Breach of balance sheet guarantees
With a balance sheet guarantee, the seller assures the buyer that the (usually most recent) financial statements, as established and audited if necessary, are correct. The balance sheet ultimately reflects the net assets, financial position and results of operations of the company sold as of the last balance sheet date. Especially in so-called locked box purchase agreements, the last (often audited) balance sheet plays a decisive role in the purchase price calculation, since a purchase price adjustment to the closing date is no longer possible. In the meantime, however, there have been repeated attempts to use the balance sheet guarantee as a general fallback guarantee. Especially since the advance of the S+I insurances, the violation of the balance sheet guarantee is inflationarily brought into the field, especially if the buyer cannot claim a violation with regard to other guarantees, which would actually be thematically closer. Indeed, almost any breach of an operating warranty may have had an impact on the balance sheet.
The characteristics of a balance sheet guarantee are manifold and therefore various points can be argued about. The following topics are typically bargaining chips:
- Is it only based on the seller’s knowledge when preparing the balance sheet or on the objective factual situation?
- Is it only based on the rules for the preparation of balance sheets?
- Is a certain amount of equity insured?
Above all, however, the legal consequences of a breach of a balance sheet guarantee are disputed because the annual financial statements and the balance sheet — unlike other breaches of guarantee — always have an influence on the purchase price calculation. The main area of dispute can be summarized by the keywords “balance sheet replenishment” vs. “purchase price reduction”. The latest court rulings point dogmatically more in the direction of purchase price reduction and open up new lines of argumentation for the buy-side. However, the parties can of course also specifically regulate the legal consequences in the contract and opt for the dogmatically questionable balance sheet replenishment. The outcome will depend on the situational bargaining power of the parties. It remains to be seen to what extent the calculation of damages based on multiples, which is often ruled out at least in continental Europe, will be able to assert itself more strongly in the negotiations (at least in the case of so-called recurring EBITDA items).
On the one hand, the latest court rulings have brought clarity to how various formulations are interpreted. Therefore, care must be taken to use clear language and nuances in the formulation. A few words can make a big difference here. On the other hand, there are massive uncertainties with regard to the legal consequences of a breach of the balance sheet guarantee. Ideally, these uncertainties should be resolved directly in the purchase agreement, despite the lengthy negotiations that are likely to ensue with regard to this point, because otherwise you may end up in long post‑M&A disputes that, in case of doubt, are of no use to either party and continue to cost money.
About Daniel Wied
Dr. Daniel Wied joined ARQIS’ Munich office as a partner in 2016 and supports Christoph von Einem’s well-known venture capital practice in advising startups and venture capitalists. Mr. Wied regularly advises on company formations and financing rounds from the concept development phase to the growth phase. — Dr. Daniel Wied also specializes in mergers & acquisitions with a focus on private equity transactions (also in the real estate environment).
Daniel Wied studied at the University of Regensburg, completed his legal clerkship in Nuremberg and London, and earned his Magister iuris degree at the University of Oxford, England. From 2014 — 2015 Daniel Wied was with DLA Piper UK LLP, Munich, prior to which he was with Ashurst LLP (2013 — 2014), Munich and with Kirkland & Ellis International LLP, Munich and New York, USA (2009 — 2013).