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Innovative technologies usually quickly find their use in the transactional practice. Blockchain technology, or more generally speaking Distributed Ledger Technology (DLT), is no exception. Here, in particular two scenarios can be distinguished. On the one hand, there are cases where blockchain applications become the subject of a transaction process as they are used by the companies involved and so become part of the (due diligence) process. On the other hand, it is – theoretically at least – also possible – that, conversely, the transaction process itself is mapped in whole or in part through a blockchain application.
As with any emerging technology, it is expected that blockchain applications will become more and more common in M&As. For example, pure blockchain start-ups can themselves become targets in M&A transactions. It can also happen that, as part of a transaction, significant parts of the value chain of the companies to be subject to due diligence will be strongly driven by this technology, as for example in FinTechs.
In this context, it should be positively assessed that the regulatory framework concerning the supervision of blockchain technology is growing. From the perspective of transaction law, this trend is welcome, as it makes both the development and the subsequent assessment of blockchain-based business models easier. This summer, for example, the German draft law on the introduction of electronic securities attracted considerable attention. Under current legislation, on principle it is mandatory that securities are represented by (physical) certificates. According to the new draft law, it should now be possible to replace the certificate with an electronic document. The new draft law assumes that instead of issuing a securities certificate, an entry will be made in an electronic securities register. It further explains that this electronic securities register may also be kept on a decentralised, forgery-proof recording system where data are recorded in chronological order and stored in a manner ensuring protection against their unauthorised deletion and subsequent modification, shortly speaking, also by using blockchain applications.
Another effect of the draft law that would have an impact on other areas significant for the transactional practice is the comprehensive protection of ownership as envisaged in the draft law, where electronic securities will be considered movables (German: Sache) within the meaning of Article 90 of the German Civil Code (BGB). In other words, this means that a digital asset will expressly be treated as a physical object.
When reviewing blockchain-based business models from the perspective of transaction law, special attention should also be paid to the history of the implementation of such models. What sounds like a banality may well be laden with pitfalls. Especially when blockchain projects, often using associated financing via ICOs (Initial Coin Offerings), were in their infancy, they were believed not to be subject to any regulation in many areas. Errors arising from such misconception can therefore be found in many constituent documents and design decisions. In the "Wild West" times, for example, published capital market information often contained errors that could give rise to liability. This applies in particular to the so-called white papers, which in some cases contained insufficient information about risks. But also other contractual stipulations, such as those governing the provision of capital market services, should be critically reviewed taking into account the timing of their drafting. In this context, the following rule of presumption may be used as a precaution: The longer ago a contract was drafted, the higher the risk that at the time of drafting the contract legally relevant information was not taken into account. This is the case, for example, with the obligation to prepare a prospectus which might have been overlooked.
Furthermore, blockchain’s special feature, at least in theory, is that Distributed Ledger Technology has the potential to be used in the transaction itself through the use of so-called smart contracts. Smart contracts can be used to map the business or contract logics in whole or in part by means of a program code using blockchain technology. In this process, transaction conditions agreed between the parties are logged as a protocol in the blockchain. If the conditions are met, the intended legal consequences (e.g. the transfer of the purchase price upon registration of the new owner in the electronic company register or the transfer of an earn-out amount deposited in an escrow account upon publication of the annual financial statements coupled with the fulfilment of specified ratios) are triggered through a technical process without the involvement of the parties or third parties – and thus without any possibility for any party to influence the transaction. Since relevant conditions and times under a contract can be automatically verified and reconciled, such applications enable highly autonomous interactions. Since the conditions of a transaction are logged in the code, intermediaries such as banks, which in a "classic" contract signing situation would otherwise have ensured the necessary level of trust among the parties to the transaction, basically become dispensable. Therefore, it would be quite conceivable to conduct company acquisition transactions via smart contracts. In reality, however, there are currently significant obstacles to this scenario. Above all, there is no appropriately differentiated ecosystem within which the desired transaction logic could be mapped from the beginning to the end of the process. An example: although smart contracts can currently be used to transfer digital assets, such as a token, it is currently impossible – at least in Germany – to use them for transferring company shares.
The number of transactions involving aspects of blockchain technology will probably increase in the future. Even if this innovative technology has potential for being used in implementing transactions, this will rather not be the case in the foreseeable future. This is contrasted by cases where it is necessary as part of due diligence for example to assess amongst other business transactions that are implemented using blockchain technology (e.g. ICO as alternative financing instrument). In all probability, there will be more such cases in the future. Especially in the area of FinTechs or tokenisation-based business models, it will become more important to be able to deal with the legal aspects of the technological part of the transaction. In due diligence audits of relevant targets and transactions, even tech transactions lawyers are no longer able to act as software experts. This is because in such cases it is particularly important to check the security of the program code of the smart contract logged in the blockchain and run the necessary simulations on the basis of which a legal assessment of the transaction can be performed and its particular features reflected in its architecture and documentation.
Tobias Kohler
Partner
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Sebastian Schüßler
Associate Partner
Christian Conreder
Transaction advisory | Mergers & Acquisitions
