I OVERVIEW OF M&A ACTIVITY
After a record year in 2015 with a total global deal value of US$3,925.9 billion, worldwide M&A activity decreased in 2016 to a total value of US$3,276.7 billion, thus dropping by over 16 per cent compared to 2015. Mega-deals continued to move the markets, including the acquisition of Time Warner by AT&T Inc, which surpassed the US$100 billion mark, as well as Bayer’s takeover of Monsanto Company (US$63.4 billion) and Sunuco Logistics Partners’ LP acquisition of Energy Transfer Partners LP (US$51.4 billion), which exceeded the US$50 billion mark.2
Looking at the German market, the picture is quite different: despite the global decrease, in 2016, the German M&A market thrived and outperformed 2015 by far. M&A activity with German involvement (as bidder, seller or target) climbed by over 70 per cent from US$128.1 billion in 2015 to US$221.4 billion in 2016. As the number of announced deals with German involvement was almost constant (1,269 deals in 2015 compared to 1,341 deals in 2016), the average deal size increased from US$101 million to US$165 million.
Deals with German targets increased by about 30 per cent from US$62.1 billion in 2015 to US$81.9 billion in 2016. Most notable was the merger of Westdeutsche Genossenschafts-Zentralbank and DZ Bank (US$19.4 billion), the investment of Chinese Midea Group in KUKA (US$4.3 billion) and the acquisition of Officefirst by Blackstone (US$3.6 billion). Germany continues to be one of the most attractive target jurisdictions in Europe, with 485 inbound transactions in 2016 (France: 280, Italy: 247, Spain: 192). Only the UK attracted more inbound deals, with 643 transactions in 2016.
In addition, outbound activity of German buyers acquiring outside Germany rose by more than 375 per cent from US$27.2 billion in 2015 to US$129.4 billion. The outbound activity was driven by several German mega-deals of more than US$5 billion: Bayer acquired Monsanto (US$63.4), Boehringer Ingelheim acquired Merial SAS (US$12.6 billion), Siemens acquired Gamesa Corporacion Tecnologica SA (US$7.5 billion), HELIOS Kliniken acquired Quironsalud (US$6.4 billion) and Hapag-Lloyd acquired UA Shipping (US$5.4 billion). In addition, the attempted merger of Deutsche Börse and the London Stock Exchange for an estimated US$14.8 billion attracted much public attention. After the Brexit vote and the intervention of the European Commission, the deal was aborted. Overall, German-based companies acquired 12 targets in foreign countries that were valued at more than €1 billion –
twice as many as 2015.
The transaction volume of the 10 biggest transactions with German involvement reached more than US$130 billion (US$53.2 billion in 2015), including the US$63.4 billion takeover of Monsanto by Bayer. The most active sector was the industrial products and services sector with 200 transactions worth US$17.7 billion, including Siemens’ US$7.5 billion acquisition of Gamesa Corporacion Technologica. This was followed by the services sector with 116 transactions worth US$5.7 billion, including the US$3.3 billion acquisition of Dematic Group by Kion Group AG. The computer software sector was in third position, yielding 86 deals and a value of US$6.5 billion. The landmark deal in this sector was the acquisition of Menthor Graphics Corporation by Siemens for US$4 billion. Further active sectors were the energy sector (70 deals with a cumulated value of US$8.1 billion) and the medical sector (68 deals with a cumulated value of US$10.6 billion).3
The market for initial public offerings (IPOs) increased in 2016 with 20 IPOs raising more than €9.5 billion (including new issues, listings, private placements, dual listings and transfers). Nine of these IPOs took place in the German Prime Standard with a total new issuing volume of more than €5.2 billion.4 2016 saw the largest IPO since 2000: innogy SE, a subsidiary of RWE AG bundling the renewables, grid and retail business, went public with a placement volume of €5 billion.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
The main source of regulation for public takeovers in Germany is the Takeover Act, as amended in 2006 to implement the EU Takeover Directive, as well as the German Stock Corporation Act, which provides the general framework of the corporate legislation pertaining to German stock corporations. In addition, provisions of the German Securities Trading Act, including provisions on the disclosure of holdings of listed securities and certain other instruments, are relevant in connection with any public takeover relating to German target companies (or, in some respects, companies with securities that are listed at a German stock exchange).
Further provisions relevant for the implementation of a public takeover and potential further steps after the completion of a takeover are set out in the German Act on Corporate Transformation, the Stock Exchange Act, the Offering Prospectus Act and the Commercial Code.
The Takeover Act creates a comprehensive legal framework that enables public takeovers to be conducted fairly and transparently. The Takeover Act is also designed to protect the financial interests of minority shareholders and employees of target companies. It contains, inter alia, provisions dealing with takeover bids and mandatory bids, including provisions on pricing and procedure, and requirements in relation to the contents of the offer document.
The Takeover Act also provides a specific squeeze-out procedure following a successful takeover bid (in addition to the general squeeze-out provisions under the German Stock Corporation Act, and in addition to the squeeze-out provisions under the German Act on Corporate Transformations) and a right of sell-out for minority shareholders following a successful takeover bid.
Pursuant to the Takeover Act, the Federal Ministry of Finance has adopted a number of regulations, one of which contains important provisions governing the contents of an offer document, the consideration payable in a takeover bid and exemptions from the obligation to make a compulsory offer.
In implementing the Takeover Directive, Germany has taken a minimalist approach, changing the existing German Takeover Act only to the extent necessary. In particular, Germany has opted out of the strict provisions of the Takeover Directive on frustrating actions that would have made such actions in hostile takeover scenarios generally subject to shareholder approval. Germany has also opted out from the breakthrough rule under the Takeover Directive that would have resulted in setting aside certain transfer restrictions and voting agreements during a takeover bid. The German non-frustration rules allow a target to take any action, including frustrating action, with the consent of its supervisory board. However, it is generally acknowledged that in giving its consent, the supervisory board is bound to authorise a frustrating action in a takeover situation only if the interest of the company to implement the action clearly outweighs the interests of the shareholders.
Although the stricter prohibitions of defensive measures and the breakthrough rules under the Takeover Directive could be opted into by German publicly listed companies, this possibility has not been used by any of the larger German corporates.
The Stock Corporation Act contains provisions relevant for all German stock corporations (both public and private), including provisions relevant to public and private takeovers of stock corporations, including those relating to the implementation of permissible defences that can be employed against hostile public takeovers, and provisions on the squeeze-out of minority shareholders by a majority shareholder (both in the case of publicly listed and private stock corporations) by a shareholder who has achieved 95 per cent or more of the shares of the corporation.
The Securities Trading Act contains provisions relating to insider dealing, which make dealing in securities based on inside information a criminal offence. It also contains provisions dealing with market price manipulation, reporting requirements for significant shareholdings and reporting obligations for listed companies regarding major new business developments; these reporting requirements for major shareholdings have been significantly extended since 2011 to include reporting obligations for holders of other instruments linked to shares.
The Act on Corporate Transformations contains the mechanics for a process of statutory merger between two German companies, which can be an alternative to a takeover offer. It also contains the most important provisions regarding corporate restructurings that could be relevant in the post-closing phase both for public and private acquisitions, including, since 2011, provisions allowing the majority shareholder of a stock corporation (which itself has to be a stock corporation holding at least 90 per cent of the registered share capital of the target company) to squeeze-out the remaining up-to-10 per cent minority by implementing a merger between the target and the shareholder (for the shareholder as surviving corporation).
The Stock Exchange Act and the Offering Prospectus Act set out the rules dealing with prospectus requirements applicable when issuing new shares as consideration for a takeover offer.
The Commercial Code provides for extensive disclosure obligations for publicly listed companies in respect of the structure of their share capital, the statutory provisions, and provisions under the company’s articles on the nomination and dismissal of members of the supervisory and management boards, and certain categories of agreements or matters that may frustrate a takeover offer, including agreements among shareholders on the exercise of voting rights and the transfer of shares (to the extent these agreements are known to the management board) and material agreements of the company providing for a change of control clause.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
A noteworthy change to the capital markets laws that will have an impact on M&A transactions on a number of levels is related to the immediate applicability in all EU Member States of the EU Market Abuse Regulation (MAR),5 effective as of 3 July 2016. The provisions of the MAR will replace a number of capital markets regulations of the individual Member States and, in many cases, significantly increase and strengthen compliance obligations. In particular, any issuers with securities that are traded at the initiative of the issuer in the regulated unofficial markets will in the future be subject to obligations to disclose inside information ad hoc, to maintain insider lists and to comply with regulations on directors’ dealings. In addition, rules restricting insider dealings and market manipulations will be significantly more strict, and potential sanctions in the case of infringements will be strengthened and more severe.
In 2013, the German legislator enacted the German Investment Code (GIC), which implemented the Alternative Investment Fund Managers Directive6 (AIFMD). The GIC applies, inter alia, to managers of ‘alternative investment funds’ (including private equity funds), and aims to reduce the risks posed by alternative investment fund managers (AIFMs) to the financial system by introducing various mandatory disclosure, corporate governance, liquidity management and other requirements. In accordance with AIFMD, the GIC contains certain de minimis provisions under which AIFMs managing AIFs below certain thresholds are exempted from the full application of the GIC, and are only subject to a registration but not a licensing requirement. The German Federal Financial Supervisory Authority (BaFin) is the regulator responsible for enforcing the provisions under the GIC.
Certain elements of the GIC are of particular relevance to private equity investors. In particular, the GIC contains a requirement for AIFMs to hold a minimum amount of capital (Section 25). For an internally managed alternative investment fund (i.e., when the management functions are performed by the governing body or any other internal manager of the fund), the minimum level is €300,000; however, for an AIFM that is an external manager to an alternative investment fund (or funds), it is €125,000. In addition, where the value of the portfolios under management exceeds €250 million, the AIFM must provide its own funds equal to 0.02 per cent of the amount in excess of €250 million. This additional capital requirement is capped at €10 million. The GIC also imposes wide-ranging disclosure obligations on AIFMs. For example, managers are required to make regular disclosures to investors, including an annual report and numerous additional disclosures, such as details of investment strategy, liquidity and risks, and the use of leverage. In addition to these disclosures to investors, managers are required to disclose to the relevant authorities details of major shareholdings in non-listed (as well as listed) companies where these holdings exceed or fall below thresholds of 10, 20, 30, 50 and 75 per cent (Section 289). These disclosure obligations are particularly onerous for private equity investors.
The GIC also provides for a restriction on ‘asset stripping’ where a private equity fund subject to regulation under the GIC has acquired control over an unlisted company or over an issuer. In particular, independent from the specific legal form of the target, any amounts available for distribution must always be determined on the basis of the annual accounts of the immediately preceding fiscal year. In the case of targets in the form of a limited liability company (the most frequent corporate form in Germany), it remains unclear (and it has so far not been decided by any court) if these restrictions impose restrictions on capital or dividend distributions in addition to the statutory restrictions under the Limited Liability Company Act, in particular the capital maintenance rules. Furthermore, the GIC restricts the repurchase of own shares by a target acquired by a fund regulated pursuant to the GIC.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
In terms of foreign involvement, the foreign bidders interested in German targets came from all over the world, with a strong showing of US and French investors, closely followed by investors from the UK, Switzerland and China. The total value of German inbound deals totalled US$52.1 billion. Outbound transactions by the German purchasers very frequently involved the United States, followed by Britain and France. They reached a total value of US$129.4 billion.7
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
i Significant transactions
The German market was characterised by several inbound and outbound mega-deals. Among the most notable are the following:
The listed German-based Bayer AG acquired US-based listed Monsanto Company for US$63.4 billion. The offer price was US$128 per share in cash, representing a premium of more than 20 per cent. The implied equity value of the transaction is US$56 billion. The deal will be financed through a combination of debt and equity, including a mandatory convertible bond and a rights issue. With this transaction, Bayer combines its broad Crop Protection product line with Monsanto’s Seeds & Traits and Climate Corporation platform to strengthen Bayer’s position in the crop science business. Closing is expected by the end of 2017.
DZ Bank AG agreed to acquire Westdeutsche Genossenschafts-Zentralbank (US$19.4 billion). DZ Bank and WGZ Bank are merging to become a cooperative central institution. All the assets of WGZ Bank will be transferred to DZ Bank. In exchange, the shareholders of WGZ Bank will get shares of DZ Bank. The agreed exchange ratio is 67.60 DZ Bank shares with an imputed nominal value of €2.60 for one WGZ Bank share with an imputed nominal value of €100. The transaction closed in August 2016.
A real estate fund of US-based Blackstone acquired Officefirst Immobilien AG, a Germany-based company engaged in office property business, from IVG Immobilien AG for US$3.6 billion. The transaction closed on 31 March 2017. Officefirst controls a 1.4 million square metre, predominantly office, portfolio in Germany.
China-based Midea Group announced a takeover offer for Germany-based and listed industrial automation company KUKA AG for US$4.3 billion. The offer will be structured as a voluntary cash public offer under German law. The offer is for the 86.5 per cent stake Midea does not own in KUKA. The offer price is €115 in cash per share, representing a 36.2 per cent premium. The consideration will be funded by internal resources and loans from Morgan Stanley and other banks. Midea does not aim at the delisting of KUKA.
Overall, the German market saw several Chinese inbound investments, including the above-mentioned acquisition of KUKA by Midea Group, the 80 per cent stake of WindMV by China Three Gorges Corporation and the acquisition of KraussMaffei Technologies by China National Chemical Corporation, Guoxin International Investment Corporation Limited and AGIC Capital. There were more Chinese investments in Q1 2016 than in the whole of 2015.8
ii Key trends
One of the most conspicuous trends we have seen is the increased interest of German strategic investors in acquiring companies in the United States and, more generally, a return of interest in targets in the Western developed world. The total volume of announced deals with German bidders and US targets was €25 billion for 2015. Compared to the previous year, German bidders are still very interested in acquiring US companies (e.g., the €2.8 billion acquisition of HERE from Nokia Oyi by a consortium including the German market leaders in the automotive industries (AUDI, BMW and Daimler)).
Analysts expect that this trend will continue. The United States economy has not yet reached its pre-crisis growth rates, but the US is once more generally seen as the country with the most positive growth prospects in the developed world. On the other hand, growth in Asia, specifically in China, is expected to decline, which will likely shift German investors’ attention away from this region and back to the developed economies. German potential bidders, including strategic investors, continue to have full coffers, so continued significant outbound investment is very likely.
Also significant is the further increase of multiples in the valuation of M&A acquisitions. The continuous increase of stock prices, driven by the low interest rate on fixed income instruments, pushed price levels in the M&A market. In particular, in the market for leveraged buy-out transactions, the average valuations and multiples have almost reached the peak levels of 2006 and 2007, which is generally seen as an expression of the dearth of suitable target companies combined with the ongoing liquidity overhang, both of which have significantly increased investors’ preparedness to take risk and accept leverage.
As far as the general market is concerned, statistics kept by St Gallen University show that there has been – as in the previous year – an increased trend towards consolidation, with transactions where the purchaser and target belong to the same sector increasing throughout the various sectors. Strong candidates for consolidation were found in the area of food producers, the textile industry, the energy and waste disposal industries and media. In 2015, there was also an increased tendency towards consolidation in the real property markets; one highlight in this sector was the takeover of Süddeutsche Wohnen by Deutsche Annington (meanwhile renamed Vonovia), which was among the top 10 deals in 2015. As a result of a number of acquisitions, Vonovia was even included in the German DAX, the first real property company ever to be so. The chemical industry also showed itself to be strong on consolidation deals, with a share of 74 per cent of all transactions in this sector involving a target and purchaser from the same sector. This tendency also underlines the increased strength of strategic bidders in the overall market, in spite of continuing low interest levels that also make transactions particularly attractive for financial investors.
Another noteworthy development that began a couple of years ago is the increased presence of activist shareholders in the German market who seek to actively influence the management of a company that they believe is underperforming or that, in the activist investors’ view, has the potential to return additional value to the shareholders. The approach is not seen as frequently as it is in the United States, but there has been a notable increase, partly driven by the same activist investors that have been active in the United States for a much longer time period.
iii Hot industries
In terms of deals in Germany, the industrial products and services sector was very frequently the target sector, followed by the services sector and the computer software sector, regarding inbound deals in Germany. With regard to German outbound deals, the industrial products and services sector and the services sector were the most sought-after sectors, followed by the computer software sector.9
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
The availability of M&A-related financing has generally been good in 2016, given the extremely low interest environment and competition for banks from alternative lenders such as debt funds on leveraged buy-outs. Mergermarket expects activity to pick up in upcoming quarters within high consolidating industries such as real estate, agriculture, the food industry or automotive suppliers.10
More stringent regulatory requirements for banks, especially in relation to capital and liquidity, resulting from the implementation of Basel III through CRD IV, CRR and related regulations, came into force in 2014 (subject to phase-in provisions over the next few years). Contrary to what may have been expected, the actual impact of these regulatory developments on the availability of syndicated bank financings (both senior tranches and, increasingly, also second lien and sometimes mezzanine tranches), both generally and for private equity investors, has been relatively limited. In particular, the increased requirements have apparently not reduced the lending capacity of banks for acquisition financings, at least where the targets were of sufficient quality. It is generally believed that this is a result of the low interest policy of the ECB, combined with an asset purchase programme of a size unseen so far, which significantly increased the liquidity in the market and thus overcompensated for any restrictive effect that the new capital and liquidity requirements might otherwise have had. Contrary to widespread expectations, the ECB has, throughout 2016, not phased out or reduced its purchase programmes in the open market; nor have any significant steps been taken towards an increase of the general interest rate level, contrary also to tendencies in the United States where the Federal Reserve has at least significantly reduced or tapered out open market purchases. In Germany in particular, these factors have been compounded by the negative real interest on German bunds, which contributed to a sustained inclination of all actors in the financial market to take risk in return for acceptable yield prospects. Competition on the syndicated lending market therefore continued to be strong.
Capital markets, in particular the high-yield bond market in Germany, have remained on a relatively low level. Only a few German-domiciled or headquartered issuers tried to tap the high-yield bond market, and some of them directly turned to the more liquid US market. Notable bond issues in 2016 included the issue by Schaeffler of a €9.5 billion corporate high-yield bond, the issue by Heidel Cement of a €752 million high-yield bond and the issue by Grenke AG of an €896 million high-yield bond on the Euromarket.11
Another factor contributing to the weak performance of the high-yield bond markets in Germany may have been a renaissance of mezzanine financings and second lien financings, as well as the availability of debt financings from debt funds, in particular unitranche financings (see below). Nevertheless, interest by investors in high-yield bond investments has remained strong, with many issues oversubscribed, in particular for issuers with a rating at the upper end of the sub-investment grade spectrum (e.g., once again – after a successful launch in 2015 – Schaeffler, which issued €9.5 billion equivalent high-yield bonds in one of the largest and most widely reported transactions of this kind in September 2016).
Despite the relative slowdown in 2016, high-yield and crossover bonds documented under German law have generally proven to be a feasible option for the financing and refinancing of private equity acquisitions. They have been successfully placed in the market in various instances as refinancing for German corporate issuers (such as HeidelbergCement, Continental, Phoenix Pharmahandel, KUKA), which shows their marketability. Issuers of German law high-yield bonds benefit in particular from two advantages: the documentation of the covenant package is in general shorter and less convoluted, but remains in substance the same as for New York law bonds, which reduces the administrative effort and operational risk for the issuer significantly; and the choice of German law and the jurisdiction of the German courts mitigates the risk of expensive US litigation (in particular in Regulation S offerings, where bonds are not sold in the US). Thus, German law high-yield bonds remain a viable alternative to New York law bonds and should also be increasingly considered in connection with private equity deals to the extent marketability of the bonds is ensured.
Finally, there has been a modest renaissance of mezzanine and second lien acquisition financings provided by banks.
As in previous years, club deal financings (mostly by banks) were also seen as a viable option in the segment of small or mid-cap transactions. They continued to be an attractive option for smaller or mid-sized acquisition financing packages, in particular given the stronger relationship of the borrower or sponsor with the financing banks, and thus the leaner post-closing communication and administration processes.
In the current environment of readily available funds at still relatively low margins, a recapitalisation through debt refinancing continues to be an attractive option, especially where a true exit may require further preparations. Even though recapitalisations pose several challenges from a legal perspective, many successfully closed transactions have shown that these can be sufficiently solved. The increase of the leverage ratio to finance the additional cash amounts taken out by the investor require diligent review and monitoring, in particular in respect of capital maintenance rules and liquidity protection rules. A violation of these rules may result in the personal liability of the management of the group companies. As with other types of financing, the refinancing documentation would usually address these issues to a certain extent (such as in respect of the capital maintenance regime) by the insertion of ‘limitation language’ limiting the liability of subsidiaries in respect of upstream and cross-stream securities granted by them. To the extent cash is upstreamed to the investors (i.e., similar to a ‘super dividend’), however, this requires additional legal and financial analysis of available capital reserves, as well as sound and solid liquidity planning to avoid personal liability risks. Additional leeway can often be created for this purpose by group restructurings, in particular where hidden reserves can be realised. Appropriate measures should also be taken to mitigate insolvency clawback risks that may arise in respect of cash upstreamed by subsidiaries to the investors if the portfolio company becomes insolvent during a hardening period that generally lasts one year. Landmark leveraged financings of German domiciled borrowers include a US$3.8 billion equivalent leveraged financing for ZF Friedrichshafen AG completed in July 2016, a US$2.8 billion equivalent leveraged loan for HSH Portfolio Management AÖR, the ‘bad bank’ of the public bank owned by the states of Hamburg and Schleswig-Holstein, a US$2.5 billion equivalent leveraged financing for Schaeffler, and a US$2.2 billion equivalent loan to Thyssen Krupp AG. Also widely noted was the successful completion of a US$1.1 billion leveraged refinancing in July 2016 by the INEOS subsidiary Styrolution.12
The trends in financial and legal terms outlined above illustrate that financing is available to those who can identify suitable opportunities to invest, and private equity investors continue to be able to raise financings on attractive terms, especially as excess liquidity is still driven by loose monetary policy and the resulting high lending capacity. Changes in financial markets that also affect private equity acquisition finance are certainly to be expected from Brexit as well as the change of government in the United States. Brexit, and the uncertainties in particular for the financial industry in the UK resulting from open questions around the regulatory environment post-Brexit as well as the open question of whether decisions of UK courts will still enjoy the benefit of direct enforceability under EU regulations, are generally expected to increase attractiveness of German law credit documentation for financing acquisitions of German targets.
The new government of the United States has announced (if not yet implemented) significant cuts in regulations for banks, in particular a partial repeal of the Dodd-Frank legislation, which may be expected to result in an increased risk appetite of at least US banks (with a potential pull effect for European institutions).
VII EMPLOYMENT LAW
The most noteworthy developments in German employment law in 2016 that may be of relevance in an M&A context concern temporary agency workers and minimum wages. Further to these, a change in the law that took effect in December 2016 now requires that the representative body for severely disabled employees must be heard prior to the termination of a disabled employee. If this is not complied with, the relevant termination will be void.13
i Temporary agency workers
The legal position of temporary agency workers has been changed significantly by substantial amendments to the German Act on Temporary Agency Work that entered into force on 1 April 2017. The law has again strengthened the position of agency workers. However, while it has resolved several previously uncertain issues, new areas of incertitude have been produced thereby.
Key changes under the law are as follows:
- a a general 18-month limit on the use of individual temporary agency workers by a hirer has been introduced;
- b re-engagement by the same hirer is only permissible after a waiting period of more than three months;
- c longer maximum terms may be permitted through collective bargaining agreements (cbas), and cbas may also permit employers to establish longer terms by way of a shop agreement. Employers not legally bound by cbas may adopt the maximum length permitted under a regional cba that applies to their industry;
- d chain hiring has been declared impermissible: agencies may only provide workers employed by themselves;
- e other typically found scenarios of abuse of agency workers, such as the use of agreements that on their face constitute service contracts, will no longer go unsanctioned;
- f differently from before, agency workers hired under an agreement that does not explicitly state that the agreement is for agency work will now be deemed to be employed by the hirer. This also applies if the relevant agency holds a valid permit for agency work; and
- g agency workers now have to be taken into account for the thresholds for co-determination and works constitution purposes as a matter of statutory law, and agency workers may not be put to work in establishments affected by a strike.
A key sanction under the law is that an agency worker taken out of work in violation of an agreement’s terms will be deemed employed by the hirer. What is new in this context is the right of the agency worker to object. If he or she does so, he or she will remain employed by the agency. The objection has to be declared in writing within one month from the beginning of a deemed employment, and presented to the Federal Labour Agency prior to delivery to the employer or the hirer. This raises issues in cases where an agency worker is unaware of the circumstances giving rise to the beginning of the term for objection. It is therefore debated among legal writers whether (contrary to the law’s wording) the objection period should only begin once the agency worker is aware of such circumstances. Biding legal precedent, this remains another area of uncertainty.
Further to the above, equal pay now has to be provided to an agency worker from the outset of his or her engagement. Cbas may provide for postponement for up to nine, or, under limited circumstances, up to 15 months. Employers not bound by cbas may adopt the rules of regional cbas for their industry. However, it remains unresolved what exactly constitutes equal pay.
ii Business transfers
In the field of business transfers within the meaning of Section 613a German Civil Code, the past year was a year of stability. The Federal Labour Court has essentially confirmed its stand on a number of previously treated items (e.g., the requirements for a business transfer).
However, just recently, in 2017, the European Court of Justice (ECJ) issued a preliminary ruling on a request by the Federal Labour Court to settle the issue of compliance with European law of the German rule that a transferee will essentially be bound by the content of the employment agreements of transferring employees as if it had concluded such agreements itself. In the underlying case, the employment agreements of transferring employees provided that the cbas of a certain industry, as amended from time to time, would be applicable to the employment relationships. The transferee was not bound by such cbas and held that the reference to such cbas could only be of static nature following the transfer. As such, the cbas would be applicable with the content they had at the time of the transfer only, and future amendments thereto would no longer have an effect on the transferred employees, the transferee’s key argument being that it had no means to influence the future content of the relevant cbas and thus should not be bound thereby.
The ECJ principally declared the rule at issue to be in accordance with the EU Directive on the approximation of the laws of the Member States relating to the safeguarding of employees’ rights in the event of transfers of undertakings, businesses or parts of undertakings or businesses, and with the right to entrepreneurial freedom pursuant to Article 16 of the EU Charter of Fundamental Rights. This was, albeit, under a precondition that national law provided for possibilities that the acquirer could make adjustments to the content of the assumed employment agreements by consensus and unilaterally. Satisfaction of this requirement was contested by the respondent in the original case, who argued that the existing roads to post-transfer adjustments under German law were not sufficiently effective to comply therewith. The ECJ left the decision thereon to the Federal Labour Court, which has yet to hand down a final ruling in the matter. It is, however, expected to declare that the European law requirements are fulfilled by German law.
iii Minimum wage
Applicable from 1 January 2017, the minimum paid gross wage of employees across all sectors in Germany has been raised to €8.84 per working hour.
In noteworthy decisions on the subject, the Federal Labour Court has decided that on-call duty constitutes working time to which the minimum wage act applies, and which has to be compensated accordingly. In addition, the Court has ruled that annual payments such as, for example, a vacation bonus, do count towards the minimum wage if they are paid in monthly instalments and payment is unconditional and irrevocable. However, beyond that, this area largely remains unclear, and lower and intermediate court precedent is inconsistent on the question of whether payments made by the employer in addition to an agreed base compensation (e.g., supplementary payments, performance-related payments or other payments) count towards the minimum hourly wage.
A number of further issues in the context of the minimum wage also continue to entail material risks for an acquirer of a business in Germany: uncertainty as to the treatment of employees working under flexible working time regimes and receiving an unvarying fixed monthly compensation remains. So does the risk that principals will not only be held responsible for a general contractor’s compliance with the minimum wage requirements, but rather for any of their subcontractors’. Finally, the burdensome documentation requirements in industry sectors deemed particularly prone to illicit employment remain in place.
VIII TAX LAW
There have been some legislative actions since the beginning of 2016 as well as some major court decisions that have had a direct impact on M&A-related aspects of German tax law. In addition, further legislative action is being considered that is of relevance to German M&A practice.
i Survival of tax loss carry-forwards in share deals
Under German tax law, a change of control can lead to a forfeiture of tax loss carry forwards. Generally, if during a period of five years more than 50 per cent of the shares in a German tax resident corporation are directly or indirectly transferred to a single party, related parties, or both, the entire unused current tax losses and tax loss carry forwards are forfeited (Section 8c Paragraph 1 Sentence 2 Corporate Income Tax Act). If, during a five-year period, more than 25 per cent but not more than 50 per cent are transferred, the tax losses and tax loss carry forwards are only forfeited on a pro rata basis corresponding to the percentage of the transferred shares (Section 8c Paragraph 1 Sentence 1 Corporate Income Tax Act).
Even if a transaction is considered to be harmful according to the general rules, unused tax losses and tax loss carry forwards continue to be available to the extent the relevant corporation has built-in gains, which, if realised, would be taxable in Germany (the ‘built-in gains rule’). Such built-in gains are calculated, broadly speaking, by subtracting the equity according to the tax balance sheet of the loss corporation from the fair market value of its shares, less any built-in gains that are not taxable or tax exempt in Germany. Since the gains from the sale of shares in a corporation are typically tax exempt at the level of the selling German corporation due to the participation exemption regime, built-in gains are disregarded insofar as they are allocable to shares in subsidiaries. This is of particular importance for mere holding companies that also act as the parent company of a German income tax group. The parent company will accumulate tax losses and tax loss carry forwards, while built-in gains will typically be allocated almost exclusively to its subsidiaries and are thus unusable for the exception. The subsidiaries themselves might have built-in gains but no losses due the tax group. As a result, the exception for built-in gains is not too helpful in cases of income tax groups.
Up until 2017, the built-in gains rule was the only way to avoid a forfeiture of tax loss carry forwards following a harmful change of control. In 2017, new legislation as well as a decision delivered by the Federal Constitutional Court provided new possibilities to retain tax loss carry forwards.
On the legislative side, a new Section 8d was introduced into the Corporate Income Tax Act. Pursuant thereto, tax loss carry forwards can, upon application, be further used after a change of control despite a lack of built-in gains, provided that the loss corporation’s business and legal structure have, broadly speaking, remained unchanged for at least three fiscal years prior to the harmful change of control and remain unchanged until the tax losses and loss carry-forwards have been eventually utilised. The new exception is mostly drafted to support start-ups and similar companies. As such, certain limitations apply. Most notably, the new exception does not apply if the loss corporation holds a participation in a partnership or is the parent company of a German income tax group. It remains to be seen to what extent the new provision will prove helpful in practice. Section 8d Corporate Income Tax Act is retroactively applicable to transactions taking place after 31 December 2015.
Additionally, the German Federal Constitutional Court ruled that Section 8c Corporate Income Tax Act is unconstitutional insofar as tax loss carry forwards are forfeited on a pro rata basis following a transfer of shares between 25 and 50 per cent. The legislator will now have to amend the law to comply with the courts’ view on the matter. While helpful in practice, the decision has two noteworthy limitations. For one, the Court explicitly did not rule on cases where more than 50 per cent of the share capital is transferred, leading to a forfeiture of all available tax loss carry forwards. It therefore remains an open legal question whether the 50 per cent threshold is constitutional. Further, the decision only applied to Section 8c Corporate Income Tax Act until 31 December 2015, because the Court argued that the introduction of Section 8d (see above), which is retroactively applicable after 31 December 2015, necessitates a separate legal analysis as it might already remedy the constitutional flaw of Section 8c. As the case at hand did not concern a tax assessment period after 31 December 2015, the Court left that question unanswered. At the time of writing, the legislator has not communicated how it will react to this court decision.
ii Distressed M&A
In a landmark decision delivered in February 2017, the Federal Fiscal Court ruled that the restructuring decree is unconstitutional because it violates the constitutional principle of the legality of administrative actions. The restructuring decree was a tool often used to recapitalise distressed companies in a tax-neutral manner. By way of background, the waiver of a loan by a third-party creditor leads to a capital gain at the level of the company subject to corporate income tax and trade tax (approximately 30 per cent). The waiver of a shareholder loan leads to a taxable capital gain to the extent the shareholder loan is impaired, which is a typical situation for distressed companies. The restructuring decree provided relief from such a tax burden if certain requirements were met, for example that the company has a positive going-concern projection.
The Court ruled that the tax authorities were not competent to issue such a far-reaching decree, and that a legislative basis in tax law is required. The legislator has reacted and introduced legislation that aims at providing a similar kind of tax relief as the restructuring decree did. Whether this is successful remains to be seen. In particular, Germany plans to formally notify the European Commission in order to ascertain that the new law does not qualify as illegal state aid under EU law. It will therefore only come into force once the Commission has given its permission.
iii Amendment of the real estate transfer tax (RETT) rules
German RETT becomes due not only upon the direct transfer of German real estate itself, but also upon certain direct or indirect transfers of shares or partnership interests in real estate-owning companies or partnerships. In particular, RETT is levied:
- a in the event of the direct or indirect transfer of 95 per cent (or more) of the interests in the assets of a real estate-owning partnership within a five-year period (Section 1 Paragraph 2a RETT Act);
- b if 95 per cent (or more) of the shares or partnership interests in a real estate-owning company are directly or indirectly transferred to a single person (including related persons) (Section 1 Paragraph 3 RETT Act);
- c if a person (including related persons) holds, as a result of a transaction, directly or indirectly 95 per cent (or more) of the shares or partnership interests in a real estate-owning company (Section 1 Paragraph 3 RETT Act); or
- d if a person holds, as a result of a transaction, a direct or indirect economic interest of 95 per cent (or more) in a real estate-owning company (Section 1 Paragraph 3a RETT Act).
The relevant threshold of 95 per cent means that, in practice, share deals are often structured in a way that manages not to trigger RETT. However, there is now a broad political consensus across party lines to amend the RETT rules with the explicit intention of capturing a larger percentage of share deals. While it is common knowledge that draft legislation is currently being prepared by experts within the tax administration, very little is known about its content. At the time of writing, the tax administration is trying to keep the exact nature of the new legislation secret in order to ensure that the market cannot adapt to the new rules to their advantage prior to the rules’ issuance. However, it is expected that structuring share deals in a RETT-neutral manner will be more difficult going forward. The new legislation is likely to be introduced before the end of 2017.
IX COMPETITION LAW
In 2016, about 1,200 merger control notifications were reviewed by the German Federal Cartel Office (FCO). Despite an increase of roughly 10 per cent compared to the previous year, the total number of notifications still remains relatively low compared to the pre-financial crisis years (2008: almost 1,700 filings; 2007: more than 2,400 filings). It is doubtful, however, whether even in the case of more M&A activity, the old level could be reached. This is because the decrease resulted not only from the financial crisis but also from the introduction of the second domestic threshold, which means that the turnover thresholds could not be met by the acquirer alone, but rather that the target needs to have a certain local nexus as well. The FCO cleared almost all notified transactions (99 per cent) within the Phase I deadline of one month, similar to previous years. Only 10 transactions raised potential competitive concerns and were reviewed in more detail (Phase II proceedings), which is one case less than in 2015. Out of these 10 transactions, one was cleared subject to conditions, and five were cleared without conditions and obligations. In four cases, the parties to the merger withdrew their notification after the FCO expressed competition concerns about the transactions.
Grocery or food retail remains a high-profile area for German competition law and its relation to M&A activities. The acquisition of Kaiser’s Tengelmann by competing grocery retailer EDEKA was among the most prominent cases in 2016, as it was in the previous year. While the deal was initially blocked by the FCO due to severe competition concerns, the Federal Ministry for Economic Affairs and Energy overruled the FCO’s decision, and cleared the transaction subject to a number of conditions primarily regarding the security of jobs. As a consequence, several of EDEKA’s competitors initiated court proceedings against this ministerial authorisation. In July 2016, the Higher Regional Court Düsseldorf granted an urgent motion by two appellants seeking to establish a suspensory effect for their appeal, thus temporarily banning the ministerial authorisation from taking effect. In its preliminary assessment, the Court pointed to a possible bias of the German Minister of Economic Affairs
and Energy as well as several substantial defects in the decision issued by his Ministry. In the end, however, the Court decision remained without consequences. In the course of the main proceedings, all appeals were withdrawn after a compromise with EDEKA was reached out of court. This compromise mainly comprised the divestment of a number of food retail outlets in Berlin, North Rhine-Westphalia and greater Munich from EDEKA to its biggest competitor, REWE. The pertinent transaction was then approved by the FCO after a Phase I review. Since the Federal Ministry for Economic Affairs and Energy considered the conditions that its decision was subject to fulfilled, the ministerial authorisation then become final and effective.
Later on, the FCO dealt with another proposed transaction in the food retail sector with similar parties but less turmoil: REWE’s planned acquisition of Coop was cleared subject to conditions. Having applied the same examination criteria as in the EDEKA/Tengelmann merger, the FCO concluded that REWE’s takeover of Coop would not result in a significant impediment of effective competition. Initial concerns of the FCO regarding eight regional markets were already resolved by respective divestments during the merger control proceedings.
A ‘cautionary tale’, albeit not in relation to substantial competition concerns, is the imposition of a fine of €90,000 on Bongrain Europe SAS (Savencia) in January 2016. The FCO imposed the fine due to Bongrain not having provided complete and correct information on a merger project, thus failing to meet a statutory obligation. In that regard, the FCO also publicly underscored that in addition to a fine, failure to meet this obligation may also result in a divestment of the merger – an important reminder that providing accurate information in merger control notifications is always crucial.
Finally, two cases regarding infrastructure markets that received considerable media attention are noteworthy. In January 2017, the FCO cleared a wet-lease agreement on 38 passenger aircraft between Lufthansa and Air Berlin. The FCO pointed out that the lease of an aircraft from a competitor is not tantamount to a merger with that competitor itself, thus warranting a different analytical framework. While the additional aircraft allow Lufthansa to expand its business, the agreement did not relate to the routes served by the two carriers or a takeover by Lufthansa of any of Air Berlin’s slots. The potential expansion therefore did not justify a prohibition of the agreement and the case was cleared. The second infrastructure merger project concerned long-distance bus operators: FlixBus’ takeover of competitor Postbus was covered broadly in the media. The parties did not cross the turnover thresholds of the German Act against Restraints of Competition (ARC), but had nevertheless informed the FCO of the merger project in advance. The authority did not intervene against the merger and only stated publicly that it had never reviewed the case due to its lack of jurisdiction over it. Still, this transaction once again highlights the importance of informal guidance procedures also for the purpose of exploring merger control notification obligations, which avoids facing unpleasant surprises later on, in particular in high-profile cases.
Despite having envisaged the end of 2016 as a likely effective date, the Ninth Amendment of the ARC is expected to enter into force only in June 2017 following delays in the consultation period. The Ninth Amendment of the ARC contains three changes which are relevant for merger control.
According to the new Paragraph 2a of Section 18 ARC, the fact that services are offered free of charge (i.e., without a monetary payment) does not exclude that there is a market (within the meaning of competition law) for these services.
Furthermore, Paragraph 3a of the same provision will complement the statutory criteria for assessing a company’s market position by factors especially relevant for multi-sided markets and networks, such as:
- a direct and indirect network effects, multi-homing and the extent to which users may switch between platforms;
- b economies of scale;
- c access to relevant data; and
- d competitive pressure driven by innovation.
Finally, and against the background of the Facebook/Whatsapp transaction, the Ninth Amendment seeks to implement an additional merger control threshold. Pursuant to Section 35 Paragraph 1a ARC, transactions whereby one party generates a turnover in excess of €25 million in Germany but where the turnover of any other party is below €5 million in Germany are now nevertheless subject to merger control if the transaction value exceeds €400 million and the target company has ‘significant activities’ in Germany. The legislator thereby seeks to close a perceived regulatory gap that was widely debated in competition law circles after the Facebook/Whatsapp merger: start-ups and companies offering free-of-charge services often simply do not generate sufficient turnover to be subject to merger control under the current regime. Hence, the new size-of-transaction test aims at drawing those takeovers within the ambit of German merger control and, thus, FCO scrutiny in order to avoid that transactions potentially impacting the German competitive landscape are implemented uncontrolled.
Generally, it has become particularly clear during the past year that there will be a growing focus on digital economy and digital markets by the FCO. In June 2016, the authority published a working paper on ‘Market Power of Platforms and Networks’, which also reflects the aforementioned changes in the Ninth Amendment of the ARC and outlines factors relevant for the assessment of the market position of platforms and networks. It is the FCO’s view that traditional tools for market definition can be ‘adjusted’ to also fit digital markets. With regard to the assessment of market power, the FCO considers competition on innovation to be relatively more important compared to competition on price due to the prevalence of comprehensive ‘free’ offers in the digital sector. Thus, absolute market shares can, in the FCO’s view, not be considered the most relevant factor for digital markets that are driven by strong innovation dynamics. This calls for a case-by-case assessment of the respective market power, considering criteria such as:
- a network effects;
- b economies of scale;
- c single-homing, multi-homing and the degree of differentiation;
- d access to data; and
- e the overall innovation potential.
As these criteria will now also become part of the law following the implementation of the Ninth Amendment of the ARC, the thoughts laid out in the working paper may gain significant practical importance for the review of ‘digital merger cases’ to come. It remains to be seen to exactly what extent the practice of the FCO will be affected by the new law, but parties to such mergers should definitely keep a keen eye on the new statutory provisions as well as the practical guidance that the FCO may present.
2017 got off to a good start: global M&A activity in Q1 2017 increased by 9 per cent to a total deal value of US$678.5 billion compared to Q1 2016 with a cumulated value of US$622.9 billion. This positive development is mainly driven by the US, with an increase of almost 20 per cent, while Europe saw a slight drop in year-on-year activity for Q1 2017 (-1.8 per cent).14
The German market started robustly into 2017: Q1 2017 yielded 281 deals with a total value of US$15.0 billion. While the number of deals was a bit lower in a year-on-year comparison (Q1 2016: 302 deals), the deal value increased (Q1 2016: US$13.5 billion). Foreign investors continued their interest in German targets, investing US$7.4 billion divided ao milliong 105 deals (Q1 2016: 101 deals with a total value of US$7.2 billion). Among the most notable deals is the takeover of Opel by PSA Group from GM. Furthermore, German outbound deals amounted to US$2.0 billion divided aong 80 deals in Q1 2017, thus increasing in number (Q1 2016: 72 deals) but decreasing in value (Q1 2016: US$3.3 billion). These figures do not yet include the announced merger of German-based Linde with US-based Praxair, the largest announced cross-border M&A transaction in 2017 so far with an estimated market capitalisation of US$65 billion. The German market sees a continued high level of PE investments.
While the German market saw a solid Q1 2017, the vote of the UK to leave the EU (Brexit), the increase in protectionist rhetoric and policies in the US and China, as well as major political events in Europe (general elections in France, the UK and Germany) and global political crises (e.g., regarding refugees, conflicts in Syria and North Korea), are causing quite significant uncertainty. While the market is still overflowing with liquidity, the battle for promising targets is becoming more fierce, as can be seen, inter alia, in the highly competitive auction for Stada in Germany at the beginning of 2017. Despite these factors of uncertainty, market participants still feel optimistic with respect to M&A activity in Germany during the remainder of the year.15
1 Heinrich Knepper is a partner at Hengeler Mueller.
2 Mergermarket Global and regional M&A: Q1 2017.
3 Mergermarket database as of 19 April 2017.
statistiken, as of 10 April 2017.
5 Regulation (EU) No. 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse.
7 Mergermarket database as of 19 April 2017.
8 Mergermarket database as of 26 April 2017.
9 Mergermarket database as of 19 April 2017
10 Mergermarket Trend Report Q1 2016: Germany.
11 Thomson One database, All High Yield Bonds-Domicile Nation Germany, 2016.
12 Thomson One database, All Syndicated Loans, Domicile Nation Germany, 2016.
13 Section 178, Paragraph 2, Phrase 3 German Social Security Code IX.
14 Mergermarket Global and regional M&A: Q1 2017
15 Mergermarket database as of 19 April 2017.