The usual warranties on the targets company’s balance sheet in share purchase agreements (SPA) are normally to be understood as objective guarantees and are not subject to any limitation based on the seller’s knowledge.  According to a recent judgment of the Court of Appeals [Oberlandesgericht, “OLG”] Frankfurt am Main, damages are supposed to place the purchaser in the position in which the purchaser would have been if the purchaser had known the less favorable earnings position of the target company and had negotiated a corresponding, lower purchase price. 

Facts

In a share purchase agreement for a GmbH, the Seller guaranteed, among other items, that the annual financial statements 2007 had been prepared with the care of a careful businessman and in accordance with applicable law, and that it presented a true and fair view of the assets, financial situation and earnings position of the company which corresponded to the actual situation.  The SPA further provided that in case of a breach of a warranty, the purchaser must be placed by way of monetary damages in the position in which the purchaser would have been if the warranty had been correct.  Any further claims for breach of warranties were excluded.

After the closing of the transaction, it turned out that a number of line items in the balance sheet were incorrect and in particular that inadequate provisions had been established.  This was not known to the seller and the management of the target company when preparing the balance sheet.

The purchaser demanded damages by way of an adjustment of the purchase price to the amount which would have been agreed as a purchase price if the breach of the warranty had been known.  The seller argued, among other points, that (i) the guarantee was to be understood as a “soft” guarantee, i.e. a balance sheet guarantee based on the seller’s knowledge, and (ii) damages resulting from the allegedly false accounting had not been adequately shown because the annual profit was only decisive for the purchase price to a minor degree.

Decision

The OLG Frankfurt decided mostly in favor of the purchaser.  The following holdings by the court deserve particular attention: 

1. The warranty was a so-called “hard” balance sheet warranty, i.e. it was an objective warranty that the assets, financial situation and earnings position of the target company were completely and correctly reflected in the annual financial statements as of the balance sheet date.  This means that the seller is responsible for the accuracy even if and to the extent certain risks, reductions in value and liabilities were not yet recognizable for the seller, i.e. although the annual financial statements had been prepared with the care of a careful businessman and in accordance with applicable law. 
   
   
2. The damages are granted in the form of an adjustment of the purchase price.  However, the adjustment does not correspond to the difference between the value stated in the annual financial statements for the disputed line items and their true value (“balance sheet replenishment”).  According to the SPA, the purchaser was to be placed in the position in which he would have been if the warranty had been accurate (restitution in kind/positive interest).  A balance sheet warranty is supposed to establish in a binding manner the factors which are decisive for the purchase price; the purchaser must accordingly be placed in the position in which he would have been if a lower price had been agreed.  Since such a lower purchase price could not be determined (if only because the method for calculating the purchase price was not set forth in the SPA), the court made an estimate of the minimum damages in accordance with § 287 German Code of Civil Procedure [Zivilprozessordnung, “ZPO”].
   
   
3.  Whether or not the breach of the warranty was recognizable for the purchaser prior to entering into the SPA is not decisive.  The fact that the SPA did not contain an express exclusion of § 442 German Civil Code [Bürgerliches Gesetzbuch, “BGB”] (which states that a party that is aware of a warranty breach beforehand cannot claim damages) is irrelevant.  In connection with an SPA, the liability of the seller can regularly not be limited outside the contractual provisions.

Practical importance

The decision has practical relevance in various respects and must be taken into account when drafting balance sheet warranties in the future.  The decision especially makes it clear that a “hard” balance sheet warranty already exists if the warranty only states that the balance sheet gives a true and fair view of the assets, financial situation and earnings position which corresponds to the actual circumstances.  However, if the parties intend only a warranty to the effect that the legal requirements for preparing the annual balance sheet were satisfied (meaning that the knowledge of the seller and the management at the time of preparing the balance sheet is decisive rather than the objective situation), that must be clearly stated.

This is also true as regards the legal consequences of a violation of the balance sheet warranty.  The parties of an SPA normally exclude indirect damages.  In light of the OLG Frankfurt case , however, this does not appear to be sufficient.  It seems advisable to expressly exclude an adjustment of the purchase price as a legal consequence and to expressly provide that (only) a “replenishment” of the balance sheet can be demanded as damages for a breach of the balance sheet warranty.

Finally, the judgment raises doubts with regard to the implicit exclusion of § 442 BGB; also in the future, any reference to § 442 BGB should be expressly excluded, particularly since an SPA normally contains detailed provisions with respect to the relevance of the purchaser’s knowledge in the case of warranty breaches.

(OLG Frankfurt am Main, judgment dated 7 May 2015 – 26 U 35/12)

Till Liebau, Attorney at Law
Frankfurt am Main