1. The structure of the acquisition

Under the Italian law the sale of a company may be achieved in two principal ways, either by a sale of the shares/quotas of the company itself, or by a transfer of the whole or part of the business as a going concern. This form of transfer (cessione di azienda) is closely regulated by the provisions of the Civil Code. The term "azienda" is defined by the Civil Code as being all those assets which are organised to carry out that business. What exactly constitutes these assets is still debated. Anyway it is generally accepted that it will include, inter alia, real estate, plants and machinery, stocks, trade receivables and goodwill.

1.1 Transfer of business

In case of a business transfer there are a lot of aspects which may differ according to a share/quota sale. The following points should be particularly noted.

When a business is sold, only the assets related to that business will be transferred. It is also possible to transfer only a specific area or branch of the business, which will be separated in this case from the remainder. Although particular assets can be expressly excluded by agreement from the sale, the parties should be careful to ensure that the transferred assets correspond to the definition of azienda given by the Civil Code. If not, the sale could be treated as a mere sale of individual assets;

  • in order to avoid disputes over the assets the parties wanted to be included in the transferred business (especially when a specific area is transferred) it is important to define them. It is therefore common practise to add an inventory or a detailed list of the stated assets to the contract;
  • although the business transfer as a going concern will automatically produce the title transfer to all pertinent assets, certain formalities (which are obviously not necessary in the case of a share/quota sale) will be required in order to make the transfer effective to third parties, especially in case of registered assets (real estate, aircraft, ships and vehicles, patents and trade marks etc.);
  • following the sale of shares/quotas, charges over the assets will follow the assets themselves.

In general the purchaser substitutes the seller in all non-personal contracts relating to the business. However, the other party is entitled to withdraw from the contract for a very special reason within three months after having given notice of the transfer, In this case, the liability of the transferor will remain unaffected.

Pursuant to the Civil Code (Article 2559), in case of an azienda transfer the assignment of claims against the azienda's debtors will be effective (even when not notified to or accepted by the debtor) by the date of the assignement registration in companies's register. However the debtor will be released from his debt when, in good faith, he pays the transferor.

Although the parties are free to establish contractually which liabilities are to be transferred to the purchaser and which will remain to the vendor, as far as third parties are concerned, all obligations and liabilities relating to business will be transferred to the purchaser, provided that they are disclosed in the relevant accounting records, However, it should be noted that the seller will remain jointly liable for those obligations and liabilities, unless the latter have been expressly discharged by relevant creditors (Article 2560);

The employment relationship of all those employed in the transferred business will continue with the purchaser notwithstanding the transfer (Article 2112 c.c.). The employees will therefore "follow" the business or the party of the transferred business. Both vendor and purchaser will be jointly liable to the employees in respect to their accrued rights. When more than fifteen employees are employed, then a complex procedure regarding the notification of the intended transfer to the relevant trade unions must be initiated. It is required to give at least 25 days' notice from the transfer to the trade unions. By the following 7 days the trade unions may ask the parties to meet and discuss the transaction. Although such consultation is compulsory, the trade unions have no legal right of veto on the transaction.

As it occurs in a share sale, certain representations and warranties of the transferred business are usually given. The issue is particularly important, as certain tax liabilities follow the business.

As by far the majority of acquisitions take the form of share or quota sale, this chapter will deal with this kind of acquisitions. Therefore, unless clearly expressed, all comments will refer to share/quota sale transactions.

2. Mergers

The Italian Civil Code lays down a compulsory procedure to be followed for mergers (article 2501 to 2504);

merger transactions can be carried out in two ways:

(i) a company "absorbs" one or more companies which are then incorporated (merger by incorporation);

(ii) two or more companies merge to form a new company (merger by consolidation).

The former is more common than the latter- the directors are required to present a number of documents relating to the proposed transaction during extraordinary meeting (with prior deposit with the appropriate company registry). These documents include the merger plan, a directors' report, including on the proposed share exchange ratio and, unless the target is already a wholly owned subsidiary of the company by which it will be absorbed, a compulsory report of a court-appointed expert on the adequacy of the exchange ratio.

Further requirements apply to listed companies:

  • when the plan is approved by the general meeting, the resolution will be subsequently ratified by the court and published in the Official Gazette;
  • the companies' creditors have a month period to lodge objections to the merger through the court. Anyway this month period can be avoided or reduced when all creditors are totally paid, or sufficient funds are deposited in a bank, or when the companies involved in the merger give sufficient guarantees;
  • the court has wide discretion to deal with dissenting creditors;

When the two month period expires, the merger is completed and legally implemented in accordance with the relevant formalities.

The form of leveraged buy-out for acquisitions is becoming more and more common. A number of points in relation thereto are specifically relevant under Italian law. In respect of loans/guarantees for the purchase of own share prohibited, it should be noted that pursuant to Italian law the target company is not allowed to participate in the purchase, either by lending the purchaser the necessary amount or by providing any form of guarantee for the finance obtained for the purchase.

In view of the prohibitions in Italy a financial assistance it is usual in Italy for LBO transactions to be carried out by the way of purchase, by a "holding" company (set up expressly by the purchases for these purposes) of all, or a majority of, the shares in the target company with the aid of a loan granted by the lender entity. The target company will subsequently be absorbed into the holding company through the merger of the two companies. The company resulting from the merger will accordingly be the debtor of the lender.

Although from time to time the question is raised as to the compatibility of the above structure with the prohibition contained in Article 2358, the general view, in both case law and doctrine, is that a leverage buy-out transaction, structured in the above way, does not constitute a breach of that prohibition. This happens because both the minority shareholders of the target company and the creditors will be protected by the means provided for in the Italian legal system.

In respect of the protection for minority shareholders and creditors it should be noted that any merger which eventually takes place between the target and the purchase will be subject to the provisions of the Civil Code. In particular, as mentioned above, both a report of the directors on the proposed merger, with particular attention to the exchange ratio, and a report from a court-appointed expert dealing with the adequacy of the proposed exchange ratio are required. The minority shareholders may also seek to oppose the resolution, claiming an abuse of power by the majority shareholder (i.e. the incorporating company), or a conflict of interest. Likewise the adequacy of the exchange ratio may be contested, although, as mentioned above, this is subject to verification by an independent expert. Creditors are given a degree of protection by the two month period in which they can lodge objections together with the court's discretion to order guarantees or resolution of any valid objection to the merger.

When the leveraged buy-out structure is used for an acquisition, it is necessary to consider any additional risk which may arise (in particular those relating to the delay to the merger transaction), whether as a result of a possible challenge to the merger resolution by minority shareholders or by opposition thereto by creditors once the resolution has been approved.

3. Methods of calculating and paying the consideration

The provisions of the Civil Code (Article 1346 c.c.) specify that in a sale contract the price must be determined or determinable, otherwise the agreement will be null and void. By "determinable" is meant that, at the time of the execution of the contract, only the criteria of the subsequent determination of the amount to be paid have been clearly expressed.

As in most international transactions, it is common for the parties to refer the exact determination of the price (including post-closing adjustments) to a third party or parties, as permitted by the Civil Code (Article 1473). The usual practise is both to appoint jointly a firm of auditors (in which case it is advisable for the parties to execute a joint and irrevocable mandate to the selected firm, annexed to the agreement), and to each designate a firm of auditors and select a third firm to act in the event of disagreement between the first two firms.

In both cases the party (ies) designated will act in the capacity of arbitrator(s). The Civil Code provides (Article 1349) that unless the parties expressly state otherwise, the arbitrator is obliged to proceed on an equitable basis (rather than leaving the determination entirely to his discretion). In the event that the third party fails to carry out the determination, or such determination proves to be inequitable or erroneous, the parties may refer the question to be determined by the court.

Generally, in the course of carrying out the determination as to price, disputes arise (such as in relation to the interpretation of the criteria for the determination). They may cause co-ordination problems with any general arbitration clause there may be in the contract for the resolution of dispute. The parties usually specify (when necessary) that the relevant firm of auditors will have the power to effect an "informal" arbitration (arbitrato irrituale) by specifying that their determination will be final and binding as if it had been expressed by the parties at the outset as their contractual intention.

If the parties fail to make provision for the situation where the third party designated is unwilling or unable to accept the appointment or (where the designation is deferred), the parties are unable to agree on the party to be appointed, then either parties may, according to the Article 1437 c.c., request the President of the competent court to designate such a person.

The valuation of the target and the calculation of the price to be paid for it are carried out in accordance with the financial and accounting principles, generally accepted in most international transactions.

Where the price is not determined in the contract itself, it will usually be determinable (and where necessary adjustable post closing) by reference to the application of specified parameters or formula. It is also relatively common for the price to be determined in the contract in part, but with the remainder being contingent insofar as it is conditional on a future event (?)(such as the outcome of litigation or the issue of a provision of a public authority).

It is important for the parties to specify how the costs of the transaction are to be allocated. Under Italian law, unless expressly agreed, the purchaser will be liable for the expenses of the contract of sale and other incidental expenses.

Where payment is made in cash it is usual to specify the value date of the payment.

It was relatively rare to find payment in kind in Italian share purchase transactions, but it is becoming increasingly common for at least a part of the purchase price to be paid in this way. Payment in kind may be made with assets (typically immovable assets), shares or bonds.

When in a purchasing company the payment is to be made by shares the following should be taken into consideration:

when payment is made by way of the purchasing company's own shares, they must be legitimately held by the purchasing company within the limits set out in the Civil Code (Article 2357) in relation to the acquisition of their own shares. The nominal value of a company's share may not exceed a tenth of the share capital. Because of this calculation shares held by controlled companies are also taken into consideration;

as an alternative to the above, the purchasing company may issue shares in favour of the vendor in one of the following ways: - by contribution of the shares of the target company into the purchasing company against an increase in the share capital which is reserved to the vendor (in this case, the transaction will assume the legal form of an exchange); - by effecting a merger through an incorporation, i.e. the target company will be incorporated by merger by the purchasing company on the basis of a pre-agreed exchange ratio. In exchange, the vendor will receive shares by the purchaser.

Payments may sometimes be made with bonds, although this is usually the case of a quoted company. This happens when the bonds are convertible. Where the purchaser issues convertible bonds in favour of the vendor, then the problems raised by the provisions of the Civil Code in this respect (Article 2441) will have to be dealt with, namely the question of pre-emption rights and the potential exclusion or restriction thereof.

Where the entire amount of the price is to be paid on the closing date no particular problems arise.

Where payment of a part or the whole of the purchase price is to be made after the closing date, or where subsequent adjustments to the price are provided for, then the question of security for the due payment becomes relevant.

4. Guarantees

Where the purchaser belongs to a large group of companies, the vendor may decide to accept a parent company guarantee.

The most commonly used form of guarantee is that of a bank guarantee. Usually the agreed text of such a guarantee are attached to the contract by way of exhibit.

A further form of security consists in creating a pledge in favour of the vendor on the shares sold in the target company. As, however, this is not a very satisfactory form of security, it is not often used. It is sometimes adopted as an additional form of security, although it can give rise to a number of problems regarding the voting rights and the management powers of the purchaser.

Pursuant to Italian law, where the contract creating the pledge is silent as regards the allocation of voting rights, these latter will pass to the creditor, and therefore to the vendor (Article 2352). Unless this issue is agreed upon between the parties, the purchaser may have some problems with the management of the company. If the purchaser negotiates the retention of the voting rights, and controls the management of the company, the pledge will be reduced to a paper guarantee and the purchaser will be free to dispose of vital assets. It should also be noted that even if the vendor negotiates a restriction on the management powers, such limitations cannot be enforced against third parties.

5. Withholding of purchase price and set-off rights

In the event of a deferred purchase price, the purchaser can withhold part of the purchaser price or indeed exercise a set-off right if a potential claim for breach of the contractual representations and warranties is discovered before the due payment date.

Where not express provision is made in the contract, the a "legal set-off" (i.e. without prior recourse to the courts) may only be exercised if the conditions specified by the Civil Code (Article 1243) are satisfied. In particular, debts must be both liquidated and enforceable. As in general the purchaser's claim does not respond to these criteria, in the absence of specific contractual provisions, the purchaser will be required to apply for judicial set-off.

In view of the above, this issue is dealt with one of the two following ways:

In favour of the vendor: by way of a clause providing that the purchaser may only reduce the deferred payment due in respect of the price if, and to the extent that, his claim for breach has either been accepted by the vendor or recognised in an enforceable judgement or arbitration award before the due payment date. Where the dispute is still open, the purchaser will not be entitled to suspend payment.

In favour of the purchaser: by way of a clause providing for a payment to be made in escrow, either when such dispute arises, or when the purchaser deposits a part of the purchase price for a specified period of time. In both cases irrevocable instructions will be issued to the escrow agent (usually, but not necessarily a bank) in relation to the release of the funds deposited at the end of the dispute between the parties.

6. Pre-contractual stage of an acquisition.

During the negotiations which are meant to lead to the termination of a contract, the parties have to act in good faith (Article 1337). The breach of this duty will result in pre-contractual liability (a kind of liability in tort). As a consequence of that the injured party will be entitled to claim damages for the suffered loss.

In general the compensation will lie for the so-called "negative interest" of the party in question, i.e. the interest resulting from the waste of time and costs. In this case the injured party can claim damages (together with damages for lost opportunities), including legal fees, travel expenses.

Until recently there was a criticised limitation on the lost opportunities. The lost `opportunity` was required to be as advantageous as the one never occured and of the same type. However, in 1993 a decision of the Court of Cassation held that sometimes damages could be recovered if the lost contract is of a different type to and/or less advantageous than the one which had been the subject of fruitless negotiations.

In Italy it is common for confidentiality and `stand-still` agreements to be entered into during the negotiation period of the transaction. They are usually contained in the same document. In the event of breach, a claim for damages will lie against the party in breach, although specific performance will not usually be available. As this kind of `confidentiality agreement` is a contractual document, the injured party will be able to recover damages for the loss suffered and not just the compensation for `negative interest` mentioned above in relation to pre-contractual liability. Any agreement not to sell the shares or assets of the company for a certain period of time will only be binding inter parties and cannot be enforced against a third party.

In respect of letters of intent, it should be noted that the question of whether heads of agreement or letters of intent will constitute a valid and binding agreement under Italian law will depend on specific circumstances of each individual case.

It should be borne in mind that under Italian law an `agreement to agree` will in certain circumstances be valid and binding. In this case specific performance thereof can be obtained from the Italian courts. In order to avoid making a valid and binding contract, careful wording will therefore be required. One common method is to provide for a number of conditions to be satisfied before the parties proceed to draw up the definitive contract. It should be noted that a contract will be null and void where a party has undertaken to dispose of a right or to assume an obligation subject to a condition, whose satisfaction depends entirely on the mere discretion of that party. It should also be borne in mind that even where the parties enter into a non-binding letter of intent from which they are free to withdraw, the duty to act in good faith mentioned above will still apply.

7. Due diligence

In Italy it is now common practice for a `due diligence` exercise or, although this is still relatively rare, a full legal audit, to be carried out in relation to a target prior to an acquisition. Although the depth of the investigation performed varies, the exercise will usually be performed by the purchaser's lawyers together with an auditing firm retained in relation to financial matters. In some cases a business/management audit may also be carried out by the purchaser and its financial advisors.

In general, the same matters are covered as inmost international transactions. Until recently, environmental questions were not so important as in other countries, but it is now becoming increasingly common for environmental audits to be effected as part of the due diligence exercise, often due to demand by foreign purchasers. The task is usually entrusted to technical firms specialising in this field.

In conducting a due diligence exercise in Italy, particular attention will generally be paid to issues relating to employees, social security matters and taxation. This will be considered below in relation to the relevant representations and warranties.

Pensions: the question of company pension schemes has not been of any particular relevance, as these are still relatively rare in Italy. However, in the light of the amended law relating to occupational pension schemes, which came into force in August 1995 as part of a general reform of the state pension scheme, it is possible that the situation will change as private pension schemes are becoming more and more common.

Social security payments: one particularly sensitive issue is that of social security payments. Due compliance with obligations in this respect should be checked at the due diligence stage as far as possible since the potential liability of the company can extend far beyond the usual contractual limitation periods agreed for claims under the representations and warranties.

One such example is in relation to obligatory pension contributions made by the company in respect of its employees. Even after the statutory limitation period within which the relevant social security department, INPS, can bring a claim against the company for unpaid or underpaid pension contributions has expired, and employee who discov0ers discrepancies in relation to pension payments made on his behalf is still entitled to bring a claim against the company.
Employment relationships: in comparison with many other countries, employment law is very highly regulated in Italy and the employees are considerably protected. This fact, together with the high cost of social security contributions, requires a careful examination. The following are accordingly some of the matters to be checked in relation to employees:

the contractual terms agreed in relation to each employee must be checked to ensure that they reflect at least the minimum compulsory conditions (including salary) provided for in the relevant collective agreement. The `collective agreements` are nation-wide agreements negotiated and entered into between the Unions, on the one side, and the employers' associations on the other side, and are generally renewed approximately every three years. The basic and compulsory provisions thereof may not be excluded by agreement between the parties. The employee's duties must reflect those in respect of which he/she was employed, as any `demotion` is not permitted;

as a general rule, any and all sums, including any benefits in kind will be considered part of the salary and these should therefore have been included therein for the calculation of social security contributions and termination indemnities ("Trattamento di Fine Rapporto - TFR");

any agreement concluded with an employee upon the termination of employment should be checked as this may be declared null and void if challenged by the employee within 6 months from the termination of the employment or of the execution of the settlement agreement, whichever is later, unless the agreement was executed before the competent Labour Office or Labour Court or with the assistance of the Unions under a special procedure.

Contracts: certain contracts entered into by the company should be carefully examined. For exmple, consultancy and agency agreements should be examined in order to ensure that they do not conceal, in substance, employment relationships. In determining whether or not a consultancy or agency agreement is really such, it is important to determine if the worker's services are actually peformed. If the agreement should subsequently be declared by the courts to be an employment relationship (whether as the result of a claim in this respect brought by the worker in question or as a result of an inspection carried out by INPS), then the employer would be in breach of several employment law obligations including those in relation to social security payments and taxes. The resulting fines and back-payments can be considerable.

So-called "distribution" contracts should also be examined with care to ensure that they are not "agency" agreements, the latter being specifically regulated by the provisions of the Civil Code. "Agents" receive protection under the employment law provisions, which require the principal to pay certain contributions and also to make provision for the severance indemnity payment due. A party (including a company) carrying out agency activity in Italy is required to be enrolled in the register of commercial agents and therefore must respond to what required for the enrolment. Agency contracts entered into with an agent which is not duly registered will be null and void.

Trade marks: it should be noted that it is not possible in the course of a due diligence exercise to give an opinion on the validity of a trade mark. Indeed for the approval of an application for the registration of a particular trade mark, the Italian trade mark registry will only check that the formal requirements have been complied with. No search as to prior use will be made, and the registration is therefore not subject to ascertainment of validity. The validity of a particular mark will accordingly remain subject to challenge by a third party for infringement.

The above matters (together with the usual questions investigated during a due diligence) will also be dealt with in the sale agreement by way of appropriate representations and warranties.

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