Share Deal: Imputation of Knowledge of the Managing Director


Due Diligence as Liability Risk

With a judgment dated June 16, 2016, the Higher Regional Court (OLG) of Düsseldorf (File reference I-6 U 20/15) has decided that the knowledge of the managing director of the target company, who is acting as a representative and who has, from the outset, an interest in the buyer's business during the purchase of a company, can be imputed to the buyer. However, the scope of knowledge can be contractually limited.

The Specific Case

The plaintiff acquired all the shares of a limited liability company (GmbH), the so-called target company, from the defendant. The directors of this target company acquired a 49% stake in the plaintiff by way of contract dated the same day and were appointed as directors of the same. The managing directors had previously tried, albeit unsuccessfully, to acquire these shares as part of a so-called management buy-out (MBO) from the defendant. This failed because the required funding was not raised.
The defendant guaranteed the plaintiff that the annual financial statements of the target company had been prepared with care and that a true and fair view of the net assets, financial position and results of operations of the company had been provided as of the relevant reporting date. The plaintiff’s claims were excluded by contract if the plaintiff knew the facts or circumstances underlying the claim. With regard to the guarantees concerning accounting, the purchaser should have been aware that the knowledge of the managing directors is treated as their own knowledge.
However, the accounting documents provided by the management board to the plaintiff during the course of contract negotiations and last year’s accounts did not reflect the actual circumstances or the generally accepted principles of accounting. The plaintiff was thereby given the impression that the target company was economically healthy, which did not correspond to the truth. A few months later, insolvency proceedings were opened on the assets of the target company.

The acquirer made a claim against the seller for damages for intentional breach of pre-contractual information and disclosure obligations and demanded the rescission of the contract for the acquisition of the shares of the target company.

The Decision

The Higher Regional Court of Düsseldorf awarded the plaintiff a claim for damages resulting from a deliberate breach of a contractual obligation.

Between the parties, a pre-contractual relationship of trust was reached within the framework of the negotiations. However, the defendant infringed its duty to inform and disclose by making objectively incorrect statements about significant value-adding factors, specifically the economic situation of the target company. The defendant imputed incorrect information to the plaintiff about the economic conditions of the target company by way of their managing director who acted as a representative. The managing directors acted as vicarious agents of the defendant. A vicarious agent is anyone who acts with the consent of the obligor as an assistant in fulfilling one of these obligations. For the managing directors it followed that it was incumbent on them, as managing directors, to manage accountancy, create the annual accounts, and submit them to the defendant.

Nonetheless, the plaintiff is partially negligent, as the plaintiff must also be imputed with the knowledge of the management board in regard to the premature transfer of loyalty. The decisive factor is that the management board originally wanted to acquire the shares of the target company itself, directly after the purchase of the company with a 49 percent stake in the plaintiff, and who was promoted to the management board. With this, the management board would be, economically speaking, allocated to the buyer’s side.

However, this imputation of knowledge does not preclude the claim for damages by the plaintiff because the parties had merely agreed in the company purchase agreement that an imputation of knowledge should occur in accordance with the guarantee promises issued by the management board. Balance sheet manipulation by the management board was not covered by this, so that an imputation of knowledge did not take place here.

Nonetheless, such an imputation of knowledge can be effectively excluded with a company purchase contract.

Recommended Action

With its decision, the court decided the question concerning the imputation of knowledge of the managing director in share deals. Managing directors of the target company are not vicarious agents of the seller, as long as they have no significant influence on the negotiations. Furthermore, an imputation of knowledge in accordance with § 166 of the German Civil Code (BGB) is excluded. Something else can only apply if the managing directors appear in the negotiations as representatives of the buyer’s side or if the MBO or M&A project structure of the buyer is included. However, the seller can exclude an imputation of knowledge from the managing directors of the target company. The seller must make it clear to the buyer that the managing directors are not representatives of the buyer or that the persons whose knowledge could be imputed to the seller are defined conclusively in the company purchase agreement. In practice, this means that the buyer, especially in situations in which the management board of the offering company is involved in the transaction, must ensure that the contractual imputation of knowledge of the management board is expressly excluded in the contract.

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Tags: #Annulment Purchase and Assignment Agreement, #intentional violation of information obligation arising from pre-contractual legal obligations, #Reimbursement of expenses incurred, #§ 241 para. 2, #§ 249 ff. of the German Civil Code, #§ 280 para. 1, #§ 311 para. 2 no. 1

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