A Seller’s Duty of Disclosure and Virtual Data Rooms in M&A Deals: German Supreme Court Provides Guidance

The German Supreme Court has outlined the duties of sellers to disclose information to purchasers using virtual data rooms, a common practice in M&A deals.

The court held that a seller had the burden of proving that a purchaser obtained actual knowledge of material risks attached to a target. The decision came in a case related to the sale of a commercial real estate, but it is safe to assume that the legal principles stipulated by the court will also apply in M&A settings more broadly.

Sellers’ Disclosure Requirements: What the Court Ruled

The judges made a number of statements concerning disclosure requirements during a transaction process as well as about the use of a virtual data room. They:

• Emphasized that each seller was under an obligation to disclose material facts and circumstances – information a prudent businessperson would expect to consider when making the decision to purchase the target.
• Stressed that a seller cannot assume that a purchaser will make a thorough due diligence and discover potential issues in a host of documents and data.
  • The court said the specific circumstances in each transaction would determine whether the purchaser was aware of all relevant information.
  • Relevant factors could include the purchaser’s business experience and whether outside counsel advised the purchaser during due diligence.

What Sellers Should Consider Doing in Light of the Decision

The judges in this case placed the burden of proof on the seller to communicate core facts to the purchaser. A late uploading of relevant documents into a virtual data room without any additional information to purchaser will, in general, not meet that threshold.

A seller providing documents and information by way of a virtual data room has to make sure the purchaser becomes aware of all circumstances requiring disclosure. To do that, sellers should consider:

• Structuring and organizing a data room effectively.
• Notifying the purchaser of newly uploaded documents.
• Giving a purchaser sufficient time to review material.

Context: More Detail on the Case

In the case at hand, a dispute arose with regard to the disclosure of facts related to the condition of the target, specifically the risks in connection with an imminent restoration and improvement of the real estate.

The seller argued that the purchaser had been aware of the need and scope of the upcoming works as minutes of a meeting discussing these topics had been included into the virtual data room a few days prior to the signing of the transaction. The purchaser denied knowing about the risks and said it did not have enough time to review the minutes included into the data room.

The District Court and the Court of Appeals ruled in favor of the seller, but the Supreme Court reversed these decisions.  The judges emphasized a seller can only fulfil its duty of disclosure if it can reasonably expect that if the buyer will become aware of the information requiring disclosure.

The judges were not persuaded that the purchaser had reviewed the documents in the data room – or that it had sufficient opportunity to review the documents.

The Importance of Arbitral Tribunals

In Germany, the case law addressing the duties and obligations in M&A transactions is limited by the fact that most disputes addressing such agreements are determined by arbitral tribunals. To provide guidance to a wider audience, various practitioners including Orrickʼs partner Siegfried H. Elsing published in 2022 a detailed analysis of arbitral awards rendered in arbitrations under the auspices of the German Arbitration Institute (DIS) (M&A-Streitigkeiten vor DIS-Schiedsgerichten, C.H. Beck Verlag. ISBN 978-3-406-77993-0).