Acquisition finance in Germany: overview
A Q&A guide to acquisition finance in Germany.
This Q&A is part of the global guide to acquisition finance. Areas covered include market overview and methods of acquisition, structure and procedure, acquisition vehicles, equity finance, debt finance, restrictions, lender liability, debt buy-backs, post-acquisition restructurings and proposals for reform.
Market overview and methods of acquisition
Acquisition finance market
Although the German M&A market was heavily hit in the aftermath of the financial crisis in 2007 and 2008, the market has seen significant activity since 2013. 2014 saw 112 transactions led by private equity investors, and a volume of EUR10 billion by private equity investors alone, making it one of the strongest years since the financial crisis. In 2014, M&A deal volume in Germany was reported at US$106 billion, although it was slightly lower in 2015. Besides private equity investors there has been significant activity in the real estate sector, which is seeing further consolidation and inbound investment from foreign investors into Germany. In particular, Chinese investors have shown increased activity and, even though they have so far not tended to finance transactions in the German market, this may change in future.
As a consequence of the European Central Bank reducing interest rates, acquisition finance has become cheaper and, in particular, loans for strategic investors or corporates have seen extremely attractive pricing for borrowers. In addition, very loose covenant structures have made a return. Leading arrangers in the German market include the major domestic banks such as Deutsche Bank, Commerzbank, LBBW and UniCredit, but increasingly also institutions from other European countries such as BNP and HSBC. These have shown strong activity in the German market with the aim of becoming core relationship banks for German corporates. Debt funds have shown a lot of activity in the last two years in smaller transactions, special situations and restructurings, and they will become more important going forward.
(All Market data from Ernst & Young "Private Equity Der Transaktionsmarkt in Deutschland in 2014", dialogic and Mergermarket trend report Germany Q1-Q4 2015.)
Methods of acquisition
Asset deals are not very common as the assets and liabilities to be acquired must be precisely defined in the acquisition agreement, and the transfer of assets and liabilities forming part of a business very often requires the consent of third parties such as creditors, licensors, landlords or customers. Therefore, the sale of a business unit by bigger corporations is very often structured so that, as a first step, the assets or operations to be sold are transferred by way of a hive down to a separate legal entity under the German transformation act (Umwandlungsgesetz), which often does not require the consent of third parties. The legal entity is then sold.
Acquisitions of German businesses are mainly structured as the acquisition of shares in corporations, mainly either a:
Limited liability company (Gesellschaft mit beschränkter Haftung) (GmbH).
Limited liability partnership (Kommanditgesellschaft) (KG).
Stock corporation (Aktiengesellschaft) (AG), in the case of publicly listed companies.
Real estate transactions are commonly structured as share deals, as the transfer of real estate triggers real estate transfer tax (Grunderwerbsteuer) between 3.5% and 6.5% of the price paid for the real estate (depending on the area where the real estate is located). This can be avoided if the transfer is structured as a share deal.
From a financing perspective, a share deal is preferable in secured transactions as the shares in the target can be pledged, and in case of enforcement the entire business can be sold making it commercially easier to realise value. Otherwise, there is no relevant difference between a share deal and an asset deal from a financing perspective.
Mergers as a method of acquisition are not very common but may be used for listed companies. In most cases no cash component is paid and therefore these structures are not relevant from an acquisition finance perspective.
A hybrid between a merger and a straight share acquisition that is used from time to time is the exchange of shares in the target company against cash and new shares in the acquiring company. In particular, this is used by listed companies for the acquisition of a comparably large target where the acquisition cannot be fully debt financed.
Structure and procedure
Acquisition finance is typically arranged by banks. In leveraged buy-outs (LBOs) it is also common to have vendor loans that are contractually subordinated to the bank financing. Generally, loan agreements are governed by German law (except in the case of soft-leveraged buy-outs, see Question 6, Documentation) and in larger transactions (above EUR100 million) documentation is generally in English and is based on the Loan Market Association (LMA) standard. There are only minor differences between the English law and the German law investment grade loan agreements recommended by the LMA. Subject to the credit quality and/or post acquisition leverage, the documentation will include various elements from the LMA Leverage Loan documentation. In the past it was common practice for lenders' counsel to draft the documentation in the case of corporate borrowers. However, in LBOs, which often involve US or UK sponsors and are typically governed by English law and originate in the London market, borrower's counsel often draft the documentation. Since market conditions have shifted to favour borrowers, it is now quite common in very sizable transactions for corporate borrowers' legal counsel to prepare the first draft of the mandate documents and loan agreement.
It is rare for sellers to merely accept that the acquisition is subject to financing by the purchaser. Therefore, purchasers generally secure financing when making their bid or sign the purchase agreement. Loans are generally only funded on the basis of a full loan agreement and not only on the basis of commitment papers. However, as sellers very often require from the potential purchaser a confirmation from its lenders that funds are available along with the final bid (not only in acquisitions by financial sponsors but also those by corporates), it is often seen that such financing confirmations are issued on the basis of signed commitment papers. However, this is different in the case of public takeovers where a certain funds confirmation (not a guarantee) from an independent bank must be made available to the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) (BaFin) and published in the offer document. It is common practice that such confirmation is only issued on the basis of the fully signed loan documentation.
LBO sponsors and strategic investors generally use special purpose entities as acquisition vehicles. This is normally a limited liability company (GmbH) established in Germany or purchased from a shelf company vendor. For some investments tax transparent limited liability partnerships (KGs) are used with a GmbH as general partner. The acquisition vehicle is directly held by the strategic investor or fund or, as is more commonly the case with private equity investors, through a complex structure of intermediate companies in Germany and Luxembourg designed to secure a favourable tax treatment on exit.
In a public takeover it is also common to use a vehicle incorporated as a German stock corporation (AG) or partnership limited by shares (Kommanditgesellschaft auf Aktien) (KGaA). This is because a squeeze-out of minority shareholders that have not tendered their shares is possible with a majority of 90% (otherwise the acquirer would have to hold 95% of the outstanding shares to effect a squeeze-out).
In acquisition finance for leveraged buy-outs (LBOs) it is very common for equity to be provided by the sponsor to a large extent by way of subordinated loans and only a smaller amount as real equity. German law does not provide for instruments such as Preferred Equity Certificates or Convertible Preferred Equity Certificates, although these are commonly used for the financing of LBOs at the level of Luxembourg intermediate holding companies. Acquisitions of German targets by foreign investors is very often structured using such instruments as, for tax purposes, they are treated as debt in Luxembourg and as equity in the jurisdiction of the investor, which leads to an overall preferential tax treatment.
In acquisitions by strategic investors or corporates the financing structure is very often less ambitious and additional equity is raised through the issuance of new shares. Most listed companies in Germany have authorised capital enabling the company to increase the capital by up to 10% without subscription rights for existing shareholders. Up to 10% can be placed and listed without publication of a securities prospectus.
Structures and documentation
Debt financing structures
The principal elements of the financing structure are:
A senior facility (with various tranches with different maturities) for the acquisition vehicle to finance the purchase price.
A working capital line for the target's working capital financing.
Depending on the risk profile of the acquisition, these may be supplemented by:
Second lien loans.
Payment-in-kind (PIK) financings (where interest is capitalised and deferred until final maturity).
Banks are structurally subordinated as lenders to the acquisition vehicle. The servicing of the acquisition debt relies on the income derived from the target and it is therefore very important to ensure that funds can flow upstream freely. This may appear to conflict with the interest of the banks financing the target itself, and therefore the lenders providing the acquisition debt and the working capital line should be the same. However, there are some corporate law limitations preventing a free flow of funds to the shareholder (see Questions 9 and 10).
Maturities available for the senior loans vary from two to five years, often divided into two or even more tranches with different maturity profiles (bridge or permanent financing) for loans for strategic or corporate investors. In leveraged buy-outs (LBOs), financing packages comprise five, seven and even nine-year tranches where the latter tranches are more funded by institutional investors and less by banks.
Where the timeline for the acquisition does not allow for full syndication before closing, the arrangers may underwrite the loan and bring it up for syndication after the acquisition has been completed. Alternatively, there may be bridge financing with a maturity of six to 12, or even 24 months to be taken out by the final loan, or a combination of loans, loan notes, bonds and additional equity. A bridge will have an exploding interest rate structure which significantly increases the cost of the loan if the takeout schedule is not met. Participation fees are often staggered over time and calculated on the basis of the outstanding commitments at the relevant time to create an additional incentive for a timely take-out.
Equity kickers are commonly used for seed financing or venture capital. They are not common for an LBO financing, but may occur where the leverage and risk goes beyond conventional standards and the lender (who is more likely to be a fund than a bank in such cases) is looking for additional return. An equity kicker represents a right of the financier to receive part of the equity in the borrower or the target at a later time. Since the lender is only interested in receiving a fungible equity interest, the kicker is usually released when the shares of the target become listed or are sold on to the next investor. The shares in a limited liability company (GmbH), which is the most popular form for an acquisition vehicle, can only be transferred by notarial deed and is therefore incapable of being listed. Since an equity interest in a GmbH is a very inflexible form of investment, equity kicker arrangements usually require the transformation into a stock corporation (AG). If the equity kicker is agreed at a time where the company is still private, this can be easily achieved.
As is the case in other jurisdictions, the documentation standard in Germany is dominated by the Loan Market Association (LMA) precedents. Traditionally, the drafting style for legal documents in Germany was short and concise. This has changed since the mid-90s when the UK/US documentation style became the international standard. Therefore, the most common language for the predominant part of syndicated loans is English. On rare occasions clients require German language loan agreements, for example where the borrower is a less international-orientated company with little international exposure. The dominance of English commercial law developed in many other European countries does not extend into Germany, where the majority of financings are governed by German law. In many cases, German law is chosen on specific request by the borrower, and arrangers are generally comfortable with this choice as German law has become a perfectly acceptable governing law for the syndication market as a whole. The LMA has therefore provided a German law precedent.
However, large LBO loan agreements are still predominantly governed by English law. This is not so much a question of market acceptance of German law as a governing law, but is more driven by the fact that in LBOs the relevant funds are often acting out of London with their loans arranged in London using the same set of banks and lawyers on both sides for all transactions handled by the same LBO firm, irrespective where in Europe the target of the acquisition is located. This allows the sponsors to push through their respective standards and use their existing banking relationships in a very efficient manner.
If there are multi-layered financing instruments (senior loans, second lien, mezzanine, high-yield bonds) it is common to have inter-creditor agreements that follow the core architecture of the Loan Market Association precedents. Besides the various providers of liquidity, it is common for hedging counterparties to also be party to the inter-creditor agreements in order to share in the collateral with the other lenders.
In addition to customary provisions dealing with the responsibility and protection of the security agent, inter-creditor agreements provide in particular for waterfall provisions and decision mechanisms of varying complexity for the enforcement of the collateral.
However, there is no real standard for inter-creditor agreements and they can differ from case to case. In the aftermath of the 2008 financial crisis some German corporates fell into financial difficulties and had to rearrange their debt financing through secured loans and secured bonds. In these cases, it has become common for loans and bonds to be secured on a pari passu basis (as opposed to the bank bond financings in LBOs, where the loan piece is normally senior to the bonds). As a consequence, voting arrangements between bank lenders and bond holders have been widely discussed and "one dollar one vote" seems to be the commonly chosen structure in these cases.
The developed market practice is for the rules of the inter-creditor agreements to apply to all guarantees, and not only security in rem, in order to:
Ensure equal satisfaction of all secured creditors.
Avoid enforcement of guarantees, in particular by single bondholders, interfering with an orderly workout by allowing such bondholders to potentially hold out.
The cost of the senior facility can be significantly reduced if it is supported by some form of subordinated financing. The availability of such subordinated financing depends in particular on the nature and business of the target and the acquisition structure. The higher risk for investors in subordinated debt must be compensated, and the availability, cost and size of a second rank financing, as well as its effects on the costs of the senior loan, should be carefully reviewed.
The subordination itself may take various forms, including:
Structural subordination in which the debt is provided to a vehicle upstream of the acquisition vehicle (usually its shareholder).
Secured loans with a second lien position.
Unsecured mezzanine debt.
These structures have the benefit that lenders on the lower level (closer to the "real" assets and operations) are better protected in a crisis, as they can enforce any pledges over the entities to which they have lent and leave behind the subordinated lenders.
However, structural subordination often has other adverse side effects, or may have a negative effect on pricing. Therefore, contractual subordination is very common and usually agreed in the inter-creditor agreement between the senior and the junior lenders. This subordination is only between the parties to the inter-creditor agreement. This avoids making the subordination effectively for the benefit of all other creditors such as suppliers. The terms of such inter-creditor agreements are often heavily negotiated. While the subordinated lenders will be paid only after full satisfaction of the claims of senior lenders, it is a matter of debate when subordinated lenders will have the right to accelerate their loans or bonds. Senior lenders may remain at ease for a longer time in view of the protection provided by the subordinated funds, while second ranking lenders may see the value of the acquired business deteriorate and want to interfere sooner rather than later. A compromise is very often that parties agree on standstill periods and the right of the junior lenders to buy out the senior lenders at par. There have also been cases where junior lenders have made use of such a right in a restructuring.
Customary subordination agreements only take effect between the parties, and do not avoid the obligation of a German corporation to file for insolvency because it is over indebted. To avoid over indebtedness, the contractual subordination would have to provide, among other things, that the relevant loan can in case of financial distress only be repaid once all other creditors are repaid. Such "deep" subordination is not seen in the case of third-party lenders, but can be appropriate from a lenders' perspective if the borrower is financed by shareholder loans.
Structural subordination is used as a method of structuring several layers of financing. It is generally only seen in leveraged buy-outs and not in acquisition finance for strategic investors or corporate borrowers. Senior lenders typically have a high interest in achieving structural subordination as this is more likely to avoid junior financing leading to a financial destabilisation of their borrower, as can be the case if different financing instruments are incurred at the level of the same entity and only contractually subordinated relative to each other but not to the other creditors.
Payment of principal
Inter-creditor agreements usually provide that the junior part of the financing only becomes due and payable a certain period of time after the senior loans have been repaid in full. Six months is a common period to address certain insolvency related claw-back risks for senior lenders who have been repaid. Therefore, payment of principal under the junior ranking financing instruments is usually excluded. In a waterfall provision, interest is normally paid first (after payment of cost and fees of the agents) before principal.
Inter-creditor agreements typically provide for restrictions with respect to any increase of the interest rate by the various debt providers after signing. Interest may be payable except in a default situation.
Normally, the same rules are agreed in respect to fees as for interest (see above, Interest).
Loan and inter-creditor agreements usually provide for sharing arrangements where only a specific lender has been satisfied through payments from the borrower or a guarantor, the enforcement of collateral, or (sometimes) by set-off. Under the sharing provisions, lenders which have been disproportionally satisfied must make payments to the other lenders against assignment of a proportion of their claims, in order to equalise the loss ratio of all lenders.
Subordination of equity/quasi-equity
In principle, all claims for repayment of shareholder loans are subordinated in a company's insolvency (section 39, para. 1, no. 5, Insolvency Code). All repayments made by the company under a shareholder loan within one year before the filing of insolvency proceedings can be challenged by the company's insolvency administrator (section 135, para. 1, no. 2, Insolvency Code). Exceptions apply for loans granted by shareholders who either (section 39, paras. 4, 5, Insolvency Code):
Do not participate in the management of the company and who hold an interest of 10% or less in the company's capital.
Acquired the shares in order to rescue the company from a financial crisis.
However, as the rules on equitable subordination only become relevant on the insolvency of the borrower, and before an insolvency the borrower can make payments on a shareholder loan, in complex financing structures it is common for the shareholders to agree with the other lenders that:
Any shareholder loan will be subordinated.
Except for interest generally, no payments will be made on the shareholder loan as long as any other financing instruments are still outstanding.
Extent of security
In a leveraged buy-out (LBO), lenders commonly expect to obtain:
Collateral over the shares in the main group entities (including over the shares of the companies forming the holding structure typically set up by the investor).
Asset collateral over the main entities' core assets (such as accounts, receivables, machinery, inventory, real estate and intellectual property rights), with the aim that between 75% and 90% of the asset value in accessible countries is subject to collateral. (Taking collateral over assets of subsidiaries or shares in subsidiaries in countries such as China, India or Russia is normally avoided.)
However, there is no "one size fits all" approach and collateral packages are carefully agreed on a case-by-case basis taking into account the practical value of the collateral and the cost to create and administer it. For example, some language may severely reduce the value of the relevant collateral in the hand of the lenders. As a general rule, asset collateral is very common in LBOs, while in acquisition financings for corporates (if secured at all) only the major subsidiaries and banks accounts can be pledged.
In addition, borrowers tend to avoid granting mortgages, given the cost involved, and security over intellectual property rights, which can often trigger the requirement to register the security agent with the relevant registers where the intellectual property rights are registered.
Types of security
Available security rights include:
Land charges (Grundschulden) and mortgages (Hypotheken).
Security transfers (Sicherungsübereignung).
Security assignments (Sicherungsabtretung).
While pledges and mortgages (not common in acquisition finance) are accessory in their nature (the secured party must be the holder of the secured claim) all other collateral can be held by a security agent acting as trustee for all secured parties. To achieve the same affect commercially and to use in particular the pledge over shares as collateral for bonds it is common (but not yet court tested practice) to create an independent claim for the security agent (so called parallel debt) which is then secured by the pledge and the lenders or bond holders take benefit from the pledge through the agent.
Collateral provided for the benefit of a parent or sister company (upstream or cross- stream collateral) is subject to certain restrictions. The same applies to upstream or side-stream guarantees and suretyships. The reason for this is that German corporate law has strict rules for the maintenance of registered capital to protect creditors of a company against an attempt by the shareholders to abuse the company's equity for their own purposes (see Question 9).
In a limited liability company (GmbH), documentation on upstream or cross-stream security routinely contains limitation language which provides that the secured party can only benefit from or enforce such security in an amount equal to the net assets of the relevant corporation. Net assets are essentially calculated as the amount of the assets of the company (as shown in its balance sheet drawn up for the calculation) after deducting the amount of its liabilities and its registered capital. Without such limitation language courts may hold the collateral void and the managing directors of the relevant entity and also of the parent company may run the risk of personal liability. It is also common for it to be agreed that the enforcement of upstream or side-stream security cannot deprive the security's grantor of any liquidity it requires to stay out of insolvency. The same rules apply in case of limited liability partnerships (KGs) where the general partner is a GmbH (a very common structure in Germany).
In a stock corporation (AG) the rules are even stricter (the same rules apply to a partnership limited by shares (KGaA) and a European company (Societas Europaea)). Upstream or cross-stream security is entirely forbidden, as an AG can only distribute dividends to its shareholders. The only exception is where the AG has entered into a domination agreement with its parent company. Under a domination agreement the parent company is obliged to compensate losses which the AG suffers for any reason. Before entering into a domination agreement, the management of an AG must satisfy itself that the parent will be able to provide loss compensation. This may not be the case where the parent is a highly leveraged acquisition vehicle. In addition, the domination agreement entails a certain risk of the parent or acquisition vehicle becoming insolvent. If the acquired business becomes loss-making for whatever reasons the acquisition entity must compensate such losses by payments to the dominated (target) entity in cash, and this payment obligation cannot be waived or deferred.
German law does not include any sort of corporate benefit test or whitewash procedure.
For the restrictions on financial assistance, see Question 10.
Shares. A pledge is the appropriate form of security over rights and participations in companies. Legally, the shares in a company that serve as security can be assigned to a security agent. However, an assignment is generally not advisable, as the lenders will then be treated as shareholders with the consequences that the rules on equitable subordination would apply (see Question 7). A pledge will avoid this problem.
Pledges over shares in a GmbH must be notarised in front of a German notary and the share pledge agreement must be drafted without cross references to any other finance documents to avoid these also having to be notarised. The notarial fees are set by statute, cannot be negotiated and are calculated on the basis of the value of the transaction. They can be significant (up to about EUR55,000).
Inventory. Inventory can be pledged or transferred by way of security to a security agent. However, a pledge on movable property is not common as it requires the relevant property to be handed over to the pledgee, which is impossible where the pledgor needs to continue to use the asset for its business.
Bank accounts. Rights under a bank account can be assigned to a security agent or pledged. Such a pledge only becomes effective if it is notified to the account bank. As this has certain advantages on an insolvency of the borrower (a lower haircut for the benefit of the insolvency estate) it is common for accounts to pledged.
Receivables. As a pledge of claims only becomes effective under German law if it has been notified to the third party debtor (see above), which is not practicable. In most cases, collateral over receivables is taken by way of assignment. If the receivables comprise claims against natural persons (for example, assignment of receivables from deliveries by a retail company) certain measures (such as the use of a data trustee) must be taken in order to comply with the very strict German data protection rules
Intellectual property rights. All forms of intellectual property rights (patents, trade marks, internet domains and so on) can be subject to collateral. Such rights are either pledged or assigned. This requires careful analysis of the kind of right and whether or not it is registered.
Real property. Germany has a land register system, and transfer of title to real estate and any form of land charges or other right in rem with respect to real estate requires registration (except for very specific exceptions). Therefore, due diligence with respect to real estate is very efficient and makes real estate an easily accessible collateral. In the context of acquisition finance (except in case of real estate companies) mortgages are not commonly used given the cost involved. Land charges must be established in notarised form and require registration in the land register to be valid. Land charges are usually in immediately enforceable form, meaning enforcement does not require a judgment against the land owner. This makes them a very efficient form of collateral. However, making them immediately enforceable may involve substantial notarial fees.
Movable assets. While ships and aircraft are registered and can be mortgaged like real estate, other movable assets (such as trucks or trains) can only be pledged (which requires transfer of possession and is therefore likely not practicable) or transferred by way of security to a security agent or a (single) lender. The same rules apply as with respect to inventory (see above, Inventory).
Guarantees are the common form of credit enhancement in connection with the financing of group entities. German law makes a distinction between guarantees and sureties. The latter are accessory (that is, the holder of the surety must be identical with the holder of the secured claim, and all objections the borrower may have are also available to the surety). Sureties are only used in very domestic transactions and not for acquisition finance involving, in most cases, international banks, which prefer a guarantee as a familiar instrument.
If security is shared by various creditors it is common to have a bank to act as security agent or security trustee. The security trustee holds and administers the security.
The following only relates to corporate thin capitalisation rules, and not to the tax law rules (where interest may be non-tax deductible under certain circumstances).
There are no thin capitalisation restrictions preventing a company from incurring indebtedness in excess of a certain multiple of its equity. However, the courts have denied limited liability and have pierced the corporate veil in extraordinary circumstances, such as when the capital of a company is from the very beginning not sufficient for the purpose it has been set up for. In these circumstances courts tend to assume an abuse of the corporate form and will hold the shareholders of the company directly liable for company debts. This also applies where a shareholder has not recognised the corporate body's existence by not keeping separate accounts for the company and commingling its funds with his own. However, these two scenarios are usually not relevant in the context of acquisition finance.
More relevant is a liability of the shareholder where the realisation of a security interest results in a repayment of capital (see Question 8). In addition, a shareholder may become liable if it deprives the company of liquid funds which are necessary for it to continue its business. Again, this is considered against the nature of a limited liability company. In all of these circumstances, misbehaviour by the shareholder can only be held against the bank if the bank has conspired with the shareholder to the detriment of the borrower and its other creditors.
There are no rules prohibiting financial assistance with respect to the acquisition of shares in a limited liability company (GmbH), other than the protection of its registered capital (except with respect to the acquisition of shares by a managing director). However, in a stock corporation (AG), partnership limited by shares (KGaA) or a European company the rules prohibiting financial assistance are very strict. Generally speaking, an AG (or KGaA or European company) is not allowed to support in any way the financing of the acquisition of its shares. This makes it very difficult, if not in most cases impossible, to access the assets of a target AG to support acquisition financing. In particular, an AG is not allowed to provide an upstream guarantee or an upstream loan to the acquisition vehicle if this guarantee or loan is used to secure or repay the purchase price for the shares.
There is some dispute over whether an upstream loan can be granted in connection with the refinancing of the acquisition debt. Technically, the refinance debt will not have served to acquire the shares. This technique is often used, but the residual risk that it is in violation of financial assistance rules (which may render the relevant agreements void) is hard to deny.
Another way of accessing the assets of a target AG in support of acquisition debt is a debt push-down through a downstream merger (or upstream merger of the target into the acquisition vehicle) or payment of a (debt financed) dividend by the target AG. Such special dividends are not subject to any restrictions and downstream mergers are generally possible. They are also not prohibited if the debt to be assumed by the surviving target AG stems from the acquisition of its shares. However, this structure is used rarely because in most circumstances the debt push-down would negatively affect the financial structure of the target in an unacceptable way and may also have adverse tax consequences. In addition, a downstream merger will generally be unavailable in practice if the target company is listed, as this normally triggers fierce resistance from the remaining shareholders.
Regulated and listed targets
The acquisition of a business in Germany is generally not subject to any specific legislation apart from the control of foreign investments under the Foreign Trade Regulation (Aussenwirtschaftsverordnung) under which the Federal Ministry of Economy (Bundeswirtschaftsministerium) may prohibit or restrict the acquisition by a foreign investor if and to the extent this is required to safeguard public order or national security. However, there are specific restrictions with respect to the acquisition of banks and insurance companies.
Effect on transaction
The leveraged acquisition of banks and insurance companies presents particular challenges. This is less the case where the acquirer is a strategic investor pursuing a long-term interest and is not focused on possible exit scenarios. In addition, the fit and proper test applicable to a purchaser of a 10% or larger interest in a regulated entity is easy to satisfy if that purchaser is itself a regulated member of the industry. BaFin, which now supports the European Central Bank when it comes to decisions about the acquisition of a significant interests in banks in Germany, has traditionally been quite hesitant to approve the acquisition of a bank or insurance company by a private equity fund. The concern was based on the expectation that the high leverage of the acquisition debt might harm the financial stability of the acquired business. In addition, a short investment horizon was seen as being detrimental to a long-term stable development in a sensitive environment such as the financial and insurance markets.
Specific regulatory rules
Acquisitions of shares in listed targets representing less than 30% of the aggregate outstanding shares do not present particular problems because they do not trigger any requirement to launch a mandatory takeover bid. However, if the ownership percentage in the voting held by a party crosses 3%, 5%, 10%, 15%, 20%, 25%, 30%, 50% or 75% it must notify the relevant company and BaFin accordingly.
Methods of acquisition
Shares can be acquired in bilateral transactions or via the stock exchange. However, if the purchaser intends to purchase more than 30% or even potentially all of the outstanding shares, the requirement to make a mandatory take-over offer may be triggered.
Any public offer (including a takeover offer) must be accompanied by proof that the bidder has the funds available necessary to settle the offer if it is accepted by 100% of the shareholders. Unlike other European jurisdictions such as France, Italy or Spain, certainty of funds needs not take the form of a bank guarantee or similar confirmation. In Germany, it is sufficient that an independent financial institution firm confirms to BaFin that the necessary funds are available (the confirmation is made public in the offer document to be published by the bidder). The bidder can secure the funds necessary in the form of available cash, a firm financing commitment letter or a fully documented loan. The latter is the usual way and the loan agreement will contain certain funds language to avoid lenders being able to deny funding for any reasons that are not under the full control of the bidder, as otherwise the relevant financial institution firm cannot issue the relevant confirmation that funds are available. As the relevant financial institution firm can be held liable if its confirmation proves to be wrong, it will demand that lenders give as firm a commitment as possible.
German law provides for a squeeze-out of minority shareholders against adequate cash compensation to enable a majority shareholder to acquire all of the shares in a target stock corporation (AG) if the majority shareholder has acquired at least 95% of its share capital. The squeeze-out rule applies to all AGs, whether listed or not. According to court rulings, the cash compensation cannot be below the market value of the shares. Independent auditors appointed by the court must review the adequacy of the cash compensation and the majority shareholder must provide a guarantee of a financial institution guaranteeing the payment of the cash compensation. At the motion of a minority shareholder, the adequacy of the cash compensation will be determined in special court proceedings (Spruchverfahren), which do not delay or prevent the execution of the squeeze-out.
If following a takeover offer the bidder holds at least 95% of the target company's voting share capital, the bidder has the right to file an application with the competent court for the squeeze-out of the remaining minority shareholders in a simplified procedure. If so, the consideration offered is deemed to be adequate if it equals the consideration offered in the takeover offer and at least 90% of the outstanding shares were tendered.
In addition, it is possible to squeeze out minority shareholders in connection with a merger of the target company into the bidding entity if the bidding entity holds only 90% of the shares.
Pensions granted by German companies are either directly funded by the company (that is, they are an obligation of the company for which provisions are made) or handled through insurance companies. Some companies also maintain contractual trust agreements. However, there are no pension trustees, as in other countries, that could demand additional funding or collateral to safeguard the claims of pensioners in the case of an acquisition. Therefore, from a financing perspective pensions are normally not relevant with respect the acquisition of a German entity. However, many German corporates have subsidiaries in, for instance, the UK, where issues with a pension trustee may arise as a consequence of an indirect acquisition of a UK entity and which may have to be considered in a financing context.
The concept of lenders' liability is not well-developed under German law. It has been applied by the courts in essentially only two circumstances. One is that the lender has taken control of the borrower by getting involved in daily management decisions, or by imposing third party advisers on the management to work out a crisis. These circumstances have led courts to hold that the bank has seized control of the company and behaved like a shareholder, turning the bank loan into shareholder financing that is subject to certain restrictions if the debtor files for bankruptcy. Most importantly, all payments made during the 12-month period before bankruptcy must be repaid (see Question 7). There is debate over whether a very tight covenant structure would have the same effect, especially where the list of actions requiring prior consent of the lenders is very long and not restricted to extraordinary events. There are no court precedents yet. However, the consensus among legal advisers is that a financing structure and covenant package which is in line with international market practice is not equivalent to the bank managing the company and should therefore not have any negative consequences.
The other scenario is linked to providing finance at a time where a company is on the verge of bankruptcy. If a lender knows that bankruptcy is imminent, providing further finance, for example to improve its own position, may cause other creditors to continue to deal with the company, and they may suffer a severe loss on insolvency. This behaviour is considered deceptive, and the bank may become liable to the disadvantaged creditors. To avoid this, banks that are willing to continue giving credit to a defaulted company will require a kind of independent business review or restructuring opinion confirming that the restructuring has a good chance of being successful (Sanierungsgutachten). Such an expert opinion is considered a good defence against lenders' liability in these circumstances and may often also be required by bank regulators.
Loan buy-backs by borrowers became a matter of debate in Germany when financial sponsors started to buy back loans from their troubled portfolio companies in the financial crisis. This raises a number of questions, the most important being whether a bank selling its interest in the loan to the borrower must share the proceeds with other banks under a sharing clause in the relevant agreement. In the past, sharing clauses normally did not address this issue, and it would depend on a general construction of what the parties intended. If the shareholder and not the borrower itself buys back the loan, there would be no sharing. On the other hand, if the borrower buys back its debt it is likely that a court would look at the buy-back proceeds as a repayment, with the consequence that it must be shared.
The other matter is voting rights. Where the borrower itself repurchases its debt, under general legal principles the debt will disappear and no voting rights can be exercised with respect to it. However, this is different if the repurchase takes place through a subsidiary of the borrower or its shareholder. Nevertheless, there is a general principle under German law that, when it comes to collective decisions like a vote, the party that is immediately concerned by the outcome of the vote has no voting right. This principle was developed originally with respect to companies but has been applied in other contexts. It is not certain that it would also be applied to lending syndicates, but the argument may be made.
Following the revision of the Loan Market Association standard agreements, these questions have been addressed in many recent leveraged buy-out loan agreements.
There are various ways to optimise a finance structure by post-acquisition restructuring. One is to transform a target in the form of a stock corporation (AG) into a limited liability company (GmbH). It is very difficult, if not impossible, to access the assets of an AG in support of an acquisition finance. This is because of the very strict financial assistance prohibition rules applying to an AG. Restrictions for a GmbH are significantly more relaxed, therefore, in some cases the lenders require that the target be transformed and then upstream security be given.
A transformation is only useful where the acquirer controls 100% of the shares. Otherwise, minority shareholders would become shareholders in a GmbH where they have significantly more rights and can cause disruption.
If all of the outstanding interest in the target has been purchased, a downstream merger of the acquisition vehicle into the target may be considered to improve the risk profile for the banks. Finally, it may be desirable to have the target enter into a denomination agreement which will, under certain circumstances, release the prohibition on the repayment of capital in exchange for an obligation of the dominating company to pay for any loss incurred by the dominated company.
Federal Ministry of Justice
Description. Contains an English translation of the German Limited Liabilities Companies Act and the German Insolvency Code.
Professional qualifications. German Rechtsanwalt
Areas of practice. Banking and finance; restructuring.
Non-professional qualifications. Universities of Bonn and Heidelberg, 1992; PhD on corporate law, Heidelberg; legal clerkship in Hamburg 1994 to 1996; lecturer at the Institute for Law and Finance at the Goethe-Universität Frankfurt am Main.
- IPOs of Schaeffler AG and KION GROUP AG and various financings of Schaeffler AG and KION GROUP AG.
- HeidelbergCement AG in connection with the financing of the acquisition of Italcementi.
- Acquisition of AAE AG by VTG AG and comprehensive refinancing of VTG Group.
- Financing of the acquisition of Wincor Nixdorf by Diebold.
Languages. German, English
Publications. Co-author of Münchner Kommentar zum GmbHG