News from Karlsruhe – New Judgement of the Federal Court of Justice Court (Bundesgerichtshof) regarding disclosure obligations of (real estate) sellers

Specifically, it dealt with the question at which point in time the seller must disclose essential documents in a virtual data room and whether, if applicable, further documents explaining the facts to be disclosed must be disclosed as well as, in principle, the question whether the seller in every case already fulfils his duty to inform if documents are disclosed in a data room by the seller.

In essence, the BGH ruled that the seller of a developed property only fulfils its duty of disclosure by disclosing documents in a virtual data room if the seller can have the legitimate expectation, based on the given circumstances, that the buyer will also become aware of the fact subject to disclosure by examining the documents disclosed in a virtual data room.

Although the decision was issued in the context of a contentious dispute relating to a real estate transaction, it seems likely that courts will apply the principles set out in the decision to M&A transactions in the future as well. In our opinion, the decision is therefore also relevant for M&A transactions, even if the underlying factual constellation (buyer does not conduct due diligence despite data room) is likely to be rather rare in M&A transactions.

The facts

The seller sold several commercial units to the plaintiff under exclusion of liability for material defects. The underlying purchase contract (concluded on a Monday) contained, among other things, a provision stating that all minutes of the owners' meetings of the last three years had been disclosed to the buyer and that the buyer had taken note of their contents. However, on the Friday before the notarisation, the seller had uploaded the minutes of an owners' meeting - without notifying the buyer separately - to the virtual data room provided for the transaction. As a result, the aforementioned minutes of the owners' meeting showed a payment obligation of the buyer that exceeded the purchase price paid many times. The buyer felt that it had been deceived by the seller and subsequently declared its rescission of the purchase contract on the grounds of fraudulent misrepresentation and (as a precaution) the withdrawal from the purchase contract. The lower courts took the view that the seller had fulfilled its disclosure obligations and thus, did not uphold the action.

The judgement

The BGH overturned the decision of the Court of Appeal (except for one minor point). The Court of Appeal's found that the seller had violated its duty of disclosure.

The BGH came to the conclusion that the seller should have separately informed the buyer about the (considerable) obligation to bear the costs, as this circumstance was "undoubtedly" of considerable importance for the buyer. The seller had not already fulfilled its duty of disclosure by disclosing the minutes in the data room. Just because the seller had set up a data room and the buyer had in principle the possibility to take note, this would not always allow the conclusion that a buyer would take note of the fact that had been disclosed. Rather, it would be necessary that in the individual case the expectation was justified that the buyer would take note of certain information provided by the seller in the data room - for example within the scope of a due diligence - and would include it in its purchase decision. Based on the circumstances of the individual case, the seller must have a legitimate expectation that the buyer will become aware of the fact subject to disclosure by inspecting the data room.

In the present case, according to the Federal Court of Justice, the seller could not have such legitimate expectation that the plaintiff would take note of the information contained in the minutes before the conclusion of the contract because - as was to be assumed for the appeal proceedings - the minutes of the owners' meeting of November 1, 2016 were disclosed in the data room shortly before the conclusion of the purchase contract without informing the plaintiff of this. Without a separate reference to the newly posted document, the plaintiff had no reason to inspect the data room again in the time window between the disclosure of the minutes on Friday, 22 March 2019, and the notary appointment on Monday, 25 March 2019, at 10 am.

Finally, the BGH came to the conclusion that in the present case, the seller could not assume that the buyer would take another look at the data room so immediately before signing the purchase contract.

Relevance for M&A transactions

Although the decision concerns a real estate transaction, the principles mentioned in the decision can probably also be applied to due diligences in the context of M&A transactions. Typically, share purchase agreements will contain provisions that documents disclosed in a virtual data room are deemed to be known to the buyer, provided that they have been disclosed in accordance with the "fair disclosure" principle. The decision underlines the importance of a well-structured data room, clear document identification and timely disclosure of documents or information. Another protective mechanism for sellers is to simply close the data room a few days before the contract is signed, thus preventing the possibility of disclosing further documents via the virtual data room. It seems equally important that when choosing a data room provider, it is also ensured that there is complete documentation of the exact time of disclosure. This should regularly be the case with professional data room providers. Particular attention should also be paid to ensuring that the data room provider informs the persons with access to the data room about newly available documents via an automatically generated email each time documents are disclosed. This would allow that, in case of doubt, it can be argued that the seller (via the data room provider) has informed about the newly available documents including the data room reference number. It is striking that the aspect of data room notifications is not discussed in the court decision at hand. It remains to be seen whether the reasons for the decision, which are not yet available, will comment on this. However, it should be considered whether the users of a virtual data room should be contractually obliged to activate the (daily) data room notifications (e.g. in the confidentiality agreement regularly to be concluded or via the data room rules). In any case, it seems advisable to at least explicitly inform the data room user about the possibility of opting for automatic notification, as this notification option is not automatically activated by most data room providers on the market.