In two consecutive judgments, the Court of Appeal of Berlin and the District Court of Dusseldorf have established some first limitations regarding lawyers’ professional liability in the context of legal due diligence analyses.

The term “due diligence” which originated from Anglo-American liability concepts describes the assessment of a target (e.g. a company) in the international transaction practice. The transaction-related due diligence concept has been firmly established in Germany for many years. However, until today, conducting a legal due diligence provided an unknown “mine field” with regard to potential liability of the relevant law firms. Recently, the issue has been decided by the courts.

In the first case that was dealt with before the Court of Appeal of Berlin, the law firm being sued had been engaged with the legal due diligence of a property. At a later stage, it turned out that some of the commercial leases for the target object were prematurely terminable because they had not duly been signed by all shareholders or duly authorised signatories of the lessee (a company incorporated under German civil law) and therefore did not fulfil the written form requirement under sections 578, 550 sentence 1 of the German Civil Code (BGB). The lessee took advantage of this detail, terminating the contracts about three years before expiration of the agreed term. The validity of the terminations was subsequently confirmed by court. The law firm engaged in the due diligence had never pointed out the risk of premature termination of the lease agreements despite such agreements having been made available to them. Instead, the due diligence report expressly stated (in a fairly common way) that it had been assumed without assessment that the agreements were formally effective.

The court of appeal did not find the acting lawyers liable for a violation of duty. According to the judgment, the extent of lawyers’ duties is determined by the individual circumstances of the matter in question. In the case at hand, it could be assumed that the lawyers did not owe an assessment of the formal validity of the lease agreements, i.e. their valid conclusion and compliance with the written form requirement. But even if the assessment of the formal validity of the lease agreements had been part of the agreed lawyers’ tasks, according to the court, the client could not claim any damages. The court argued that it considered the obligation to draft a due diligence report a so-called service contract duty. Under German law, in case of poor performance, the principal of a service contract must request supplementary performance (section 635 BGB) before being entitled to claim damages. Therefore, the client should not have accepted the law firm’s expressly limited due diligence report without requesting supplementary performance. Apart from that, the lease agreements had in no way pointed to a lack of a formally valid conclusion on the lessee’s part and the lawyers had not had any other indications to suggest otherwise in this regard. In any event, the court held that the lawyers were not obliged to provide advice regarding risks that are merely abstract.

The court’s decision is based on general principles of the German law of obligations as well as German service contract law and readily stands to reason. Lawyers who carry out their inquiries as agreed on the basis of particular documents are not obliged to point out (abstract) risks for which no indications are provided in those documents. An obligation to notify about legal risks, however abstract they may be, has to be ruled out for reasons of efficiency. Moreover, the additional expenditure is unlikely to be accepted by clients who are usually not interested in a washy and confusing report but rather request a compact presentation of the legally relevant issues.

In the case the District Court of Dusseldorf had to deal with, the defendant had to carry out a so-called “red flag due diligence” prior to the acquisition of a group of companies active in the provision and brokerage of personnel services. The targeted group had concluded collective employment agreements, inter alia, with “Tarifgemeinschaft Christliche Gewerkschaften für Zeitarbeit und Personalserviceagenturen” (CGZP). Post-merger, the German Federal Employment Court rejected CGZP’s collective bargaining capacity which led to all collective employment agreements being deemed ineffective. This resulted, inter alia, in the newly acquired group having to bear subsequent social security payment obligations which ran into millions. The involved law firm had not pointed out to its client the potential lack of CGZP’s collective bargaining capacity and the associated risks. However, when the due diligence was carried out, there had not yet existed any case law suggesting a lack of collective bargaining capacity on CGZP’s behalf. Whilst some legal scholars had already doubted or even rejected the idea that CGZP had collective bargaining capacity, altogether no clear direction of opinion had yet developed in German legal literature. And in fact, the focus was often put on CGZP’s “assertiveness”, a point that was later not deemed decisive by the Federal Employment Court.

In this case, the court also refused to find that the lawyers who had carried out the legal due diligence had breached their duties. Just like the Court of Appeal of Berlin, the District Court of Dusseldorf referred to the individual matter which, in this case, only consisted of a “red flag due diligence”. Therefore, the lawyers just owed information on so-called “deal breakers”, i.e. on circumstances and risks which would be crucial for the prospective purchaser’s buying decision. Since the discussion on CGZP’s collective bargaining capacity was merely academic, the defendant correctly assumed that the client’s buying decision would not have depended on this discussion. The court’s judgment is now final.

Bottom line

Pursuant to general principles, with regard to due diligence examinations, lawyers are obliged to provide comprehensive advice “only” within the limits of the individual client matter in question. It is therefore recommended to both clients and lawyers to define precisely and in advance the content of each project and in particular the expected scope of the legal due diligence exercise to be carried out.

(Court of Appeal of Berlin, decision of 17 September 2013 - 7 U 160/12; District Court of Dusseldorf, decision of 15 October 2013 - 7 O 6/12)

Dr Dominik Ziegenhahn, Attorney (Hamburg)
Jan Bela Hermann, Attorney (Hamburg)