The Anglosaxon concepts of M&A in Spanish jurisprudence

Author: M.A. Albadalejo Campoy, Doctor in Law and Professor at IE Law School.

 

A review of the jurisprudence of the last 20 years reveals the agility with which methods such as the MOU, due diligence and others have been adopted and codified to create a system of liability of the seller beyond the aedilitian remedies and other measures provided for in articles 1484 et seq. of the Spanish Civil Code.

The traditional approach as a starting point

Traditionally, transactions related to the sale and purchase of companies were simply accompanied by a balance sheet—the accuracy of which was the responsibility of the seller—and whose guarantee included, at the most, the possibility of settlement of any tax liability that might arise.

This approach was often inadequate due to the extraordinary complexity of the subject itself—the company—which is made up of assets, liabilities, human resources and one critical component: the organization of all these elements by the entrepreneur. Several court decisions prior to 2015 demonstrate the inadequacy of the system and of the aedilitian remedies provided for in article 1484 of the Spanish Civil Code. The decision of the Court of First Instance (Eighth Chamber) of A Coruña on October 21, 2010, detailing the main mechanisms of the Anglosaxon system—which even then began to overlap with the Spanish system—is representative in this regard and will be examined below.

Memorandum of understanding (MOU)

The memorandum of understanding (MOU) is one of the first documents exchanged between the parties. It outlines the starting point of the negotiation and the position reached after the preliminary discussions.

The problem posed by these documents, which are often drafted with ambiguous or confusing wording, is determining whether they are legally binding, since they are not provided for in Spanish law. Nevertheless, much of the jurisprudence considers these documents to be preliminary or preparatory instruments.

As early as 1998, in a decision dated June 2, the Supreme Court referred to the MOU as “nothing more than a starting point for further negotiations.” In another, dated April 11, 2000, it likened the MOU to preliminary dealings, because it isn’t “drafted with the detail required for it to be legally considered as anything other than preliminary dealings, since its subject matter is not yet clearly defined.”

Due diligence

The aforementioned 2010 decision of the Court of A Coruña defined due diligence as: “An English expression that refers to the set of activities related to the investigation or verification of the different areas of a company carried out on behalf of a potential investor as part of the assessment and valuation of an investment in that company.”

The fact that the court found it necessary to explain the concept and purpose of this mechanism is significant, as it shows that its implementation was not yet sufficiently widespread in the early 2010s. The phenomenon of integration of the concept into the Spanish jurisprudence began just over a decade ago, and the definitions or explanations that accompanied the introduction of this concept are repeated in several court decisions prior to 2015.

Representations and Warranties

The term Representations and Warranties is a descriptive list of the company. The seller is responsible for its existence and completeness and is liable for its veracity. Its incorporation into the sale and purchase agreement of a company, therefore, creates an additional obligation for the seller.

It eliminates the need to resort to the specific remedies for non-compliance with sale and purchase agreement regulations provided for in articles 1484 et seq. of the Spanish Civil Code and replaces them with the remedies for non-compliance provided for in articles 1101 and 1124.

There aren’t many court rulings concerning this mechanism, but its guaranteeing nature is generally accepted. One example is a decision of the Provincial Court of Navarre, dated October 4, 2010, which stated that “in the final contract, the Representations and Warranties expressly state what is being acquired and under what conditions.”

Alongside due diligence, they constitute the foundation of the system of liability of the seller, which is the most notable feature of the Spanish corporate world’s new mergers and acquisitions (M&A) mechanism.

Contingency

In the context of M&A transaction, the system of liability of the seller of a company is fundamentally based on the concept of contingency.

The concept of contingency, a key element in such transactions, had already been included in our financial practice by the end of the last century, namely by the Civil Chamber of the Supreme Court, in Decision no. 1117/1999 of December 18; and the First Chamber of the High Court, in a decision dated July 11, 2000. Therefore, the term was part of our legal acquis prior to this Anglosaxon influence. Nevertheless, it only took on its own substantive and specific role when included in the set of liabilities established under the new system of liability of the seller.

Liability of the seller

The innovation of the new system is the introduction of a guarantee of liability of the seller. It stems from objective non-compliance, but the concurrence of fraud on the part of the seller and error on the part of the buyer should not be ruled out.

Several court decisions have referred to its characteristics and requirements, distinguishing between non-compliance and improper compliance to conclude whether or not the seller is liable. As an example, Decision no. 190/2016 of the Provincial Court of A Coruña (Fifth Chamber), dated June 7, 2016, referred to the “concurrence of a series of requirements that imply a fundamental, unjustified, serious and negligent non-compliance with [the seller’s] obligation.”

 

Remedies for non-compliance

As we have already mentioned, there are many examples of rulings in which the courts pointed out the limitations of the traditional approach. This inadequacy also extends to the aedilitian remedies (whether redhibitory or quanti minoris) to claim against defects in the financial substance of the company transferred when the manner of that transfer is limited to the sale and purchase agreement accompanied by the traditional balance sheet.

The earliest court decisions mentioning remedies for non-compliance excluded the aedilitian remedies. A very explicit example of this is a decision of the Provincial Court of Navarra, dated October 4, 2010, which insisted on the exclusion of aedilitian remedies and outlined the advantages of the Anglosaxon system in the context of M&A transactions. One of them is that “in the event that any of the seller’s assertions or representations is found to be untrue, there is no requirement to prove bad faith, nor knowledge of the misrepresentation by the seller.”

The most distinctive innovation in the context of M&A transactions is the creation of a more effective system for enforcing the liability of the seller than the mere exercise of the aedilitian remedies provided for in the Spanish Civil Code (articles 1484 et seq.).

Conclusion

The significance of the aforementioned court decisions—and of similar rulings over the past 15 years—lies in the fact that they occur within the context of the sale and purchase of a company and are specific to this matter, as opposed to the traditional approach of purchase guaranteed by a balance sheet. They each demonstrate the agility and adaptability of our courts in dealing with these relatively new instruments, imported from the English-speaking world, in the context of the sale and purchase of companies.

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M.A Albadalejo Campoy is a Doctor in Law, Legal Corporate Professor at IE Law School and Founding Partner of DIKEI Abogados. He specializes in brankrupcy & corporate law and regularly publishes in the OTROSÍ Magazine of the Madrid Bar Association and collaborates in other professional magazines.