Draft of the Corporate Sanctions Act: Impact on transactions

Following the ministerial draft dated 22 April 2020 of the Act to Reinforce Integrity in Business, the core element of which is the Act on Sanctions for Corporate Crimes (‘Corporate Sanctions Act’), which we presented in our article on 14 May 2020, the government’s draft of 16 June 2020, which is essentially identical, has now been published. At its meeting on 18 September 2020, the upper house of the German parliament (‘Bundesrat’) endorsed the draft Act in principle and proposed only a few amendments. This is likely to lead to the introduction of the Corporate Sanctions Act in this legislative term. The following comments address the question of the impact of the proposed Corporate Sanctions Act on business transactions. A distinction must be made between the effects on a due diligence examination (I), the structuring of the transaction (II) and, finally, the provisions in a company purchase agreement (III.), in each case from the perspective of the buyer’s adviser.

I. Impact on the due diligence

1. Increase in the sanctions framework and introduction of the legality principle

The proposed Corporate Sanctions Act significantly increases the sanctions framework for large companies and groups. While the fine provided for in section 30(2), first sentence no. 1 of the Administrative Offences Act (OWiG) was capped at €10 million, that rigid ceiling is removed in section 9(2), first sentence no. 1 of the Corporate Sanctions Act. According to that rule, in the case of a corporation with an average annual turnover of more than €100 million (such average annual turnover being calculated as the worldwide turnover of the last three financial years preceding the conviction of all natural persons and corporations forming an economic unit), a flexible upper limit of 5% (for negligent acts) or 10% (for wilful acts) applies.

The draft Act has identified the principle of opportunity and the partial competence of the local administrative authorities as a major weakness of the current position in the Act on Regulatory Offences. This has led to a different likelihood of prosecution, depending on the region and the workload of the authorities. The draft Act now links the penalty to the existence of a corporate crime, so that in principle the public prosecutor’s office is competent (exceptions apply, for example, to tax offences where the tax authorities are competent and in the case of corporate crimes under antitrust law, if the antitrust authorities have initiated proceedings, section 42 of the draft Corporate Sanctions Act) and must start investigations if there is evidence (principle of legality).

As a result of this tangible threat of penalties, combined with the increased likelihood of prosecution, a compliance due diligence examination is becoming more important with regard to the detection of corporate crimes. In future it will have to be part of a compliance due diligence to ask whether the target company has publicly announced a conviction under the Corporate Sanctions Act in accordance with section 14 of the draft Corporate Sanctions Act (known as naming and shaming), unless this ‘pillory’ is removed from the text of the Act as suggested by the Bundesrat, or whether there is an entry in the register of corporate sanctions (sections 54 et seq. draft Corporate Sanctions Act).

2. Existence/establishment of an effective compliance management system

As described in our article on 14 May 2020, an efficient compliance management system (CMS) can lead to the removal of allocation of liability to the corporation pursuant to section 3(1)(2) draft Corporate Sanctions Act if corporate crimes are committed by employees or third parties, thus avoiding a penalty for the corporation. In addition, in the context of section 10(1)(1) of the draft Corporate Sanctions Act, instead of a collective fine penalty, a warning with a group fine is possible if there is an efficient CMS in place and the violation is basically an outlier. Finally, the existence or establishment of a CMS pursuant to section 15(3)(6) and (7) of the draft Corporate Sanctions Act must be taken into account when calculating the penalty for the collective fine. The existence of an efficient CMS will therefore also be the subject of a compliance due diligence under these aspects. The specific requirements for the CMS are not clear either from the draft Corporate Sanctions Act itself or from the questions and answers to the government’s draft Act published by the Federal Ministry of Justice and Consumer Protection. It is stated there that this depends on many factors, including the sector, the size of the company and the risk involved, and that it can best be assessed by the companies themselves. It remains to be seen whether, as suggested by the Bundesrat, the wording of the Corporate Sanctions Act will still express that small and medium-sized enterprises are subject to lower requirements for the CMS.

II. Transaction structure

1. Asset deal instead of share deal

To prevent what has become known as the ‘sausage loophole’ (allowing groups of companies to avoid antitrust fines by dissolving the subsidiaries concerned, originating in a case involving a cartel of sausage manufacturers), sections 6 and 7 of the draft Corporate Sanctions Act contain rules on legal succession and default liability (see also our article on 14 May 2020, part V). Under section 7(1)(2) of the draft Corporate Sanctions Act, corporations which ‘have taken over key assets of the corporation concerned and have essentially continued its activities (individual legal succession)’ may also face legal action if the transferring corporation ceases to exist after commencement of the penalty proceedings has been announced or if a penalty is unlikely to be able to be enforced. Thus if the target company has already been notified of the initiation of the penalty proceedings, the buyer may be held liable even if it acquires the target as part of an asset deal. However, it is questionable whether this also applies where the buyer acquires parts of the company which are not related to the corporate crime. It is true that the legislature regards that provision as a provision similar to the civil law concept of challenge, which is intended to extend enforcement access. However, the criteria described above, namely ‘key assets of the corporation concerned’ and ‘substantial continuation of the activity’, leave some room for interpretation, which given the criminal-law nature of the Corporate Sanctions Act should be used only restrictively.

Another aspect to be taken into account when structuring the transaction is the determination of a possible fine as described in I.1. on the basis of the worldwide group turnover of the corporation concerned. Thus, rather than as a share deal, it may make sense to deliberately structure the transaction as an asset deal in order to avoid forming an economic unit of the target company and the buyer group, which could lead to the buyer group’s worldwide turnover being used as a basis for calculation of the fine. If the assets of the target company are acquired, rather than the shares, a court will be much less likely to assume an economic unit. In the context of the buyer’s only possible default liability under section 7 of the draft Corporate Sanctions Act, only the seller group’s turnover could be taken into account in any case.

Finally, it may sometimes be a reasonable alternative to structure the transaction as an asset deal rather than as a share deal if the target company has publicly announced a conviction under the Corporate Sanctions Act in accordance with section 14 of the draft Corporate Sanctions Act and therefore its reputation has been damaged.

2. Timeline of enforcement

Calculating the corporate sanction as described in point I.1 based on the worldwide group turnover of the corporation concerned may be relevant not only for structuring the transaction as a share deal or asset deal, but also for the timing of the transaction as part of a share deal. If a large group acquires a target which is subject to penalty proceedings under the Corporate Sanctions Act from a relatively small seller entity, it may be appropriate to postpone the implementation of the acquisition such that the conviction falls before the closing date and thus the average annual turnover of the seller (group) is taken into account. Admittedly, it is doubtful whether and to what extent the buyer group’s turnover should already be taken into account in this situation. What argues against taking the buyer group’s turnover into account is, in particular, the legislator’s objective of encouraging the group to ensure uniform compliance in all its subsidiaries. However, this is not in the control of the buyer group if it was not involved in the target company at the time of the corporate crime. In the absence of explicit rules, there is thus considerable legal uncertainty in this respect.

III. Provisions in the company purchase agreement

1. Warranties

Market-standard seller guarantees in company purchase contracts concerning compliance are often limited to the seller warranting that its business has been conducted in accordance with laws, regulations and other legal provisions and administrative acts and has not infringed any rights of third parties. Due to the significant increase in the penalty framework in the draft Corporate Sanctions Act, this warranty should be extended so that all compliance measures that exclude or reduce penalties are introduced and implemented.

2. Cooperation covenants

Company purchase agreements where, as is often the case, the closing date follows the signing date (e.g. due to the need for antitrust clearance, financing, etc.) usually contain provisions governing the seller’s conduct between signing and closing. If a breach of compliance by the target company exists or is being examined, cooperation with the investigating authorities should be contractually agreed in order to benefit from a lower penalty or no penalty. Moreover, in such a case, if the court considers the cooperation to be sufficient for mitigation pursuant to section 17 of the draft Corporate Sanctions Act, the conviction may no longer be published (2nd sentence of section 18 draft Corporate Sanctions Act). This obligation to cooperate should, as far as possible, be imposed not only on the seller but also on the directors. On the other hand, this may conflict with their right to avoid self-incrimination (nemo tenetur).

3. Exemption clauses

Finally, in the case of specific suspicions of non-compliance or where an investigation has already been initiated, an exemption from the financial consequences of any penalties should be provided for in the company purchase agreement. If at all possible, it should be ensured that such an exemption not only covers the period up to closing, but also a certain period of time afterwards, in order to establish the buyer (group)’s own CMS at the target company.