excluding preemptive rights. In the next ordinary shareholders' meeting resolutions were passed inter alia on the discharge of the management board (Agenda Item 3) and on the creation of new authorized capital (Agenda Items 10 and 11). With regard to already effected capital increases no statements were made in the shareholder' meeting regarding the reason for the exclusion of preemptive rights and the respective issue price determined at the time.
Contestability of the Resolution Concerning the Discharge of the Management Board
Regarding the action for annulment and contestation, the Higher Regional Court of Frankfurt declared the resolution on the discharge of the management board as being void, because the discharge awarded to the management board was unlawful inter alia due to a violation of the reporting obligation under Sec. 203 para. 2 sentence 2 in connection with Sec. 186 para. 4 German Stock Corporation Act. Pursuant to Sec. 186 para. 4 sentence 2 German Stock Corporation Act the management board, in the event of a capital increase against capital contributions, has to make a written report available to the shareholders' meeting giving the reason for a partial or complete exclusion of preemptive rights; the proposed issue price must be justified in the report. Although a prior report in accordance with and/or analogous to Sec. 186 para. 4 sentence 2 German Stock Corporation Act is not required according to the adjudication of the Federal Supreme Court, the management board must report on the details of its course of action in the next following shareholders' meeting of the company – as far as it had made use of the authority to exclude preemptive rights.
In the opinion of the Higher Regional Court of Frankfurt the management board in the aforementioned case did not sufficiently fulfill this obligation. The Higher Regional Court of Frankfurt concludes insofar from the adjudication of the Federal Supreme Court that the management board not only had to respond to questions from shareholders but of its own accord had to provide a report. In any event this report had to include the information required by Sec. 186 para. 4 sentence 2 German Stock Corporation Act (reason for the exclusion of preemptive rights as well as justification of the issue price for shares). Only in this way would it be possible for the shareholders' meeting to assess with regard to the exclusion of preemptive rights whether the management board had appropriately exercised its corporate discretion in the interests of the company. In this respect the Higher Regional Court of Frankfurt clarifies that even in the event of a simplified exclusion of preemptive rights the reporting obligations are not inapplicable (Sec. 186 para. 3 sentence 4 German Stock Corporation Act).
Contestability of New Capital Measures
Moreover the Higher Regional Court of Frankfurt also declared the resolution concerning new authorized capital (Agenda Items 10 and 11) void due to the violation of the reporting obligations. The proper execution of capital increases, for instance from capital authorized in the past, to which compliance with reporting obligations also belongs, is also important for shareholders when deciding on the approval for new capital. The reason is that the shareholders' meeting transfers, by means of authorization, its competence to the management board. Therefore, trust in the management board's actions must exist. As a result the Higher Regional Court of Frankfurt infers from a violation of the information obligation regarding past capital measures that resolutions, which authorize the management board to carry out future capital measures, are contestable.
Assessment
However, in view of the contestability of new authorizations for capital measures, the decision of the Higher Regional Court of Frankfurt is to be rejected. In this respect the court's reasoning stating that because of any errors in connection with already issued authorizations the management board has also gambled away trust for the future is not convincing. Such a narrow connection between the utilization of an authorization and the creation of a new authorization – possibly valid for the next five years – cannot be determined. It is, therefore, to be hoped that the Federal Supreme Court in the appeal currently pending in court under Ref. No. II ZR 159/11 will correct the decision of the Higher Regional Court of Frankfurt. From a practical point of view it would be desirable that the Federal Supreme Court would confirm the opinion prevailing in literature, whereby the retroactive reporting obligation for the utilization of authorized capital does not require a written report prior to the shareholders' meeting but can be made orally during same.
FEDERAL FISCAL COURT: REAL ESTATE TRANSFER TAX TRIGGERED BY A UNIFICATION OF SHARES (ANTEILSVEREINIGUNG) CONSTITUTES TAX DEDUCTIBLE EXPENSES FOR INCOME TAX PURPOSES
In a recent decision, the Federal Fiscal Court held that German real estate transfer tax ("RETT") triggered by a share transfer constitutes tax deductible expenses rather than acquisition costs (see Federal Fiscal Court of 20 April 2011, Ref. No. I R 2/10). A share transfer triggers RETT if, after the share transfer, at least 95% of the shares in an entity owning real property are held, directly or indirectly, by a single shareholder or a group of related shareholders (so-called unification of shares (Anteilsvereinigung); Sec. 1 para. 3 German RETT Act (Grunderwerbsteuergesetz – GrEStG)). This rule is based on the rationale that the unification of shares in an entity which holds real property is deemed to be an direct acquisition of the real property from such entity.
The Federal Fiscal Court based its decision on the reasoning that the RETT triggered by a unification of shares is not directly connected to the transfer of the shares. For the classification as acquisition costs an intentional link would be required. This has been denied by the Federal Fiscal Court since the mere causal link between the RETT and the share transfer does not suffice to treat the RETT as acquisition costs for the shares. This is also based on the argumentation that there is no change of the ownership of the real property for income tax or legal purposes.
Consequences for the M&A Practice
The Federal Fiscal Court's decision has a substantial impact on the transaction and restructuring practice. With respect to not finally assessed or future transactions, RETT triggered by a unification of shares should be treated as immediately tax deductible expenses. In addition, the Federal Fiscal Court's argumentation indicates that also RETT triggered by a change in the partnership structure of a partnership owning real property (see Sec. 1 para. 2a GrEStG) might be treated as expenses rather than acquisition costs. Under such rule, RETT is triggered if the partners of a partnership change within five years directly or indirectly in such a way that at least 95% of the shares are transferred to new partners. Note that the RETT rate deviates between the German states (Bundesländer) and ranges between 3.5% and 5%.
INTERVIEW: EVALUATION REPORT OF THE EUROPEAN COMMISSION ON THE SE-REGULATION
Mr. Kiem, in Autumn 2010 the European Commission published its evaluation report on the SE-Regulation. What were the reasons behind this?
According to the SE-Regulation the European Commission is obliged to prepare an evaluation report on the practical implementation after the expiry of a period of five years after its entering into force – i.e. actually in the Autumn of 2009. With the report of Autumn 2010 this has happened – albeit one year later.
What exactly should be the requirements and objectives?
The main purpose of the report is to illuminate the implementation of the SE-Regulation and its expediency on the basis of an extensive analysis of the practical knowledge with the SE Statute and to sum up five – now actually six – years of particular legal experience with the SE-Regulation. Based on the report an open-ended discussion on the further development of the SE should be conducted.
In your opinion, what are the main findings of the report?
The summary of the evaluation report is tight-lipped. In short it can be concluded that the Commission concedes that the practical implementation of the SE-Statute is accompanied by a series of problems, which is inter alia expressed in the unequal distribution of the SE within the Community. These problems are also based on the fact, that SE-law is not consistent throughout the Community, but that rather 27 different variations can be found.
How do you assess these findings?
In any case the report has the merit of increasing the attention on the application problems due to the legal form. However, there are number of evident criticisms against the presented report. In particular, a clear contouring and positioning on the part of the European Commission is missing. Even clearer is the attempt being made by the different lobby groups to literally not sit on the fence. Against the background of the SE's weaknesses mentioned in the report itself, this is not enough.
In your opinion, what are the consequences of this?
The primary focus of the Community legislator now has to be the attractive composition of the legal form of the European Stock Corporation throughout the whole Community. Should it not succeed in doing so serious doubts on the necessity for pan-European legal forms remain.
How should the Community Legislature react to improve the attractiveness of pan-European legal forms, in particular the SE?
The first step has certainly to include the elimination of disadvantages caused by the legal form, as for example the parallelism of registered and administrative office or the simplification of the founding procedures which are considered complicated. Nonetheless this would only be a modest increase in attractiveness – a breakthrough cannot be achieved by this. Therefore, extensive amendments of the SE-Regulation would be necessary.
How do you assess the future of the SE against the background of the evaluations report and your experience?
The SE's track record is mixed. Especially in Germany it is a success, whilst in many other member countries it does not play a vital role. Overall, the aims of the SE-Regulation have not been achieved. A number of minor interventions could noticeably improve the practical implementation of the SE-Regulation. Whether that is sufficient to awaken interest in this legal form in all member states, cannot be conclusively assessed at this point. However, the possibilities of fundamentally changing the SE-Regulation are either limited, or where they do exist, not necessarily desirable. Therefore, a modest amendment to the SE-Regulation is at the moment desirable and realistic.
NEW TREND IN RESTRUCTURING PRACTICE: SILENT RESTRUCTURING OF GERMAN COMPANIES BY MEANS OF SCHEME OF ARRANGEMENT
The financial and economic crisis caused a wave of reconstruction that has already affected many German companies and will affect many more. In this connection the Scheme of Arrangement according to English law has attracted a lot of attention because it can be used to implement a reconstruction concept that, for example, provides for a waiver of claims, a deferment or the adjustment of the interest structure.
The procedure is already available before insolvency and can bind dissenting creditors by means of a majority decision. A simple majority of the voting creditors in every creditor group is required, who in turn must each represent at least 75% of the claim volume. On the other hand for complex financing of certain restructuring measures credit agreements usually demand unanimity within the creditor groups concerned. With the aid of a Scheme of Arrangement, therefore, a reconstruction concept can be pushed through by the majority against minority creditors who pursue particular interests and let their disruption potential play in the reconstruction negotiations. German law currently only provides for a possibility for binding minority creditors in an insolvency plan procedure or for reconstructing convertible bonds.
Use of a Scheme of Arrangement by German Companies
The hurdles for using a Scheme of Arrangement by German companies are thought to be low: according to the latest confirmed English judicature it is sufficient when the obligations to be reconstructed are subject to English law and in the credit agreement the place of jurisdiction is established in England. The company must neither have assets in England nor remove its seat or the centre of its main interests (COMI) to England.
Recognition of a Scheme of Arrangement in Germany
For the Scheme of Arrangement to be effective it is decisive that it also unfurls its effects in Germany. In German judicature it is disputed whether the Scheme of Arrangement can be recognized in court proceedings. In a currently pending hearing the German Federal Supreme Court will shortly have the opportunity to ensure legal certainty on this point (Ref. IV ZR 194/09). In any case the Scheme of Arrangement will receive substantive legality in Germany. According to international private law for a demand based on a decree according to English law, English law is definitive so that in this respect a German court would be bound to the Scheme of Arrangement.
An overview of the possible uses for a Scheme of Arrangement as a reconstruction instrument and other details concerning questions of its recognition in German is offered by: Laier, Die stille Sanierung deutscher Gesellschaften mittels eines "Scheme of Arrangement", GWR 2011, 252 et seqq.
REFORM OF THE GERMAN ACT ON MODEL CASE PROCEEDINGS IN CAPITAL MARKET DISPUTES (KAPITALANLEGER-MUSTERVERFAHRENSGESETZES – KAPMUG)
The Federal Ministry of Justice (BMJ) has recently publicized the draft bill of a law for reforming the Act on model case proceedings in capital market disputes. By grouping parallel proceedings the procedural law newly created in 2005 is aimed at effectively enforcing rights as part of capital market disputes, i.e. particularly when the liability due to alleged erroneous or misleading prospectus information or claims for performance pursuant to the German Securities Acquisition and Takeover Act (Wertpapiererwerbs– und Übernahmegesetz – WpÜG) arise. The draft bill provides inter alia for expanding the scope of application of the KapMuG to investment intermediaries and consultants (Anlagevermittler- und -berater). In addition the requirements for introducing and expanding the draft bill along with individual cost regulations are to be modified.
The core of the reform is formed by the planned introduction of a new form of settlement proceedings, the legally approved settlement with opt-out model. Whilst the conclusion of a settlement so far has required the agreement from all participants, in the future it should be possible that the model case plaintiff (Musterkläger) and the model case defendants (Musterbeklagte) agree on a settlement that then must be approved by the Higher Regional Court. Finally the remaining participants, the interested parties summoned (Beigeladene), should have the opportunity to exit the settlement within one month. If they make use of this opportunity, their main proceedings will be set back to the status it had before the proceedings were suspended. The extent of the legal effect unfurled by the settlement prevents the interested parties summoned from making a renewed application for a model case proceeding. The planned new regulation is basically to be welcomed. In consequence, however, the practical relevance of the new settlement model may prove to be limited, as a model case defendant normally only agrees to a settlement when it is ensured that the settlement binds all those involved in the proceedings. Otherwise the model case defendant would have to pursue if necessary costly and time consuming separate main proceedings and possibly repeat evidence already heard in the model case proceeding.
Further information can be found in our client information from the practice group litigation and arbitration from August 2011 as well as the contribution Sustmann/ Schmidt-Bendun, Der Referentenentwurf zur Reform des Kapitalanleger-Musterverfahrensgesetzes (KapMuG), NZG 2011 (to appear shortly).
The client information can be downloaded under www.shearman.com/publications/. The draft bill can be read on the web site of BMJ (www.bmj.de/).
Footnote
1. Gesetz zur Umsetzung der Aktionärsrechtrichtlinie (ARUG) = Law Implementing the Shareholders' Rights Directive
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
