Since the beginning of the year we have seen an increase in the number of share transactions, either in the terms of M&A transactions or intercompany transactions following re-organization.
I thought that this week it would be a good idea to consider some of the potential pitfall in an M&A transaction especially regarding some popular misconceptions. For foreign investors and in this context I am thinking about those investors from common law countries the use of certain concepts and provisions may create false understanding and a sense of security in relation to sale purchase transactions. How these provisions are interpreted in Romania may on occasion differ from those familiar with the Common law practice and such provisions may be false friends.
Under Art 1170 of the New Civil Code which replaced a provision in the earlier Code agreements are interpreted in favour of the person owing the debts under a particular obligation. A provision in the original Code and which has been included into the New Civil Code provides an exception to this in relation to share sale-purchase agreements. The Code states clearly that that where a clause is unclear these are to be interpreted against the Seller whether or not the clause creates rights or obligations for the Seller. This is because there is an obligation on the Seller to explain clearly to the Purchaser all the obligations which the purchaser undertakes under the agreement as well as the general rule that all agreements must be concluded and performed in good faith.
In many cases in a transaction the Purchaser will interview and obtain information from the management of the company. When we are instructed to carry out a due diligence we take care to understand from the Client whether or not this is to be a documentary due diligence, or one based not only on documents but also on enquiries made of the management. Depending on the level of due diligence the Purchaser may have a claim against the seller for representations made by the management of the company being purchased. This places a greater duty of care on the Seller.
The Purchaser may receive substantial legal protection in view of the seller’s obligations under the law and clauses exempting the Seller of the shares in the sale/purchase agreement may be ineffective. This is because the Seller is required to act in good faith and supply clear information.
There are also warranties imposed by law which can also impact on the seller. The first is the warranty against eviction. The seller can be liable for the total or partial loses due to causes which were in existence before the transaction and claims that were not declared at the time of signing any agreements.
The courts have over the last few years extended the interpretation of these clauses to the detriment of the seller. The New Civil code has not done anything to redress the balance. Undeclared debts can in themselves seriously reduce the value of the asset and trigger a claim.
There is also an implied warranty against hidden flaws in the assets which are being purchased so that the assets cannot be used. This whilst not affecting the shares in question may seriously reduce their value. Whilst there are strict duties on the Purchaser even so the Seller must make sure that they do not fall foul of this warranty. There are no limitations on the extension of the seller’s liability for hidden flaws.
To overcome these implied warranties the parties can in certain circumstances agree other terms limiting them or excluding the implied warranties. The provisions must be expressly clearly and unambiguously in all documents.
The limitation of or exemption from such liability depends on two factors. Such a limitation or exemption is valid only if the Seller acted in good faith otherwise, the Seller is still liable under the code. Further the one-year warranty term dating from the takeover may be reduced or even eliminated, but the statute of limitation (ie, six months, increased to three years if the flaws were fraudulently concealed) may not be reduced.
When a foreign Buyer is involved common law contracts are widely used and include representations and warranties on a wide range of matters relating to the target company’s activity, assets and liabilities. Such clauses do not necessarily provide greater protection to Purchasers than the warranties against eviction and hidden flaws in the Code. Care must therefore be taken in giving instructions and at the same time in drafting any agreements.
Lawyers must be prepared to advise clients if they go beyond their legal obligations to supply information or if, on the contrary, the seller may be deemed to have failed to provide adequate information to the Purchaser.
