Defensive Measures During an Acquisition

The Stock Corporation Act grants the shareholders of a stock corporation the right to delegate certain powers to the company’s management by authorizing certain activities that the company’s management may take at a future date subject to the exercise of its business judgment. Furthermore, the Takeover Act permits the authorization by the shareholders’ assembly of defensive measures against a takeover bid. The combination of these two constructs have given rise to a series of defensive measures that can successfully deter a hostile takeover bid.

Authorized Capital. The shareholders’ assembly may authorize up to a 50% increase in the company’s share capital for cash contributions or contributions in kind. The authorization may have a five year term and enable the management board to restrict the existing shareholders’ subscription rights as to some or all of the newly issued shares. The capital increase will require the approval of the company’s supervisory board, however. Furthermore, restricting the subscription rights of existing shareholders is subject to certain limitations. See also "Statutory Framework—Stock Corporation Act—Subscription Rights."

The issuance of authorized capital in connection with a business combination would enable the company to issue new shares representing up to one-third of the company’s share capital following the capital increase for a contribution in kind, that could conflict with the business interests of the hostile acquiror, thus thwarting the hostile bid.

Treasury Shares. As indicated above, the shareholders of a stock corporation can authorize the management to repurchase up to 10% of its existing shares and to resell the same at a future date. The authorization can last as long as 18 months and may require the approval of the supervisory board. See also "Statutory Framework— Stock Corporation Act—Treasury Shares."

The effectiveness of treasury shares as a defensive measure is quite limited on its own ( e.g., it can be used to increase the market price of the target’s shares), but may be significant if used in combination with newly issued authorized capital.



Once the offeror has acquired a controlling majority in the target company, it will wish to pursue one or more postacquisition measures to consolidate its control over the target company, to financially and strategically incorporate the target into its corporate group and/or to dispose of assets and consolidate its business in order to take advantage of synergies and increase the value of its equity in the target.

Some of the measures will require altering the corporate governance of the target, some affect the relationship between the target and the acquiror, some are aimed at altering the corporate structure of the target company, and others are aimed at altering the rights of minority shareholders in the target. The Stock Corporation Act limits the extent to which an acquiror can effect the foregoing and ultimately achieve its objectives. Consequently, it is important that potential acquirors plan their post-acquisition strategy, to the extent possible, prior to launching a takeover bid or pursuing the transactions that would lead to a mandatory offer.

The following is a brief summary of some of the more important measures acquirors may wish to pursue and the limitations imposed by German corporate law.

Squeeze-Out of Minority Shareholders

In many circumstances, ultimate goal in an acquisition is the ownership of 100% of a target’s share capital. If feasible, this would eliminate the limitations German corporate law imposes on the management and restructuring of a stock corporation with minority shareholders.

The statute, pursuant to which the Takeover Act was adopted, included an amendment to the Stock Corporation Act that, for the first time in Germany, provides for the involuntary disposition of shares held by minority shareholders ( i.e., squeeze out). Once a shareholder holds, directly or indirectly, at least 95% of the target company’s share capital, it may initiate a squeeze out procedure by proposing a resolution at a shareholders’ assembly to that effect. Since the adoption of such resolution requires a simple majority, once the 95% threshold is satisfied, the procedure is but a formality.

A 95% shareholder is not required, however, to pursue a squeeze out procedure. The means by which the 95% threshold is reached are not limited to a takeover bid; the shareholder may reach the 95% threshold through a series of measures, including capital increases and business combinations.

The provisions of the Stock Corporation Act dealing with the squeeze out procedure, however, require the 95% shareholder that is pursuing the squeeze out to offer consideration that is "adequate," taking into account the financial condition of the target company. The consideration must be in cash and the 95% shareholder must present a formal report to the shareholders at the assembly that demonstrates how the consideration is determined.

The consideration is determined on the basis of a valuation involving, among other things, a form of discounted cash-flow analysis, the target company’s liquidation value, and its market price. While the market price of the target’s shares can act as an indicator in determining the adequacy of the consideration, case law suggests that it is neither definitive, nor does it purport to act as a floor or a ceiling in every circumstance.

In determining the adequacy of the consideration, the 95% shareholder must engage an independent court-appointed auditor that presents a fairness opinion concurrently with the 95% shareholder’s report at the assembly. In addition, the shareholders will receive the financial statements of the target company for the three preceding fiscal years as well as the proposed resolution to be adopted at the shareholders’ assembly.

Prior to inviting the shareholders to the assembly, the 95% shareholder must deliver to the management board of the target company an unconditional guarantee of a German financial institution in respect of the consideration to be paid to the minority shareholders in the squeeze out proceeding in the amount determined by the 95% shareholder.

The minority shareholders can challenge the consideration to be paid in connection with the squeeze out proceeding, in which case the court would evaluate the fairness of the 95% shareholders’ proposed consideration, usually by appointing an additional independent auditor. Such a challenge will not affect the outcome of the proceeding ( i.e., 100% ownership), however. Alternatively, the minority shareholders can challenge the validity of the resolution or the proceeding if either violates corporate law. If successful, the resolution would be set aside by the court.

De-Listing of Target’s Securities

Once all or substantially all of the issued and outstanding share capital of a publicly traded stock corporation is acquired, it may be in the interest of the acquiror to terminate the public trading of the target’s shares on a stock exchange. The target’s management can apply for such termination in accordance with the rules of the stock exchange and the respective segment thereof on which its shares are traded. Furthermore, certain corporate measures ( e.g., squeeze out, merger of a publicly traded company into a non-publicly traded company, change of corporate form) can result in the automatic de-listing of such shares ( i.e., cold de-listing).

Corporate Governance Measures

Because German corporate law affords the management board of a stock corporation a great deal of independence in conducting the day-to-day operation of the company, the replacement of members on such board with those more amenable to pursue the acquiror’s plans becomes one of the first measures an acquiror will wish to pursue once it has obtained a controlling majority in the target. As stated earlier, the members of the management board are appointed and removed by the supervisory board, whose members in turn are appointed and removed by the shareholders’ assembly.

Since the Stock Corporation Act does not provide for proportionate representation or a staggered board, shareholders with a simple majority are able to appoint all of the members of the supervisory board that represent the shareholders so long as the company’s articles of association do not grant another shareholder the exclusive right to appoint members of the supervisory board. Of course, this does not alter the right of employees of a stock corporation from appointing the members of the supervisory board that represent the employees; in a stock corporation with more than 2,000 employees, they constitute half of the members of the supervisory board. See also "Statutory Framework— Stock Corporation Act— Corporate Governance" and "Defensive Measures—Pre-Acquisition Defensive Measures—Supervisory Board Appointment Rights."

The removal of a member of the management board prior to the end of his or her term can only occur for cause or by a vote of no confidence at the shareholders’ assembly. Given the limited definition of cause in such instance, the latter is the only viable means by which members of the management board that are determined to keep their posts following an acquisition can be removed from office. While the foregoing is theoretically possible, in most instances, members of the supervisory board and management board are likely to resign following the acquisition of a majority interest in a publicly traded company.

Enterprise Agreements

As indicated above, one of the fundamental principals of German corporate law is the independence of a stock corporation’s management from any third party or individual shareholder. Any action by the management of a stock corporation must be to the benefit of the stock corporation, and not to the benefit of any third party or individual shareholder. As a consequence, unless provided for in the Stock Corporation Act, the shareholders are not entitled to influence the stock corporation’s actions to their individual benefit. Accordingly, the management board of a stock corporation is insulated from any instructions from individual shareholders; it is subject to shareholders’ instructions in only a limited number of instances and only if such instructions are resolved by the appropriate majority of its shareholders at a meeting thereof.

To protect the stock corporation from any detrimental measures taken in violation of the above-mentioned principal, individual shareholders and their authorized representatives, as well as the members of the management board and supervisory board can be held liable for any disadvantages the company incurred as a result of such detrimental measures. Furthermore, in the event that a stock corporation is subject to "control" ( Beherrschung) as determined under the Stock Corporation Act, it must disclose a report ( Abhängigkeitsbericht) as to its relationship with its controlling shareholder ( herrschendes Unternehmen) on an annual basis.

A controlling shareholder can avoid the foregoing requirements by entering into an enterprise agreement with the target company. An enterprise agreement typically provides for the controlling shareholder’s right to issue certain instructions to the target company’s management ( i.e., a domination agreement ( Beherrschungsvertrag)) or to receive all or a portion of the target company‘s profits ( i.e., a profit sharing agreement ( Gewinnabführungsvertrag)). Often, controlling shareholders and target companies enter into a combination of both.

Given the significant impact of an enterprise agreement on the target company‘s corporate governance regime, the Stock Corporation Act provides detailed procedures for entering into an enterprise agreement, and sets forth various provisions to protect the target company‘s shareholders who are not party to the enterprise agreement ( i.e., outstanding shareholders) and creditors.

The controlling shareholders obligations under an enterprise agreement are as follows:

Profit Sharing Compensation. Outstanding shareholders of a stock corporation that is a party to a profit sharing agreement who do not tender their shares in exchange for an exit consideration have the right to receive from the controlling shareholder an annual compensation ( i.e., a profit sharing compensation ( Ausgleich)) in connection with the profits transferred from the target company under the profit sharing agreement. The profit sharing compensation must be "adequate." The adequacy is determined on the basis of the target company‘s profits in the past, necessary write-offs, and estimates of the target company‘s future profits, with the assumption that all of the target company‘s profits are distributed to its shareholders ( Vollausschüttungsgebot).

Guaranteed Profits. Outstanding shareholders of a stock corporation that is a party to a domination agreement but not a profit sharing agreement who do not tender their shares for an exit consideration are guaranteed an annual dividend ( i.e., guaranteed profits) equal to the profit sharing compensation had such stock corporation been a party to a profit sharing agreement. The controlling shareholder is required to pay the difference between the guaranteed profits and the actual dividends distributed by the target company each year.

Exit Consideration. In addition to the annual profit sharing compensation or guaranteed profits, the outstanding shareholders of a stock corporation that is a party to an enterprise agreement have the right to tender their shares to the controlling shareholder at a pre-determined price ( i.e., the exit consideration). The period during which the outstanding shareholders can tender their shares in exchange for the exit consideration must be at least two months as of the date on which the commercial register publicly announces the registration of the respective enterprise agreement. Unless the controlling shareholder is a stock corporation or stock partnership, the exit consideration must be in the form of cash. The exit consideration must be "adequate." The adequacy is determined on the basis of a valuation involving, among other things, a form of discounted cash-flow analysis, the target company’s liquidation value and its market price.

Court-appointed Auditor. The management board of the target company must file an application for the appointment of an independent auditor ( Vertragsprüfer) with the relevant regional court once an enterprise agreement is contemplated. The auditor has specific rights to information vis-à-vis the controlling shareholder and the target company in order to perform its review. The auditor must prepare a written report as to its review of the enterprise agreement, that must in particular include a statement as to the adequacy of the exit consideration and the profit sharing compensation or guaranteed profits, respectively.

Disclosure. The management board of the target company must prepare a report, in which the management board justifies entering into the enterprise agreement and discloses the terms and conditions thereof, including the adequacy of the exit consideration and the profit sharing compensation or guaranteed profits.

Compensation for Net Losses. The controlling shareholder must compensate the target company for any net losses incurred during each fiscal year in which an enterprise agreement is in effect to the extent such losses exceed retained earnings ( andere Gewinnrücklage) during the period the enterprise agreement was in effect ( i.e., profits transferred to capital reserves from previous fiscal years during which the enterprise agreement was in effect).

The controlling shareholders’ rights and the outstanding shareholders’ rights under an enterprise agreement are as follows:

Instructions from Controlling Shareholder. The controlling shareholder is entitled to issue instructions to the target’s management board, even if such instructions are detrimental to the target, provided that such instructions are in the interest of the controlling shareholder group. The target’s management board must comply with such instructions, unless such instructions are unlawful or patently clear not to be in the interest of the controlling shareholder group.

Upstream Payments. The capital preservation rules under German law do not apply to payments from the target company to a controlling shareholder under an enterprise agreement. The controlling shareholder’s right to instruct the target’s management board is limited to instructions the implementation of which would not risk the continued existence of the target.

Outstanding Shareholders’ Rights. Outstanding shareholders who are of the opinion that the profit sharing compensation, the guaranteed profits or the exit consideration is inadequate do not have the right to file an action to set aside the shareholders’ resolution ( Anfechtungsklage) approving the enterprise agreement. Instead, such outstanding shareholders have the right to initiate a judicial review proceeding ( Spruchverfahren). Even if as a result of such proceeding the amount of the profit sharing compensation, the guaranteed profits or the exit consideration is deemed inadequate and therefore increased, such decision will have no bearing on the validity of the enterprise agreement or the authorities vested in the controlling shareholder as a result thereof. The outstanding shareholders have the right, however, to file an action to set aside the shareholders‘ resolution for other reasons that are not subject to a judicial review proceeding described above.

Restructuring Measures

The Transformation Act ( Umwandlungsgesetz) governs many of the corporate restructuring measures that an acquiror may wish to pursue following a takeover bid. These include mergers ( Verschmelzungen), spin-offs ( Abspaltungen and Ausgliederungen) as well as changes in corporate form ( Formwechsel). Many of these measures require that the shareholders be provided adequate information, including a formal report by the management board and a fairness opinion by an independent auditor, in order to make an informed decision in respect of the same at a shareholders’ assembly. Which measure the acquiror may wish to pursue is determined by the interplay among a number of factors including the objectives of the acquiror, the extent of its holdings in the target company and the rights of the minority shareholders in connection with each measure.



This article is a publication of Jones Day and should not be construed as legal advice in any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at its discretion. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. For further information, readers are encouraged to contact the Jones Day attorney identified on the back of this article.

The Firm

Tracing its origins to 1893, today Jones Day encompasses more than 2,300 lawyers resident in 29 locations and ranks among the world’s largest and most geographically diverse law firms.

The Firm acts as principal outside counsel to, or provides significant legal representation for, more than half of the Fortune 500 companies, as well as to a wide variety of other clients, including privately held companies, financial institutions, investment firms, health care providers, retail chains, foundations, educational institutions, and individuals. Surveys repeatedly list Jones Day as one of the law firms most frequently engaged by U.S. corporations, and many of the Firm’s lawyers have achieved national recognition in their disciplines.

According to Thomson Financial Securities Data, Jones Day ranked number one in completed M&A deals worldwide with 360 transactions in 2002 and 461 deals in 2003. Also in 2002, Jones Day was voted "law firm providing the best client service" by U.S. corporate counsels and the Firm’s global litigation group was named "Litigation Department of the Year" in 2002 by The American Lawyer.

Jones Day Germany

Since opening its first office in Frankfurt in 1991, Jones Day’s German operation has grown to become one of the largest of the Firm’s international locations. The new Munich Office, opened in 2003, significantly expands the Firm’s capabilities and reach in one of the most important European markets. In accordance with our "One Firm" principle, the lawyer teams in Frankfurt and Munich form an integrated German Practice.

Our attorneys advise national and international corporate clients on a wide range of German and cross-border acquisitions and joint ventures, corporate finance and securities matters, as well as private equity and venture capital. They offer legal services in matters regarding commercial, labor, tax, intellectual property and unfair competition law. The Munich IP team, with its integrated group of patent attorneys, protects and enforces our clients’ intellectual property rights by prosecuting and litigating patents, trademarks and copyrights. Our specialized industry expertise includes financial services, pharma/biotech, telecommunications and the chemical industry. Technology experience includes E.U. as well as national regulations concerning new technologies and all corporate and regulatory aspects of information technology, such as e-commerce, software and licensing.

Our lawyers are involved in a variety of general litigation and arbitration matters. The Frankfurt Office also has a very active forensic services and white-collar crime practice. As part of the European Jones Day antitrust practice, our German attorneys represent clients in E.U. and national merger control proceedings and a variety of competition and antitrust matters. Finally, our attorneys handle administrative law issues such as environmental and public procurement issues.

The Authors

Sina Hekmat. Mr. Hekmat is a partner at Jones Day. He is a U.S. attorney-at-law and a member of the California, Texas and D.C. bars. Mr. Hekmat’s practice is concentrated in the areas of mergers & acquisitions and corporate finance, involving both U.S.-based and cross-border transactions.

Mr. Hekmat has advised acquirors, sellers, and target companies in a number of U.S., European, and global M&A transactions, including tender offers, exchange offers, and hostile takeovers of publicly traded companies, as well as acquisitions (including management and/or leveraged buyouts) and dispositions (including auction sale) of business units and divisions. As a member of the Firm’s Restructuring and Reorganization Team, Mr. Hekmat advises a number of investment firms specialized in turnaround investments with acquisitions and dispositions of distressed assets, restructuring of non-performing loans, debt to equity swaps, and negotiations with bondholders.

In addition, Mr. Hekmat has advised issuers, shareholders, investors, and investment banks in a number of U.S. and global public offerings and private placements of debt and equity securities. He has also represented U.S., Canadian, and European companies and venture capital and private equity firms in connection with start-up to pre-IPO investments, especially in the information technology and telecommunications industries.

Mr. Hekmat advises numerous U.S. and European clients of the Firm with ongoing general advice dealing with U.S. securities law compliance (including the Sarbanes-Oxley Act and the Investment Company Act of 1940), corporate governance, fiduciary duties, executive compensation, and various other public company concerns.

Mr. Hekmat received a Bachelor of Arts degree in 1989 from the University of California, Los Angeles, a Juris Doctor in 1993 from Vanderbilt University Law School, where he served as Research Editor on the Journal of Transnational Law, and a Masters in Business Administration in 1993 from Vanderbilt University, Owen Graduate School of Management.

Mr. Hekmat has published a white paper entitled Investment in the German Distressed Debt Market, as well as English translations of the Takeover Act and related regulations and the German Statute Governing Common Rights of Owners of Debt Securities ( Gesetz betreffend die gemeinsamen Rechte der Besitzer von Schuldverschreibungen). He is fluent in English, German, and Persian and has some proficiency in French, Arabic, and Japanese.

Hanno Schultze Enden. Mr. Schultze Enden practices in the areas of mergers and acquisitions and corporate finance. He also has an expertise in German and European antitrust/ merger control regulations.

Mr. Schultze Enden has represented numerous clients of the Firm in domestic and cross-border transactions, including a share-for-share acquisition by a publicly traded German company of a publicly traded Canadian company via a plan of arrangement. He is an expert in the German Stock Corporation Act and German securities laws and regulations. He has also been engaged as an antitrust lawyer in connection with a number of merger notifications filed with the German Federal Cartel Office and the European Commission, as well as the coordination of multi-jurisdictional merger filings in various industry sectors.

Prior to joining the firm, he was an academic assistant at the Chair for Civil, Commercial, and Corporate Law at the European University Viadrina in Frankfurt (Oder), where he was involved in drafting new editions of a textbook on German Corporate Law and a commentary on the German Stock Corporation Act. Furthermore, he has interned with the German Federal Cartel Office in Berlin.

Mr. Schultze Enden is native in German and fluent in English.


Resolutions before a Shareholders' Assembly

Requisite Majority

Appointment of auditors for the annual report (Jahresabschluß)

> 50% of shares present

Approval of actions of the management board and the supervisory board (and release thereof of liabilities in respect of same) (Entlastung)

> 50% of shares present

Election of members of the supervisory board representing the shareholders

> 50% of shares present

Vote of no con.dence in a member of the management board

> 50% of shares present

Authorization to purchase treasury shares

> 50% of shares present

Squeeze-out of minority shareholders (requires 95% of share capital owned directly or indirectly by one holder)

> 50% of shares present

Ordinary capital increase

75% of shares present

Contingent capital increase

75% of shares present

Authorized capital increase

75% of shares present

Restriction of subscription rights in a capital increase

75% of shares present

Issuance of convertible bonds and other securities exchangeable in shares of the company

75% of shares present

Amendment to the company’s articles of association

75% of shares present

Approval of sale of all or substantially all of the company’s assets

75% of shares present

Approval of enterprise agreements

75% of shares present

Approval of sale of treasury shares on a non-pro-rata basis

75% of shares present

Approval of a business combination ( e.g., merger, spin-off) or change in corporate form

75% of shares present

Approval of defensive measures against a hostile takeover bid

75% of shares present

Liquidation of the company

75% of shares present

Removal of a member of the supervisory board

75% of votes cast

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.