Private Equity Update – ninth amendment of the German Competition Act comes into force – legal changes will substantially affect transactions

On 9 June 2017, the amendments to the German Act against Restraints of Competition (ninth amendment of the Competition Act) have come into force. The new Competition Act not only implements the EU Directive on Antitrust Damages Actions into national law but also aims at ensuring effective merger control, especially in light of increasing digitalisation in commerce. The amendments also bring with it a tightening of liability for acquirers. The numerous changes to the Competition Act will have a strong impact on transactions, making it of great significance, especially for private equity investors.

Introduction of a size-of-transaction test in merger control

The current thresholds in German merger control require, inter alia, that

• the participating companies to a transaction had total worldwide revenues of more than EUR 500 million in the last completed fiscal year and
• at least two companies had domestic revenues
  • of which one company's was more than EUR 25 million and
  • another company's more than EUR 5 million (second domestic threshold).

These thresholds did so far not catch transactions with (target) companies having rather small revenues but strong innovation potential, network effects and high purchase prices (especially start-ups and digital companies). One example is Facebook's acquisition of WhatsApp, which was not subject to a notification requirement in Germany although the purchase price amounted to USD 19 billion. On this occasion, an additional threshold based on the transaction value is now in effect. According to this threshold, a transaction needs to be notified also if

• thresholds are reached (except for the second domestic threshold) and
• the value of the consideration for the merger is more than EUR 400 million and
• the company to be acquired operates domestically to a significant extent.

The term "consideration" includes all assets and other monetary consideration (purchase price) as well as liabilities that the acquirer. According to the legislative materials for the new Competition Act, the term "consideration" is to be interpreted broadly. It includes in any consideration that is contingent on subsequent fulfilment of certain conditions ("earn-out" clauses). In addition, depending on the particular case reinvestments for acquiring parties granted at a discount ("sweet equity") may also have to be considered.

The new German threshold based on transaction value is higher than the thresholds in other jurisdictions (e.g. USA: USD 80.8 million for merging parties of a certain size or USD 323 million as a "stand alone" transaction-value-based threshold). Thus, the amendment is further not to be expected to become an "anti-exit law".

Increased liability risks for acquirers due to introduction of "group liability"

While applicable EU law already provides that any "economic entity" operating in the market, in particular group structures, but also private equity investors, can be liable for antitrust law infringements (e.g. Goldman Sachs/Prysmian Cable & Systems, High-voltage cable cartel, 2014), according to German law up to now, as a general principle only the legal entity acting itself has been held liable (known as the “legal entity principle”). For the purpose of harmonisation with EU law and especially to ensure that it is no longer possible in Germany to circumvent liability by selling or restructuring subsidiaries, the number of parties that can be held liable to pay fines is increased. Controlling parent companies, universal successors and commercial successors will be subject to liability.

This means that acquirers should focus even more on liability risks in the future. Thus, contractual protection mechanisms (particularly reps & warranties) will become even more important. Especially within competitive auction processes, warranties in the acquisition agreements will typically not be able to provide sufficient protection for the acquirer, because sellers are further expected to insist on usual limitations of liability (e.g. through knowledge qualifications, short periods of limitation, liability caps, etc.).

Continued increasing significance of antitrust due diligence and compliance

Against this background, the implementation of a risk-adjusted due diligence investigation under antitrust law and the structuring of the transaction (particularly carve-outs, internal equitability rules, warranties, indemnities, etc.) will continue to gain significance for acquirers. The scope of a due diligence investigation in an antitrust law context will need to be determined depending on, inter alia, previous / current antitrust proceedings, market structures and existing compliance programmes.

In addition, post-merger compliance measures should be part of the toolbox. These include not only employee training but also internal screenings of the acquired companies at a depth that is regularly impossible during the auction process (post-closing audit). “eSearch” is a proven tool in order to keep this efficient. If an antitrust infringement is discovered, discontinuation measures can be taken and risks can be averted. Depending on the individual case, it is important to consider applying for leniency and cooperating with competition authorities to gain immunity from or at least a reduction in fines.

Conducting an antitrust due diligence investigation and introducing compliance programmes in general does not result in lower fines. However, it provides a different basis for arguing and negotiating with competition authorities if adequate measures have been taken to avoid and to disclose antitrust infringements. If fines cannot be fended off, at least the amount of the fine can be reduced if the commercial situation has changed due to the acquisition of the company by a third party during or after the antitrust infringement. Thus, when a company involved in a cartel is acquired, according to the legislator's intention at least the basis for setting the amount of the fine should not be the entire revenue of the new group of companies.