The Share Purchase Agreement (SPA)

Why is the contractual liability regime so important?

In a share deal, the buyer acquires shares in a legal sense. The target company, with its assets and liabilities, continues to exist. Statutory purchase law offers only limited protection regarding the state of the company, and this protection may be uncertain in individual cases. For this reason, the SPA independently sets out which representations the seller is liable for and what the legal consequences are in the event of a breach.

The contract should clearly distinguish between the various levels of regulation.

The starting point is fundamental warranties regarding the company’s existence, ownership, power of disposal and capitalisation, as well as operational warranties relating to the day-to-day business. Tax warranties and a separate tax indemnity are usually dealt with separately. Specific indemnities are added for identified individual risks.

Covenants govern conduct before and after closing. Disclosure and knowledge qualifications determine which information excludes or limits claims. Thresholds, caps and time limits form the general liability regime. W&I insurance may transfer parts of this liability to the insurer on a commercial basis, without eliminating any remaining seller liability.

Section 442 of the German Civil Code (BGB) concerns statutory rights in respect of defects where the buyer is aware of them. It does not automatically determine claims arising from an independent contractual warranty. What is decisive in this regard is what the parties agree in the SPA regarding knowledge, disclosure and the exclusion of claims. Consequently, due diligence knowledge does not apply across the board. Some contracts stipulate that only facts specifically disclosed in the Disclosure Letter are relevant. Others incorporate the entire data room or allow certain warranties to apply regardless of knowledge. This structure must be deliberately negotiated.

What should be included in the warranty catalogue?

The warranty catalogue sets out the business model and the due diligence risks.

The corporate law fundamentals include legal existence, capital structure and ownership of the shares being sold. The financial guarantees relate to annual financial statements, management accounts and material changes since the reference date.

For operational activities, customer, supply, financing and other key contracts, as well as the ownership, encumbrances and condition of key assets, are covered. Depending on the business model, this may also include intellectual property, IT, cybersecurity and data protection, as well as employee, management and pension obligations.

Other areas include licences, compliance, sanctions and export controls, the environment, product liability and insurance, as well as litigation and taxation. The scope of the catalogue is determined by the value drivers and risk areas of the specific company, not by its length.

Every warranty must specify a clear effective date. Statements may apply at signing, at closing, or on both dates. A ‘bring-down’ at closing also requires rules governing circumstances that have come to light in the intervening period.

Knowledge qualifications must specify whose actual knowledge is attributed to the seller and whether these persons are obliged to carry out reasonable enquiries. They should also determine from which other persons information is to be obtained and whether attributed knowledge or negligent ignorance plays a role.

The seller limits risk through materiality, knowledge and disclosure. The buyer ensures that these qualifications do not undermine the core statement. Fundamental warranties are typically secured in a more objective manner and for a longer period than operational statements.

Why does the buyer need indemnities?

An indemnity clause assigns a specifically identified risk to one of the parties. It is particularly suitable where the facts of the case are known, but the extent or occurrence of the loss remains to be determined.

Typical examples include ongoing tax audits, environmental issues or contaminated sites, pending legal disputes and missing permits. Specifically identified compliance breaches or demarcation issues in a carve-out can also be addressed in this way.

The same applies to customer or product damage where the cause arose prior to closing but the financial consequences only materialise later. The indemnity clause can then be precisely tailored to the known facts without artificially overstretching the general warranties.

A known risk can also be addressed through a warranty, a purchase price adjustment, an escrow arrangement or specialised insurance. It is not legally mandatory to always use indemnities. In practice, however, it offers a more precise allocation of risk, as the conditions for claims, defence, payment and duration can be tailored to the specific circumstances.

Several points must be expressly regulated. The clause must specify whether the buyer, the target company or both are the beneficiaries, and which losses, taxes and costs are covered. Insurance proceeds, tax benefits and other claims for compensation must be treated in such a way that neither over- nor under-compensation arises.

For third-party claims, rules are required regarding disclosure, cooperation and oversight of the defence. The cap, excess and time limit are tailored to the specific risk and distinguished from the general liability regime. Where the seller’s creditworthiness is relevant, the claim may be secured by escrow, a guarantee or a retention of the purchase price.

Tax exemption is typically aligned with the tax covenant, the monitoring of tax proceedings and the tax limitation periods. Fixed time limits are risky because suspensions of the limitation period and subsequent audits can extend the actual exposure.

Locked Box or Closing Accounts: how is the purchase price settled?

The enterprise value agreed between the parties is almost never the amount that is ultimately paid. Negotiations usually centre on a debt-free and cash-free value, known as the enterprise value. From this, net financial liabilities are deducted – that is, financial liabilities minus available cash – and an adjustment is made for any deviation of net working capital from an agreed normal value. Only then is the equity value – the amount the buyer actually pays – derived. The key question is: which cut-off date and which figures does this reconciliation rely on? There are two models to choose from.

Under the closing accounts approach, a balance sheet is drawn up as at the closing date. Net debt and net working capital are determined as at that date, and the provisional purchase price paid is subsequently adjusted, usually on a euro-for-euro basis. The economic risk of the target company is therefore only transferred to the buyer on the completion date. The price is precise, but it is not finally determined until weeks after closing, and the figures are often still the subject of dispute.

The ‘locked box’ approach reverses this logic. The purchase price is fixed at a past reference date – usually the date of the last audited annual accounts – and is not adjusted thereafter. The buyer bears the financial results of the company from this ‘locked box’ reference date onwards, even though they do not take over the business until later. To ensure that the seller does not drain value in the meantime, the contract prohibits any so-called ‘leakage’: distributions, excessive directors’ remuneration, and payments to related parties. Only explicitly specified transactions – ‘Permitted Leakage’ – are permitted, such as payments for regular services.

The seller often receives interest on the purchase price for the period between the reference date and completion. Because the price is fixed from the outset, the locked-box arrangement is the preferred mechanism in tender processes and private equity transactions, where bids must remain comparable.

Closing accounts, on the other hand, remain the usual choice in bilateral deals and where target structures are complex, where accuracy as at the closing date is crucial.

In addition to this basic mechanism, further clauses can affect the actual amount paid. A portion of the purchase price may be held in an escrow account to secure subsequent warranty claims. A variable portion, linked to future earnings performance, is governed by an earn-out. And in the event of a material adverse change occurring between signing and completion, a MAC clause grants the buyer a right of withdrawal or adjustment. These three instruments are the subject of separate articles. As regards the purchase price, it is sufficient here to choose the right basic mechanism, as this determines who bears the outcome of the transition phase.

How is the seller’s liability limited?

The liability regime combines several levels:

At the lower end, a de minimis threshold excludes individual minor claims. The ‘basket’ bundles the remaining claims and determines whether, if the threshold is exceeded, the entire amount or only the excess is recoverable. The cap limits the maximum liability for each category of claim, whilst different time limits apply to operational, fundamental and tax-related claims.

The definition of damages covers consequential damages, loss of profit, multiplier damages and internal costs. No-double-recovery and mitigation clauses prevent multiple compensation and take into account damages that could have been avoided or have otherwise been compensated.

Knowledge and disclosure rules determine which matters are excluded from the seller’s obligations. An exclusive remedy clause is intended to provide an exhaustive list of contractual remedies in principle, but remains subject to mandatory limitations, particularly in cases of fraud and wilful misconduct.

Market ranges depend heavily on deal size, seller structure, due diligence, competition and W&I cover. Flat-rate percentages are therefore of limited significance.

Mandatory limits remain in place. Intent cannot be waived in advance. Fraud and knowingly false representations are regularly excluded from contractual protection. In a W&I structure, the buyer may be protected against the insurer, whilst the insurer is entitled to rights of recourse in the event of seller fraud.

The claims procedure is just as important as the figures. Notice requirements should be clear, without allowing legitimate claims to fail due to unreasonable formalities.

Does the company purchase agreement have to be notarised?

In the case of shares in a limited liability company (GmbH), both the transfer of shares and the undertaking to transfer them must be notarised. The entire legal framework of obligations must be in writing, insofar as the agreements stand or fall together in accordance with the parties’ intentions.

In practice, therefore, the SPA, relevant annexes and ancillary agreements must be structured with the notary at an early stage. Depending on their structure, documents may be read out, referred to or concluded outside the deed. It is crucial that no obligation requiring formalisation is improperly placed outside the deed. A document structure that is added later or is unclear may give rise to risks regarding validity.

In the case of an asset deal, there is generally no standard notarial form. However, notarisation may be triggered in particular by land, shares in a limited liability company (GmbH), certain conversion measures or an obligation to transfer current assets. The formal review should therefore take place at the start of the documentation planning process, not just during the final week of signing.