Vendor’s duty of disclosure owing to the coronavirus crisis

published on 12 May 2020 | reading time approx. 2 minutes

The coronavirus crisis brings with it a number of new legal risks in the context of the sale of a company. One of these risks is the duty of disclosure on the vendor, which may be significantly aggravated by the special circumstances, especially due to the loss of customers or supply chains, any threat of insolvency and business shutdowns. The vendor therefore has extensive duties of disclosure which must urgently be considered. If there is any fraudulent or intentional breach of this, then there is a risk of purchase price adjustments, payment of damages or even the reversal of the contract.

General duty of disclosure by the vendor

Every party normally has to obtain for themselves the information they require, and take the necessary steps to obtain disclosure of this information. There is no fundamental duty for the contracting parties to disclose all the facts without being asked. However, the Federal Court of Justice (BGH) has consistently ruled that the contracting parties must voluntarily disclose circumstances which could frustrate the purpose of the contract, and that are therefore of fundamental importance for the decision of the other contracting party.

In the case of the sale of a company, the vendor bears an increased duty of information and care, due to the economic importance of the sale of a company. If there is any fraudulent or intentional breach of the duty of disclosure, the vendor is liable; this liability cannot be excluded. The BGH will assume fraud if the vendor responds incorrectly by plucking answers “out of thin air” to questions that are obviously significant for the purchaser. “Out of thin air” means that the vendor provides an answer to a question despite his not knowing.

Special duty of disclosure owing to the coronavirus crisis

This obligation on the vendor to disclose information is expanded in scope due to the current coronavirus crisis. Special circumstances that arise due to the coronavirus crisis can have an immense economic impact and thus affect the purchase price. The vendor must inform the purchaser about the changed circumstances and events, as otherwise he will remain liable due to a breach of his duty of disclosure.

Some negative circumstances that may arise for the contracting parties as a result of the coronavirus crisis are the following:

• the (potential) customer base disappears due to the economic situation or due to cost-cutting measures by customers;
• there are significant bottlenecks in supplies to the company, because the supply chains or suppliers can no longer meet demand;
• the company is forced to shut down its business operations by the authorities;
• a significant collapse in revenue has been recorded;
• tenants have announced, or already applied for a deferral of rent payments or have not paid;
• legal employment measures (short-time working, redundancies) have been or need to be applied;
• the company to be sold is threatened with insolvency, or it has not yet been filed due to the suspension of legal obligations.

The vendor will not normally have greater knowledge than the purchaser with regard to the potential consequences of the coronavirus. However, the vendor must clarify where he has more knowledge of risks and loss of income than the purchaser thanks to domain knowledge, especially in relation to issues that are already occurring or can be specifically expected. Although the purchaser must also use his own due diligence to check for risks/loss of income that are possible or may already have occurred due to the coronavirus crisis, the due diligence process cannot discover all risks. For example, the purchaser will not normally be able to recognise on the basis of annual financial statements from 2019 how much turnover has been lost in the 1st quarter of 2020, meaning that using a fixed box mechanism makes it impossible to adjust the purchase price and therefore price in the loss of revenue or profit. However, the risks and failures must be correctly priced in by the purchaser, making them extremely relevant for the level of the purchase price.

This significantly increases the duty of disclosure and the preceding duties of information and validation on the vendor’s part, based on the current economic situation, and greater attention needs to paid to complying with them. For this purpose, the close involvement and regular questioning of senior management and knowledge bearers is recommended. If the vendor decides to whitewash the impact or fails to disclose information, this may result in liability. In addition to a reversal of the contract or overall compensation, it is also conceivable that the purchaser may demand as compensation the difference in value had the vendor has made correct disclosures.

Conclusion

The coronavirus crisis is giving rise to increased requirements with regard to the vendor’s duty of disclosure. The vendor must inform the purchaser about circumstances and measures caused by the coronavirus crisis, and thus find out more information about these himself. In the event of non-disclosure, there is a risk of the reversal of the purchase contract or a claim for damages, including for the difference in value.