I OVERVIEW OF M&A ACTIVITY
After the huge drop in deal value of more than 16 per cent in 2016, to US$3.26 trillion, the downward trend continued in 2017, albeit to a lesser extent, with a total global value of minus 3.2 per cent. Although the total global deal value fell to US$3.15 trillion, it was nevertheless the fourth year in a row in which M&A has broken the US$3 trillion barrier. Several mega-deals in December, including the acquisition of Twenty-First Century Fox Inc by the Walt Disney Company (with a value of US$68.4 billion) and the merger between CVS and Aetna meant the year ended on a high and achieved the largest monthly total of the year, at US$427.5 billion.2
By taking a look at the German market, it is evident that, despite the global decrease, the German M&A market remained steady in 2017. M&A activity with German involvement (as bidder, seller or target) stayed above the mark of US$200 billion in value. Although the number of announced deals with German involvement remained relatively constant (1,247 deals in 2016 compared to 1,256 in 2017), the average deal size decreased from US$175 million to US$166 million.
The volume of deals with German targets increased again by about 40 per cent from US$90.3 billion in 2016 to US$126.3 billion in 2017. Most notable was the merger of Linde AG and Praxair Inc (US$45.5 billion), the combining of Siemens' mobility business with Alstom SA (US$8.7 billion) and the acquisition of ista International GmbH by Sarvana S.a.r.l. (US$7.3 billion). Germany continues to be one of the most attractive target jurisdictions in Europe, with 559 inbound transactions in 2017 (France 327, Italy 301, Netherlands 270). Only the United Kingdom attracted more inbound deals, with 785 transactions in 2017.
On the other side, outbound activity of German buyers acquiring outside Germany dropped by about 40 per cent, from US$129.4 billion in 2016 to US$77.4 billion. The German outbound activity was driven by one of the top five global mega-deals of more than US$10 billion: the acquisition of Albertis Infrastructuras SA by Hochtief AG (US$39.9 billion). The acquisition of BUWOG by Vonovia (US$5,9 billion), Akron by Fresenius Kabi (US$4.8 billion) and Elenia Group by ACP (US$4.6 billion) also attracted attention. Overall, on the top 10 list of German-based companies acquiring targets in foreign countries, all acquisitions were valued at more than €1 billion.
The transaction volume of the 10 biggest transactions with German involvement increased again and reached more than US$140 billion (US$130 billion in 2016), including the US$45.5 billion takeover of Linde AG by Praxair Inc. The most active sector was the industrial products and services sector with 195 transactions worth US$25 billion, including Alstom SA's US$8.7 billion acquisition of Siemens AG (mobility business). This was followed by the services sector with 131 transactions worth US$1.3 billion. Attention should be paid to the chemicals and materials sector with just 63 transactions worth US$59.4 billion. The landmark deal in this sector was also the acquisition of Linde AG by Praxair Inc. Further active sectors were the computer software sector (120 deals with a cumulated value of US$1.6 billion) and the medical and medical pharmaceutical sector (112 deals with a cumulated value of US$19.3 billion).
The market for initial public offerings (IPOs) decreased a little in 2017 with 18 IPOs. Some of the companies that failed to list in the last quarter of 2016 recovered and achieved their goals in 2017. As an example, the German battery producer Varta successfully completed its IPOs.3 More remarkable has been the IPO of the leading global provider of online food ordering services, the Delivery Hero AG. Since the IPO in June, its success has been worth just over US$1.1 billion.4
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 Corporation. 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, 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 EU 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 of 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 benefit for the company of implementing the action clearly outweighs the interests of the shareholders.
Although the stricter prohibitions of defensive measures and the breakthrough rules under the EU 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 minority of up to 10 per cent 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 the 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 that 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 notable change to capital markets laws that has had a significant effect 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 have replaced 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 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 Directive (AIFMD).6 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 the AIFMD, the GIC contains certain de minimis provisions under which AIFMs managing AIFs below certain thresholds are exempted from full application of the GIC and are subject only to a registration rather than 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 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, if 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, if 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 of '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 continued to come from all over the world, with a strong showing of investors in 2017 from the United States, followed by Switzerland, the United Kingdom, France, the Netherlands, Sweden and China. The value of German inbound deals totalled US$109.6 billion – more than twice as much as in the previous year (US$52.1 billion). Outbound transactions by German purchasers very frequently involved the United States, followed by Britain and Italy. They reached a total value of US$38.8 billion.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
i Significant transactions
The German market is characterised by several inbound and outbound mega-deals. Among the most notable in recent years 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 and Traits and Climate Corporation platform to strengthen Bayer's position in the crop science business.
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 predominantly office portfolio of 1.4 million square metres 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 was structured as a voluntary cash public offer under German law. The offer was for the 86.5 per cent stake, Midea does not own in KUKA. The offer price was €115 in cash per share representing a 36.2 per cent premium. The consideration was funded by internal resources, and loans from Morgan Stanley and other banks. Midea does not intend for KUKA to be delisted.
Overall, the German market attracted several Chinese inbound investments, including the above-mentioned acquisition of KUKA by Midea Group, an 80 per cent stake in WindMV by Chine Three Gorges Corporation or 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 year in 2015.7 Chinese attempts to invest in German hi-tech companies abated slightly in 2017; there were no further significant acquisitions in the sector.
Partly as a reaction to the takeover by a Chinese company of KUKA, the German government tightened regulations on foreign investments in Germany to restrict non-EU acquisitions of German companies in certain industries. In particular, on 18 July 2017, an amendment to the German Foreign Trade and Payments Ordinance came into effect, which specified critical industries, introduced obligations to notify the authorities and extended applicable review periods, among other things. This amendment is part of a recent political trend towards stricter control of foreign investments, triggered in particular because of Chinese efforts to acquire German hi-tech companies. The latest amendment introduces examples of German companies whose acquisition may be considered a risk to public policy or security (and which, as a result, may be prohibited by the German Federal Ministry for Economic Affairs and Energy). These areas include the operators of critical infrastructure (energy, transport, water, IT, telecoms, finance, insurance and health), developers of software serving the operation of critical infrastructure, certain telecoms and surveillance technology companies, companies in the area of crowd computing and certain companies in the area of telematics.
ii Key trends
One of the most conspicuous trends 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, for example 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 this trend to continue. The United States economy has not yet reached its pre-crisis growth rates but is generally seen as the country with the most positive growth prospects in the developed world, once again. On the other hand, growth in Asia, specifically in China is expected to decline, which is likely to shift German investors' attention away from this region and back to the developed economies. Potential bidders in Germany, including strategic investors, continue to have full coffers so a 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 in stock prices, driven by a low interest rate on fixed income instruments, pushed price levels in the M&A market. In particular in the market for leveraged buyout transactions, the average valuations and multiples have almost reached the peak levels of the years 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 risks and accept leverage.
As far as the general market is concerned, statistics kept by St Gallen University show that there has – as in the previous year – been 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 the area of food producers, the textile industry, the energy and waste disposal industries and media. In 2015, and, to a lesser extent, in 2016 and 2017, 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 (since renamed Vonovia), which was on of the top 10 deals in 2015. As a result of a number of acquisitions, Vonovia was the first real property company to be included in the German DAX. The chemical industry also showed itself to be strong in consolidation deals, with a share of 74 per cent of all transactions in this sector involving 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 notable development that began 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 in the United States but there is a notable increase, partly driven by the same activist investors that have been active in the United States for much longer.
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, followed by the computer software sector.8
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
The availability of M&A-related financing has generally been good in 2017, given the extremely low interest environment, and competition for banks from alternative lenders such as debt funds on leveraged buyouts. Mergermarket expects activity to pick up in the upcoming quarters within high consolidating industries such as real estate, agriculture, the food industry and automotive suppliers.9
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 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 2017, 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 risks 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, has remained at 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.10
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, who 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. This trend continued in 2017. Issuers of high-yield bonds under German law 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 United States). 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 that 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 medium-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 managers 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 that 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.11
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, also affecting private equity acquisition finance, is 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 United Kingdom resulting from the open questions around the regulatory environment post-Brexit, as well as the open question of whether decisions by UK courts will still enjoy the benefit of direct enforceability under EU regulations, are generally expected to increase the attractiveness of German law credit documentation for financing acquisitions of German targets.
The new government of the United States has announced (and has already partly 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 notable developments in German employment law in 2017 that may be of relevance in an M&A context concern temporary agency workers, business transfers and minimum wage.
i Temporary agency workers
The legal position of temporary agency workers was strengthened significantly by the amendments to the German Act on Temporary Agency Work that became effective in April 2017. However, while the law resolved several previously uncertain issues, new areas of incertitude have been produced thereby.
The key changes introduced by the Act are as follows:
- a general 18-month limit on the use of individual temporary agency workers by a hirer, with re-engagement permissible after a waiting period of more than three months;
- longer maximum terms may be permitted directly through collective bargaining agreements (CBAs), or indirectly through shop agreements concluded on their basis. In fact, CBAs have already been concluded in some industries, most prominently in the metal industry, where a maximum term of 48 months for the engagement of individual temporary agency workers has been agreed upon. Employers not legally bound by CBAs may adopt the maximum length permitted under a regional CBA that applies to their industry.
Agencies may only provide workers employed by them (no chain hiring). Moreover, typical other scenarios of abuse of agency work, for example the use of agreements that on the face of it constitute service contracts, will no longer not be sanctioned: agency workers hired under an agreement that does not explicitly state that it is for agency work will be deemed employed by the hirer. This also applies if the relevant agency holds a valid permit for agency work. However, some of the edge of this change has been taken off by a 2017 precedent of the Federal Labour Court. Previously, in the event of a discrepancy between the formal denomination of an agreement and its actual implementation, for the purposes of the legal qualification of the agreement, the factual situation prevailed (i.e., if agency work was provided although a service agreement had been concluded, the agreement was legally deemed to be one for agency work). Pursuant to the recent ruling, however, this only applies if individuals legally capable of representing the parties are (1) actually aware of and (2) (at least impliedly) approve how the agreement is implemented. Otherwise, the formal denomination of the agreement will prevail.
Agency workers have to be taken into account for the thresholds for co-determination and works constitution purposes as a matter of statutory law. In this context, the Federal Labour Court has requested a preliminary ruling from the European Court of Justice (ECJ) on whether agency workers also count towards the thresholds of mass redundancy proceedings. Finally, agency workers may not be put to work in an establishment affected by a strike.
A key sanction under the Act on Temporary Agency Work is that an agency worker taken out of work in violation of the terms of employment will be deemed employed by the hirer. What is new is that agency workers may object thereto, in which case they will remain employed by the agency. Objection has to be declared in writing within one month of 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 if the agency worker is unaware of the circumstances giving rise to the beginning of the term for objection. Biding legal precedent on the question whether (contrary to the law's wording) the objection period should only begin once the agency worker is aware of the circumstances, 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. The concept of equal pay has been defined by the Federal Labour Court as meaning payment of the same aggregate compensation as paid to an employee of the hirer in the same function (i.e., who performs the same tasks) as the agency worker. If the actual function of the agency worker varies over time, separate comparisons have to be made for each function. Despite this, many aspects of what exactly constitutes equal pay remain unclear.
Finally, the Federal Labour Court has ruled on who can be an agency worker: namely, individuals who are not employees, but who perform their work under an obligation resulting from their membership in a registered association, and who are provided to a third party by that association, do constitute agency workers if, in light of the work performed by them, they are legally protected as employees. The decided case concerned nurses of the German Red Cross. On the other hand, a company's sole shareholder cannot constitute an agency worker, even if he or she is 'provided' to a third party, since he or she is not subject to his or her own company's instructions.
ii Business transfers
In the field of business transfers within the meaning of Section 613a of the German Civil Code, 2017 was another 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).
Following a preliminary ruling issued by the ECJ, the Federal Labour Court declared that the German rule, essentially binding a transferee by the content of the employment agreements of transferring employees as if it had concluded those agreements itself, was in compliance with EU law. In the decided 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.
In two other rulings, the Federal Labour Court continued to sharpen its stand on the right of an employee to object to a transfer of employment following deficient information letters: it held that forfeiture of the right to object to a transfer does not require any acts demonstrating acceptance of the transfer, provided the employee has worked for the transferee for a sufficiently long period of time following the transfer. The passage of seven years from the later of the business transfer or the expiry of the one-month objection period following receipt of the information letter was found sufficient. However, the decision also made clear that the seven-year threshold is rather strict: in the decided case, the employee's right to object was upheld even though the threshold was only about a week short of a full seven years.
Further to that, the Federal Labour Court ruled that an employee could no longer object to a transfer following an information letter failing to set out that the transferee was a newly founded company and as such liberated from the requirement to negotiate a social plan in the event of an operational change. Its key argument was that the information letter's deficit no longer affected the employment relationship as the four-year period during which the privilege was applicable had lapsed.
In other cases in the context of business transfers, the ECJ has ruled (1) that an employer has to honour times of service of transferred employees with a previous employer, except in the context of benefits to which the employee became eligible only because of the transfer (e.g., jubilee benefits under a programme introduced by the new employer), and (2) that if services transfer to a new provider, this will only constitute a business transfer if the new provider directly or indirectly takes over from its predecessor equipment that is necessary for providing those services.
iii Minimum wage
The minimum gross wage of employees across all sectors in Germany was raised to €8.84 per working hour as from 1 January 2017.
In notable decisions on the subject, the Federal Labour Court ruled that compliance with the Minimum Wage Act can be tested by multiplying the actual number of hours worked with the statutory minimum wage. The compensation paid has to be equal to or exceed that amount.
However, payments by an employer only count for the purposes of the minimum wage requirement if they (1) are made in return for work performed and (2) are unconditional and irrevocable. That is to say, payments do not count if they are made as a reward for a purpose other than the actual performance of work or for which statutory law defines a specific purpose (e.g., Section 6, Paragraph 5 of the Working Hours Act) for supplementary payments for work at night-time). Hence, the Federal Labour Court has established that, besides the base compensation, the following compensation elements in principle count towards minimum wage: supplementary payments that are performance-related, or paid for Sunday or holiday work, and service awards paid in the form of a supplementary payment per hour worked. The same goes for annual payments (e.g., a vacation bonus or a service award) that are paid in monthly instalments and payment of which is unconditional and irrevocable. Whether this also applies if the same kind of payment is made annually remains unclear. On the other hand, compensation paid for days of vacation or holiday does not count towards minimum wage claims since these are not paid in return for work performed, but rather for times in which no work is performed.
In another notable decision, the Federal Labour Court held that on-call duty, during which the employee has to stay in a certain place and it can be expected that he or she has to perform work, constitutes working time to which the Minimum Wage Act applies, and which has to be compensated accordingly.
Currently, the question is pending before the Court as to whether exclusion clauses are invalid as a whole or only in part if claims for a minimum wage are not explicitly excluded from their scope. Lower courts have decided both ways.
A number of further issues in the context of minimum wage also continue to involve material risks for an acquirer of a business in Germany: uncertainty as to the treatment of employees 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 much-debated burdensome documentation requirements on industry sectors deemed particularly prone to illicit employment remain in place.
VIII TAX LAW
From a legislative perspective, the year 2017 was overshadowed by the federal election in October 2017. After the election failed to produce a clear winning coalition, it took until the middle of March 2018 for a new government to be formed. As a result, very few major legislative initiatives that could have an impact on German M&A practice were introduced in 2017. New developments, if any, were mostly forced by court decisions and the obligation to implement the rules of the EU Anti-tax Avoidance Directive into German law. Other projects discussed in last year's edition are still pending.
i Distressed M&A
In a landmark decision delivered in February 2017, the Federal Fiscal Court ruled that a 'restructuring decree' is unconstitutional because it violates the constitutional principle of 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 on 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 that 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 Federal Fiscal Court ruled that the tax authorities were not competent to issue such a far-reaching decree and that a legislative basis in tax law was required. The legislator reacted and introduced legislation that aims to provide tax relief that is of a similar kind to the restructuring decree. However, to avoid this being classified as illegal state aid under EU law, the new legislation will only come into effect once the EU Commission has given its permission. Germany notified the EU Commission in autumn 2017 but, at the time of writing, has not yet received an answer. According to sources familiar with the proceedings, there are indications that the EU Commission might view the legislation as illegal state aid. Should this view prevail, the restructuring of German companies in the future could face significant difficulties without further legislative action.
Moreover, the German tax authorities tried to provide some form of relief by issuing a decree according to which the rules of the restructuring decree could still be applied to debt waivers implemented before and including the day on which the landmark decision of the Federal Fiscal Court had been published (8 February 2017). Even this decree was ruled to be unconstitutional in another decision by the Federal Fiscal Court to which the German tax authorities reacted by issuing yet another 'non-application decree', according to which German tax offices shall not apply the latter of the Federal Fiscal Court decisions.
ii Anti-treaty shopping rule
The ECJ ruled in December 2017 that a pre-2012 version of Germany's anti-treaty shopping rule in Section 50d, Paragraph 3 of the Income Tax Act (ITA) violates the EU Parent–Subsidiary Directive as well as the freedom of establishment principle of Article 49 of the Treaty of the Functioning of the European Union.
Section 50d, Paragraph 3 of the ITA limits the ability of foreign taxpayers to claim a relief from German withholding tax on dividends under applicable double taxation treaties or the Parent–Subsidiary Directive. The provision aims at preventing foreign taxpayers who would not otherwise be entitled to withholding tax relief to gain such relief by interposing a functionless intermediate company that is entitled to relief. The pre-2012 version of Section 50d, Paragraph 3 of the ITA therefore stipulated that a foreign company is not entitled to withholding tax relief if (1) the foreign company's shareholders would not be entitled to similar benefits had they received the taxable income directly, and (2) the foreign company lacks sufficient substance. Whether sufficient substance is present was determined by a number of substance tests. These substance tests were (and even in the current version are) rather strict. While the ECJ recognised the authority of Member States to disallow withholding tax relief on mere artificial constructs, it ruled that Section 50d, Paragraph 3 of the ITA was too broad. In particular, it criticised the substance tests for being too general and did not allow the taxpayer to prove that a certain structure was not an abuse of law, even if it nominally failed a substance test. The German Federal Ministry of Finance reacted by publishing a decree, dated 4 April 2018, according to which the current version of Section 50d, Paragraph 3 of the ITA has to be interpreted in light of the ECJ decision to the extent that the current version matches the pre-2012 version. However, this decree only applies to relief claims based on the Parent–Subsidiary Directive, not double taxation treaties. While the decree somewhat lessens the requirements for claiming withholding tax within the European Union, it also creates further uncertainty. It remains to be seen whether legislative action will be taken to bring German anti-treaty shopping rules in line with EU law.
iii German controlled foreign companies rules to be revised
As part of Germany's obligation to implement the rules of the EU Anti-tax Avoidance Directive into German law, it is also expected that the German rules on controlled foreign companies are going to be revised. However, the exact content and scope of these revisions are as yet unclear, as a first draft of the revised rules was not expected to be published until June 2018.
iv Amendment of the real estate transfer tax rules
German real estate transfer tax (RETT) becomes due not just 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:
- on 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 of the RETT Act);
- 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 of the RETT Act);
- 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 or the RETT Act); or
- 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 of the RETT Act).
The 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. The new legislation was originally expected to be introduced before the end of 2017. However, at the time of writing, draft legislation has yet to be published. As such, very little is known about its content. Nevertheless, it seems realistic that the new legislation will be introduced before the end of 2018.
IX COMPETITION LAW
In 2017, about 1,300 merger control notifications were reviewed by the 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).
The FCO cleared almost all notified transactions (more than 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 the same number of cases as in 2016. Of these 10 transactions, the acquisition of Four Artists by CTS Eventim was prohibited, whereas three transactions were cleared unconditionally and one was cleared subject to conditions and obligations.
In five cases, the parties withdrew their filings after the FCO expressed competition concerns about the transactions. The reasons for withdrawal vary. Sanitation wholesalers Cordes & Graefe and Wilhelm Gienger withdrew their filing to address the FCO's concerns by means of a 'fix it first' solution (i.e., the sale of one of Gienger's subsidiaries in the affected geographical market), allowing them to obtain Phase I clearance upon the refiling of the transaction. The FCO expressed its strong preference for 'fix it first' or 'up-front buyer' solutions (including a possible withdrawal of a pending filing in close cooperation with the FCO) in its Guidance on Remedies in Merger Control, published in May 2017. On the other hand, the FCO claims that conditions subsequent and obligations are only accepted in exceptional cases because such commitments require the toleration of negative effects on competition, for a certain period at least. The FCO's guidance paper also indicates that the FCO, which – compared to the European Commission – has so far been outspoken against behavioural remedies, may accept such commitments in the future if a divestment will be deemed an inappropriate response to the competition concerns. Nevertheless, behavioural remedies will still need to have a lasting effect on market conditions (e.g., through access to important infrastructure or technologies) and must not require continuing control by the FCO.
In other cases, the notifying undertakings decided to withdraw their filings after receiving a formal statement of objections from the FCO to avoid a prohibition decision (in the cases of the planned acquisition of Sovitec Mondial SA by Potters Industries LLC and the intended creation of a joint venture between Raiffeisen Waren-Zentrale Rhein-Main eG and Landgard Blumen & Pflanzen GmbH & Co KG). A prohibition decision would set out the FCO's competitive assessment in detail and could de facto even establish a ruling on the parties' market power in the public domain after, or even before, the transaction.
Another interesting case in 2017 has been the agreement between Lufthansa and Air Berlin regarding the wet-lease of 38 airplanes. As is common in wet-lease agreements, the responsibility for, inter alia, flight operation, crew planning and maintenance remained with the wet-lease provider, in this case Air Berlin, as did its airport slots. After the European Commission declined its jurisdiction because the wet-lease agreement did not constitute a concentration under the European Merger Control Regulation, the FCO considered whether the wet-lease agreement needed to be qualified as an acquisition of a substantial part of another undertaking's assets. Upon its substantive assessment, which did not raise any competition concerns, the FCO could ultimately leave this question open.
It remains to be seen whether the newly introduced transaction value threshold, which entered into effect on 9 June 2017 as part of the Ninth Amendment of the Act against Restraints of Competition (ARC), will further increase the number of merger control notifications. Against the background of the Facebook/WhatsApp transaction, the Ninth Amendment provides for a new Section 35, Paragraph 1a of the ARC. Transactions whereby one party generates a turnover in excess of €25 million in Germany but 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 closed a perceived regulatory gap that was widely debated in competition law circles after the Facebook/WhatsApp merger: start-ups and companies offering free 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 to draw those takeovers within the ambit of German merger control and, thus, FCO scrutiny in order to avoid any transactions that could potentially affect the German competitive landscape being implemented without control. While the legislator assumed during the consultation period that only three concentrations will be filed on a transaction value basis per year, the new 'German activities' criterion will require further interpretation. A case-by-case analysis will include raising the question whether the undertaking that does not meet the revenue threshold has a significant customer base or a large number of users in Germany (e.g., in the case of a free app) or specifically addresses the German market with a product under development that has not yet reached market maturity. The FCO has announced that guidelines addressing these questions will be published later this year to provide further guidance for the parties' self-assessment (as pre-merger consultations remain unusual in Germany).
The Ninth Amendment of the ARC contains two further important changes that are relevant for merger control: (1) according to the new Paragraph 2a of Section 18, the fact that services are offered free of charge (i.e., without a monetary payment) does not exclude that fact that there is a market (within the meaning of competition law) for these services; and (2) 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 direct and indirect network effects, multi-homing and the extent to which users may switch between platforms, economies of scale, access to relevant data and competitive pressure driven by innovation.
Generally, it has become particularly clear during the past two years that there will be a growing focus on digital economy and digital markets by the FCO. Following the 2016 Paper on 'Market Power of Platforms and Networks', the authority published a working paper on 'Big Data and Competition' in October 2017, which focuses on competition and consumer protection in the digital economy as new digital products and business models emerge that do not only concern telecommunication markets. Access to data has become the key parameter in many industries, including the energy, banking and insurance sectors.
Another important working paper, published in November 2017, focuses on innovation that poses a challenge for competition law practice. After innovation-centred theories of harm took centre stage in global merger cases (e.g., Bayer's acquisition of Monsanto or Dow's acquisition of Dupont), the FCO lays out its thoughts about the role of innovation as a competitive and often disruptive force, both in traditional industries and markets and in the digital economy.
The ARC's response to the trend towards digitisation inspires one more change destined to 'support' traditional press publishers. The Ninth Amendment to the ARC lessens the level of scrutiny over cooperation among press publishers. While the new Section 30, Paragraph 2b of the ARC does not affect the applicability of merger control provisions, it exempts certain commercial (not editorial) cooperation agreements between press publishers from the German cartel prohibition in Section 1 of the ARC. Hence, cooperation agreements may become an interesting and suitable alternative to conventional mergers or acquisitions.
Shareholders and the search for innovation continue to drive corporates towards M&A. In the first quarter of 2018, US$890.7 billion was recorded across 3,774 deals, an increase of 18 per cent on Q1 2017's value of US$754.7 billion (4,672 deals). A clear wave in deal-making in March pushed Europe's year-to-date figure to its highest post-crisis value. Activity in the first quarter achieved US$256.4 billion (through 1,409 deals), which is 21.6 per cent more than Q1 2017's already high figure of US$211 billion. This year's figures were driven by an increased number of mega-deals, with six exceeding US$10 billion, the largest of which was E.ON's US$46.6 billion acquisition of German-energy firm innogy, accounting for just under a fifth of Europe's value so far this year.12
1 Heinrich Knepper is a partner at Hengeler Mueller.
2 Figures sourced from Mergermarket, 'Global & Regional M&A Report FY 2017/Q4'.
3 Source: Mergermarket, 'European IPO Trend Report 2017'.
5 Regulation (EU) No. 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse.
6 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No. 1060/2009 and (EU) No. 1095/2010.
7 Mergermarket Database as at 26 April 2017.
8 Mergermarket Database as at 19 April 2017.
9 Mergermarket, 'Trend Report Q1 2017: Germany'.
10 Source: Thomson One Database, 'All High Yield Bonds-Domicile Nation Germany' – 2016.
11 Source: Thomson One Database, 'All Syndicated Loans, Domicile Nation Germany', 2016.
12 Source: Mergermarket, 'Global and Regional M&A Report Q1 2018'.