M&A deals fail regularly, for example because the requested purchase price is too high, or an agreement cannot be reached on guarantees, warranties or tax exemptions. But also, the pride of both managements can lead to failure: Who will stay and who will go and who will decide? Or one of them wants a joint venture, but the other one is only interested in a takeover. It is not uncommon for the question of location to be a deal breaker when each side wants to impose its location and remains stubborn. Or the parties cannot agree on which plants, products or technical platforms to keep or close. If one of the parties cancels the contract negotiations, there are quickly claims for compensation.
But – what does actually happen when a deal fails?
Prior to the Conclusion of the Contract
If the negotiations stop even before the contract is concluded, the basis for a claim for damages is already problematic. Although the pre-contractual relationship of trust between the parties in principle gives rise to the possibility of a claim for damages, the fact remains that expenses incurred by a party with a view to the intended formation of a contract are incurred at the party’s own risk. However, expenses incurred by a party with a view to the intended contract conclusion are at the party’s own risk. Another complicating aspect is that the case law of the Federal Court of Justice (Bundesgerichtshof, “BGH”) is comparatively restrictive. On the one hand, costs would have arisen even if the contract had been executed as agreed. On the other hand, these costs would probably also have arisen in the event of a sale to another buyer. Therefore, without an agreement on damages prior to the start of negotiations, it will be difficult to obtain damages for the breakdown of negotiations.
After the Conclusion of the Contract
But even if the contract has already been signed, the deal can still fail. For example, if the agreed purchase price is simply not being paid. This is precisely what just happened recently at Heidelberger Druckmaschinen AG. Within the scope of the restructuring and transformation of Heidelberger Druckmaschinen AG, the sale of the Gallus Group to Benpac Holding AG for EUR 120 million was negotiated. But the buyer did not pay and the hue and cry was great. In 2020, the airline Condor experienced a similar situation when the owners of the Polish airline Lot backed out. Polish media says Condor has now filed a lawsuit against Lot for nearly EUR 56 million.
Failure to pay the agreed purchase price when the parties have agreed to sell all or part of a company is a breach of contract. The seller is entitled to demand compensation from the buyer for the incurred damage. However, the purchase agreement remains effective for the time being. For this reason, the seller cannot easily start or resume a new transaction with another interested party in this case. The seller has to set a deadline for the buyer to fulfill the contract and can only withdraw from the contract after its unsuccessful expiration. Only then the seller can move on to other interested parties and/or claim damages. Alternatively, the seller can take legal action against the buyer for execution of the purchase contract and thus for payment of the full transaction amount.
However, as a rule, the contract will no longer be executed. One reason can be that the buyer does not want the company (anymore). Another reason might be that the seller will have to continue to run and, above all, to finance the sold business until the result of any legal dispute. This is why the seller will generally declare his withdrawal from the contract and then assert claims for damages. Alongside the transaction and M&A consultancy costs for the second M&A round, these damages can primarily comprise the difference between the initially agreed purchase price and the proceeds from the second sale.
Although this may sound simple at first glance, it is often problematic in practice. It is clear that the seller has suffered a loss if he sells the company at a second attempt on worse terms. But the problem in practice is how to prove this. It is not unusual for the target to turn out worse than planned after the failed sale, in particular because the subsequent integration into the new corporate structures was expected to be different. In these cases, it is difficult to clarify whether the buyer has to pay for the damage or not.
Another example relates to so-called earn-out clauses, i.e. parts of the purchase price that depend on certain milestones and are only paid when these are reached. If such contractual provisions are present, it must be determined whether they are to be taken into account in the calculation of damages.
If the parties have not considered the possibility of a termination of negotiations or of the deal failing and have not made any arrangements for this, it will be difficult to enforce any claims for damages. This is why it is critical to ensure the greatest possible transaction security as early as the contract drafting stage. This is usually done in advance by concluding so-called break-up fees. These specify what the compensation should be at least if one of the contracting partners withdraws from the sale. Guarantees or equity commitments are also possible to secure the enforcement of claims in the event of a dispute. Ultimately, the Corona pandemic has brought into focus the use of contractual clauses that apply when a material and adverse change occurs (MAC clauses for short). These allow the contracting parties to withdraw from the contract if certain events agreed in advance in the contract arise, such as a significant deterioration in the business figures or the occurrence of other economic or even political events.
However, regardless of this the buyer of a company still has the right to renegotiate individual contractual terms even after the purchase agreement has been concluded. In practice, it is rather the exception that the contractual partner agrees to such a request. But it is not impossible in general.
Every M&A transaction is an individual case. Neither the buying nor the selling side has a fundamentally stronger negotiating power, and therefore generalizations and standards should be avoided. For this reason, it is extremely important that every sales negotiation and every purchase agreement is tailor-made. The concrete situation must be represented in the contract.