When analyzing mergers and acquisitions (M&A) in the European Union and related pitfalls that may arise, strategic and institutional investors should remember that, while the EU legal framework is harmonized in several fields, M&A transactions and contractual relationships in general are still very much driven by the local rules applicable in the relevant EU country. As a result, even an investor from one EU country may encounter unexpected obstacles in pursuing a transaction in another EU country with which the investor is not familiar.
This guide aims to provide examples of issues that investors may face when acquiring a company (or business) located in the EU, with the caveat that, as mentioned, the lack of harmonization across the EU may mean that certain issues are present only in some countries. Therefore, the first pitfall is that each EU country has its own nuances that may lead to surprises.
Freedom of Contract: Is This Real?
Despite decades of efforts to facilitate cross-border transactions by strengthening the principle of “freedom of contract” at an EU level, most EU countries still have stringent rules that significantly limit the parties’ ability to determine the content of an agreement or, more generally, a transaction, including in the context of inter-European M&A deals.
A purchase agreement governed by the law of an EU country (whether as the law chosen by the parties or otherwise) would be typically subject to the limitations imposed by those provisions of the legal system of such country which are mandatory and cannot be derogated by the parties. In certain EU countries such limitations may be rather stringent and impact a broad range of clauses (as specified below).
Also, the parties’ right to choose the law governing the purchase agreement in an M&A transaction in Europe, which may be seen as a way for the parties to pick a legal system which allows more freedom in determining the content of their agreement, is often constrained by the applicable rules on conflicts of laws. These rules may, in particular, prevent the parties from avoiding certain overriding mandatory substantive provisions in force in other countries, such as the country where the agreement must be enforced (in case of litigation) and, in some instances, where the transaction must be performed. Such mandatory provisions may prevail (to some extent and under certain circumstances) over any conflicting clause agreed by the parties under the relevant agreement even when the governing law chosen by the parties allows them.
In light of the above, the choice of any more flexible foreign law as the one applicable to the purchase agreement in a European M&A transaction should not in principle be seen as certainly allowing full freedom to determine the terms of such an agreement.
On the contrary, particularly in circumstances where the parties choose the law of a country that has no connections with the transaction, such choice may raise more uncertainty regarding the extent to which the law of other countries (which, in the case of an M&A deal, would likely be the country where the target is located and/or where the purchase agreement would need to be enforced) may be applied in place of the law chosen by the parties.
It is therefore customary in Europe to make purchase agreements subject to the law of the country of the target.
That being said, below are some examples of mandatory provisions often present in the legal systems of EU countries, which may prevail over anything agreed to the contrary by the parties in an M&A transaction in Europe (including, potentially, in cases where the parties have chosen a different governing law for the reasons mentioned above).
- Statute of Limitations. In M&A deals, a key element from an investor’s perspective is the ability to rely on a full set of representations and warranties given by the seller(s) on the target and its operations. These are typically subject to survivability periods, which may vary depending on the type of representation and warranty. The parties often take for granted that any survivability period they agree upon under the relevant purchase agreement would be enforceable. However, certain European jurisdictions contain stringent provisions on the statute of limitations that may, or otherwise may be deemed to, apply to the remedies for breach of representations and warranties. In such cases, if the statute of limitations expires before the end of the survivability period, the investor may face a risk that a claim made after the expiry of the statute of limitations may be deemed unenforceable in court, even if at the time of the claim the (allegedly) breached representation or warranty is still active according to the terms of the agreement. An investor should, therefore, assess whether any such risk exists in the relevant jurisdiction and, to the extent possible, carry out a global assessment of the trueness and accuracy of the representations and warranties before the statute of limitations set forth in the applicable law expires.
- Duration and Geographical Scope of Restrictive Covenants. In several jurisdictions, time and/or geographical limitations are imposed on any restrictive covenants that may be undertaken by a party. In the context of European acquisitions, this may apply to noncompete, non-solicitation, or similar post-closing covenants. The investor should carefully consider the scope of any such covenants with a view to ensuring full enforceability in accordance with the terms agreed with the seller(s).
- Knowledge. While in other jurisdictions the actual or constructive knowledge of a party may have a lower impact on the implications arising from an agreement, under the laws of several EU countries, this may actually affect the position of a party, including with respect to the remedies available to a buyer in connection with a breach of representations and warranties arising from circumstances of which the buyer was aware. Sandbagging clauses (whereby the buyer reserves the right to make a claim for breach of representations and warranties even if it was aware of such breach before the signing of the purchase agreement) may be disregarded by a court, also in light of the good faith principle that typically applies to the parties in most EU jurisdictions. When dealing with findings made by the investor and its advisors during the pre-signing phase, a safe approach would be to address them in the purchase agreement through ad hoc special indemnities whereby both parties acknowledge the identified issue, and the seller expressly takes the risk of any loss arising from such issue.
- Liquidated Damages. Several European countries have adopted civil law (as opposed to common law) systems. Purchase agreements sometimes contain “liquidated damages” clauses aimed at entitling the nonbreaching party to claim a predetermined amount as compensation for damages caused by a contractual breach of the other party, thus releasing the nonbreaching party from the burden of proof with respect to the actual damage suffered from the relevant breach. In M&A transactions, liquidated damages often are used as a remedy for the buyer in connection with a breach by the seller of certain of its obligations, such as noncompete covenants. It is worth noting that civil law systems (like those in force in some EU countries) usually allow the court to adjust (and basically reduce) the stated amount of liquidated damages when such amount is deemed to be unfair. In European acquisitions that imply the application of civil law provisions, the buyer should take into account that, when the amount of liquidated damages applicable to obligations undertaken by the seller is set at an unequitable level (also for the purposes of discouraging the seller from breaching such obligations), chances are that a breaching seller may successfully claim in court a reduction of its exposure under the “liquidated damages” clause.
- Restrictions on the Exemption from Liabilities. Purchase agreements entered into in connection with M&A deals often include clauses that limit or exclude liabilities for breach of obligations undertaken by a party thereunder. While these clauses are mainly used to protect a seller, it is not uncommon to see limitations or exclusions of liabilities of a buyer in the case of a breach of any of its undertakings. Once again, the laws of some European jurisdictions restrict the scope of such exclusions and limitations, in particular by denying their enforceability in the case of a breach arising from willful misconduct or, in some jurisdictions, gross negligence on the part of the breaching party. An investor should be advised that its obligations under the purchase agreement may expose it to liabilities (or liabilities in excess of the maximum amounts agreed by the parties) notwithstanding any contractual exclusion or limitation of its liabilities.
Regulatory Approvals: Increasing Scrutiny
In addition to the merger control clearances that may be required based on the applicable thresholds or approvals from regulators in connection with the acquisition of targets operating in regulated markets (e.g., banking, insurance, and telecommunication), EU countries have been experiencing a progressive strengthening of the scrutiny powers granted to local governmental authorities regarding acquisitions of targets operating in certain critical sectors, including the 11 critical sectors defined in the EU Critical Entities Directive (CER Directive).
Enacted in 2019, the CER Directive established a framework for the screening of foreign direct investments. However, the regulation left broad discretion to each country on its implementation. As a result, each EU country has adopted (or simply updated) its own unique screening system. Certain EU countries that had already taken a stringent approach to governmental scrutiny of foreign investments in critical sectors before the enactment of the CER Directive maintained, or even strengthened, their system.
Currently, the range of sectors and related transactions on which local governments have screening powers is often wide, and the exact perimeter is sometimes unclear, thus raising concern on whether a transaction must be disclosed to the government for the purpose of obtaining its approval. In some instances, even EU-to-EU and domestic transactions are subject to the relevant regulations and the scrutiny of the government. Also, considering that the sanctions for failing to disclose a transaction may be severe, the parties are now often inclined to notify the government and seek its approval even when the investment relates to sectors or targets that were previously deemed not critical.
An investor acquiring, or otherwise investing in, an EU target (or even a non-EU target with assets or subsidiaries in the EU) should carefully assess whether the transaction would be, or may be construed as, falling within the scope of the governmental screening and approval required under the local regulations on investments in critical sectors. Any such requirement may have an impact on the timing, as the related approval process may take months, and on the actual outcome of the transaction, in case the approval is denied or it is given with prescription by the local government.
Finally, the EU Foreign Subsidies Regulation (FSR), enacted in 2022 to address market distortions caused by foreign subsidies, has introduced a new regulatory hurdle for M&A transactions in the EU, in addition to merger control and foreign direct investment screening. Namely, M&A transactions involving a buyer and/or a target that has received a foreign financial contribution must be disclosed to and approved by the European Commission if certain conditions set forth in the regulation are met.
Financial Assistance Restrictions and Implications on the Structure of the Transactions
Legal systems in force in the EU typically contain provisions prohibiting, at least in certain instances, a target company from financing (whether through loans, securities, guarantees, or similar means) the acquisition of its own shares (or equity interests). Each country has different rules, sometimes with exceptions that are often linked to the type of transaction. Also, certain jurisdictions allow whitewash procedures whereby a target company may be allowed to provide financial assistance. On the other hand, the meaning of the term “financial assistance” is often intended to be very broad, thus including leveraged buyouts and other transactions that may indirectly result in financial support being granted by the target or its subsidiaries.
When structuring the funding of an acquisition in the EU, an investor should consider the local provisions to ensure that the funding would not constitute a violation of local laws on financial assistance.
Employees: Consultation and Protection
Protection of employees is a very sensitive issue in most European legal systems. As a result, the application of mandatory provisions relating to the employees may be triggered by the acquisition of an EU business. These may include mandatory prior consultation procedures (mostly required in connection with asset deals, but which may also apply to share deals implemented in certain jurisdictions), obligation to maintain the employees’ pre-closing status, rights of certain employees to indemnification if they (even voluntarily) leave the company after its sale, etc. Stringent limitations apply to the ability of a company to dismiss employees. An investor should not, therefore, assume that any post-closing reorganization plans that contemplate a layoff of the target’s personnel could be implemented without limitations or encumbrances. An adequate assessment of any impact that employment laws may have on the transaction should be carried out during its structuring, as they may affect timing, formalities, and costs.
Closing Formalities: Is a Notary Public Required?
In some European countries, the involvement of a notary public may be required in connection with the sale of shares (or equity interests). In such countries, the functions of the notary public include material responsibilities and authority (as a public officer) with regard to the identification and certification of the signatories, their powers, the content of the executed documents, and, to some extent, their validity under local laws. In this situation, it is necessary to liaise timely with the notary public to make sure that any documents are approved before the closing date and that any pre-closing formalities (including evidence to the notary public of the powers granted to the signatories) are duly and timely completed.
Potential Indirect Taxes
It is not uncommon that the sale of shares (or equity interests) or assets may trigger transfer taxes or similar taxes in the EU. In certain countries, such taxes may be material, as they may represent a percentage of the value of the transaction or of the underlying assets. It is worth assessing in advance any tax implications when investing in an EU company, as they may also play a role in the structuring of the acquisition.
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