BGH tightens duties to provide information in due diligence audits to the detriment of the seller

Federal Court of Justice tightens disclosure duties in due diligence audits to the detriment of the seller; Sell-Side, therefore, shall adapt the structure and management of due diligence procedures qualitatively.

BGB § 241 para. 2, 280 para. 1, 311 para. 2

Even if the law does not recognize an obligation to examine the object of purchase before it is handed over or delivered (Section 377 I HGB -German Commercial Code-), it is a good business practice to subject it to a due diligence review (e.g., commercial, tax, legal, technical) before the acquisition of complex material and legal entities, e.g., companies, or before the acquisition of economically very significant assets, e.g., real estate. For managing directors or board members of corporations, this practice is even becoming an obligation for reasons of compliance and directors’ and officers’ liability if the object of acquisition is not of minor importance (in terms of legal or economic risks).

In due diligence reviews, the seller usually compiles data, (original) documents, and analyses relating to the purchase object in virtual data rooms at the prospective buyer’s request. Consultants commissioned by the buyer, or sometimes the buyer himself, evaluate the contents before they make the decision.

In its judgment of September 15, 2023, case no. V ZR 77/22, the BGH now had the opportunity to clarify the seller’s obligations because it is not sufficient under tort law to “only” store important information in the data room. The seller may be subject to duties of disclosure and explanation (Section 241 (2) BGB), the breach of which gives rise to claims for damages (Section 280 (1) BGB), as a contractual obligation with rights and duties does not only arise upon conclusion of the contract but upon commencement of contract negotiations or contract initiation (Section 311 (1) BGB).

What had happened?

A property transaction involved several commercial units in a large building complex. The purchase price was around €1.5 million. The purchase agreement excluded the warranty for material defects. It contained a declaration by the seller that no resolutions had been passed in the community of owners that would result in a special levy due in the future. The seller also assured that he was not aware of any further extraordinary costs outside the amount of the maintenance reserve or that any official body had decided on a further special levy. Three days before notarization, the seller had uploaded the collection of resolutions of the community of owners from the past 12 years to the data room, which was still open. This data contained a three-year-old protocol to claim payment of €50 million from the majority owner for implementing a reorganization concept that had been decided years ago. One co-owner had filed a lawsuit in this regard, which resulted in a settlement one year after the relevant sale, according to which the owners of the commercial units were to be charged a special levy of initially €750,000 and up to €50 million if required, for the refurbishment. The plaintiff was unaware of this when the property purchase agreement was notarised.

BGH recognizes the claim for damages under sec. 280 I BGB (German Civil Law Code) in conjunction with sec. 311 II, 241 II BGB!

In this case, the BGH considers a claim for damages under three aspects:

1. Due to an incorrect declaration by the seller in the purchase contractIn contract negotiations in which the parties pursue opposing interests, not every circumstance that could be disadvantageous to the other party must be disclosed. However, suppose the seller makes factual statements that could be significant for the other party’s decision to purchase. In that case, these must be correct, even if there was no obligation to disclose them. Suppose it is a declaration of knowledge or a communication of knowledge. In that case, the seller is liable for ensuring his information is correct and complete (see also BGH, the March 12, 2008 – VIII ZR 253/05 judgment, NJW 2008, 1517 para. 16).Irrespective of liability arising from subjective guarantee declarations, often found in company purchase agreements, liability for declarations of knowledge outside the guarantee catalogs can arise from the jurisdiction above. At this point, the extent to which such liability can be legally excluded should be agreed with the legal advisors.
2. Due to incorrect or incomplete answers from the seller to questions from the buyerAccording to the established case law of the BGH, a seller is obliged – again, irrespective of the existence of a duty of disclosure – to answer the buyer’s questions correctly and completely (see BGH, the judgment of June 14, 2019 – V ZR 73/18, ZfIR 2019, 846 para. 25).For this reason alone, asking sensible and adequate questions in due diligence reviews and documenting the answers is essential. The seller is responsible for the fault of the seller’s advisors following sec. 278 BGB.
3. Failure by the seller to provide information about circumstances subject to disclosureAccording to established supreme court case law, there is no general legal obligation in contract negotiations to inform the other party of all details and circumstances that could influence their decision. In principle, each negotiating party is responsible for its legal actions and must, therefore, obtain the information necessary for its own decision at its own expense and risk. However, even in contract negotiations, each contracting party is obliged to inform the other party of circumstances that could frustrate the purpose of the contract and are therefore of material importance for the other party’s decision, provided that the other party can reasonably expect to be informed in good faith, taking into account the view of the contract (see BGH, judgment of August 11, 2010 – XII ZR 192/08, NJW 2010, 3362 para. 21). Such a circumstance may also exist if it is capable of causing considerable economic damage to the contractual partner (BGH, judgment of August 11, 2010 – XII ZR 192/08, loc. cit. para. 21).

Significance for practice – duty of disclosure for electronic data rooms

The judgment is essential for the organization and use of electronic data rooms from the perspective of the selling party. It is not sufficient to supposedly disclose documents and facts by merely posting them in the data room. The seller must separately disclose to the buyer any facts that, from the seller’s point of view, are of such legal or economic relevance to the buyer that the seller must assume that the buyer will make material contract-related decisions to the detriment of the seller if he is aware of these facts. The seller must show that the buyer has gained knowledge of these facts.

Although the judgment was issued on a real estate matter, the decision can easily be applied beyond the area of real estate law to corporate contracting. To avoid liability for damages, the seller must ensure that the buyer becomes aware of such facts using suitable time and order processes concerning the data room. Electronic data rooms allow documents to be stored flexibly in terms of time and structure. From the seller’s point of view, he has to organize this process and plan much more than in the past; therefore, he requires special preparation. In particular, the seller must explain such relevant documents uploaded to the data room shortly before the contract is signed separately. The Federal Court of Justice has clarified in a ruling that the seller cannot assume in these cases that the buyer has taken note of such documents and assessed them in preparation for a contractual declaration. In any case, a breach of such disclosure duties leads to liability for damages on the seller’s part.