Warren
Buffet, one of the most successful investors of all time, enriched the business
world with the concept of risk arising from lack of preparation and ignorance.
If there were only one principle that applied in the world of M&A, it would
be this one.
Therefore,
it is advisable to conduct an economic, legal, or technical review before
implementing an investment plan. In this article, we offer you a basic overview
of legal risks that purchaser should be aware of when acquiring assets (most
often business shares, stocks, or real estate).
Pitfalls of Corporate structures and documents
- Invalid previous share purchase agreement. The
fact that the signatures of the contracting parties are not certified is
sufficient to establish the invalidity of the previous share purchase agreement.
If the agreement by which your current seller acquired a ownership interest in
the company being sold is invalid, then you are negotiating and communicating
with the wrong person, because the ownership interest (which you want to
acquire) does not belong to this person (they could not acquire it on the basis
of an invalid agreement).
- The
absence of the agreement on performance of the function of a executive director.
If the company you plan om acquiring does not have contracts with its statutory
representatives (e.g., managing directors in the case of a limited liability
company), it may have costly consequences even several years later. According
to established court practice, in the absence of a written contract on the
performance of duties and its essential requirements under the Commercial Code,
a statutory representative is entitled to demand the market value of their
remuneration for the entire period during which the contract was not concluded,
which, depending on the duration and market focus of the company, can amount to
hundreds of thousands of euros. This remuneration would have to be paid by the
acquired company, and after the acquisition, the costs can essentially be
indirectly transferred to the new owner;
- Grounds
for invalidity or dissolution of a company. If the
core corporate documents have not been drawn up in the form required by law,
this is a reason for declaring the company invalid. At the same time, we would
like to point out that even often underestimated acts such as the timely filing
of financial statements in the collection of documents or proving a
relationship to the company's registered office may constitute basis for the
dissolution of a commercial company.
Observations
in relation to Real Estate
- Lack
of property acquisition documents. If you are purchasing
a building complex or larger plots of land (which are often overly fragmented),
it is advisable to have a lawyer thoroughly check whether the current seller
has purchased all the plots or buildings being sold in the past, i.e., whether
the subject matter is included, for example, in the purchase agreement (in the
form in which it was entered in the real estate cadastre). In practice, a
missing title often leads to disputes over ownership.
- Verification
of full payment of the agreed purchase price. If
the current seller has not yet paid the full purchase price for the subject of
the transfer (e.g., land), there is a risk that the former owner will withdraw
from the contract, which may result in the restoration of the original
ownership and the transfer to the purchaser may not become valid.
- Protection zones, networks and access to land. Landowners are also restricted
by protection zones. The width of a protection zone for outdoor overhead power
lines for example can be set at up to 35 meters. In this context, it is also
necessary to consider the presence of utility networks and power lines on the
land. It is prohibited to erect buildings in the protection zone. Therefore, if
you are buying land for construction, it is advisable to check the existence
and extent of protection zones in order to obtain an accurate idea of the area
that can be built on. It is also necessary to check whether there is legal
access to the land and whether utility networks are available on the land.
Usual
findings related to IP rights and market digitization
- Expired
trademarks and disputes regarding the use of trademarks and other IP. Did
you know that trademarks are valid for a limited time period? Expired
trademarks may signal a risk that the brand has lost its legal protection,
which opens up opportunities for third parties to use or register it.
- The
extent of protection of trade secrets and confidential information. While
conducting a legal review, it is advisable to examine the method and extent of
protection of trade secrets against misuse, as well as the persons that have
access to any specific manufacturing processes that represent a key competitive
advantage for the acquired company on the market.
- Analysis
of specific regimes and regulatory market behaviour. Based on the nature of the services they
provide and their market position, some companies might have to implement
mechanisms, especially for cybersecurity under the NIS 2
Directive, or for regulating digital services (especially in the context of the
Digital Services Act and the Digital Markets Act). The degree of compliance
with the obligations under this legislation should be duly considered and
assessed as part of the legal review.
Labour
Law risks
- Employment contracts without
essential details and illegal employment. In the case of employment contracts not containing
legally required information the Labour Inspectorate may impose a fine of up to
EUR 100,000. The situation is even more serious if there is no employment
relationship between the employer and the employee. This constitutes illegal
employment, for which a fine of up to EUR 200,000 may be imposed. Liability for
illegal employment also arises if the work is performed under a different type
of contract (e.g., a commercial contract – contract for work, or a civil law
contract – mandate contract, or even on the basis of a trade license), even
though the nature of the relationship indicates that it is dependent work,
which must be regulated by an employment contract or an agreement on work
performed outside of an employment relationship.
- Existence of collective
agreements. Collective agreements concluded between
employers and employee representatives may contain provisions governing mutual
rights and obligations that differ from those stipulated by law, with certain
employee benefits having a significant impact on either the company's
operations or its financial costs.
- Performance
of statutory activities (e.g., managing director of a limited liability
company) based on an employment contract. As
mentioned in the points hereabove, the company must conclude a special type of
commercial contract with the statutory representative – a Contract for the
Performance of Duties, as the statutory representative is not an employee. The coexistence
of a Contract for the Performance of Duties of an Executive and an employment
relationship must be viewed very sensitively, and it is always necessary to
consult in advance.
Other
conclusions
- Ongoing legal proceedings. In
case of a potential transaction, it is necessary to take into consideration not
only the number of court proceedings in which the seller is involved, including
the matters they concern, the value of these disputes, the predicted outcome
and associated risks for the purchaser. The existence of a legal dispute does
not necessarily mean that the transaction will fail if the seller provides the purchaser
with sufficient guarantees in the transaction documentation in the event of the
failure of the acquired company concerning the dispute.„“. Banks and credit institutions often base their
assessment of a company's creditworthiness as a debtor on the personal and
financial circumstances of the entire group of companies to which the target
company belongs. Parent companies often provide collateral for loans taken out
by their subsidiaries (e.g., guarantees, liens on the parent company's assets
in favour of the bank). Under loan agreements banks protect themselves by
requiring that they must give their consent to the sale of a subsidiary (as the
new owner may not have sufficient assets to secure the loan of the subsidiary
as a borrower). If the bank does not give its consent even though it is
required, according to the loan agreements the consequence usually is the
possibility of redeeming in the entire loan at once (the debtor loses the
benefit of instalments and must repay the entire balance of the loan in full
within a specified period).
- „Change of control“
clauses in loan agreements. Banks and credit institutions often base their
assessment of a company's creditworthiness as a debtor on the personal and
financial circumstances of the entire group of companies to which the target
company belongs. Parent companies often provide collateral for loans taken out
by their subsidiaries (e.g., guarantees, liens on the parent company's assets
in favour of the bank). Under loan agreements banks protect themselves by
requiring that they must give their consent to the sale of a subsidiary (as the
new owner may not have sufficient assets to secure the loan of the subsidiary
as a borrower). If the bank does not give its consent even though it is
required, according to the loan agreements the consequence usually is the
possibility of redeeming in the entire loan at once (the debtor loses the
benefit of instalments and must repay the entire balance of the loan in full
within a specified period).
- Conditions and permits
associated with business activities in regulated markets. If
the intended purchase is a stake in a company operating in a regulated market
(e.g., energy market, financial market, transport, etc.), it is necessary to
verify that the company has all the necessary permits required for access into
these markets. At the same time, it is important to examine whether the company
meets all specific regulatory requirements – in the case of certain violations,
sanctions amounting to several percent of turnover may be imposed.
How
to avoid mistakes?
Investing
in a high-quality legal review always pays off – whether in the form of a
better negotiating position or the certainty that the transaction will proceed
without unpleasant surprises.
This
article is only a basic overview of common risks that arise in the legal due
diligence process. It is not a comprehensive legal assessment of individual
legal issues and risks and cannot replace specific legal advice on any
individual matter.
Therefore,
we recommend consulting an expert in advance to assess possible risk areas
regarding a specific transaction or purchase.
It
is advantageous if you are guided through the purchase process by an
expert with many years of experience in various areas of transactions,
who also a guarantees the quality and reliability of the outputs from the legal
review. The backbone of the team is typically an expert in M&A
and commercial law, who ensures the timely and
correct movement of the entire legal team.
In
case you are considering investing in the purchase of an office building or
land, it is advisable to add a specialist in real estate and
construction law to your team, who will be
able to thoroughly assess the pitfalls of your prospective property.
If you
are planning to buy a company operating in the energy market, it is advisable
to seek advice from an experienced energy lawyer
who will alert you to all the significant risks associated with regulated
business.
Or if
you want to acquire a stake in a high-tech company that, for example develops
new AI software, we recommend that you consult an experienced legal specialist
in intellectual property (IP law)
and an expert in the dynamically developing field of digital
space regulation, cybersecurity, and compliance.
