Closing Conditions

What are closing conditions?

Closing conditions (in German, Vollzugsbedingungen, also called conditions precedent) are the prerequisites set out in a company purchase agreement that must be met after signing before the parties are obliged to complete the agreement. Closing means that the shares pass to the buyer and the purchase price is paid. Typical conditions are regulatory clearances, approvals of bodies and contracting parties, and confirmation that the seller's warranties remain accurate on the closing date. Warranties are binding assurances by the seller about the condition of the company, such as regarding contracts, taxes or legal disputes.

An everyday picture is buying a house at the notary: the contract is signed on one day, but the purchase price falls due only when the notary confirms that certain prerequisites are met, such as the entry of a priority notice in the land register. In a company purchase, closing conditions perform this function.

Closing conditions exist when signing and closing are separated in time. They are set out in the share purchase agreement or, in an asset deal (purchase of individual assets instead of the shares), in the agreement for the purchase of the assets. They appear less often in participation agreements for funding rounds.

Signing and closing

With signing, the purchase agreement is concluded and binds both sides. In the sale of GmbH shares (German limited liability company), it coincides with the notarial recording (Section 15(3) and (4) of the German Limited Liability Companies Act, GmbHG). Transfer of the shares and payment follow only at closing, often weeks or months later.

In German contracts, the assignment of the shares is often already declared in the deed, but subject to the condition precedent of payment of the purchase price (Section 158(1) of the German Civil Code, BGB). The closing conditions determine when the parties must carry out the closing actions: payment of the purchase price, repayment of existing financing, release of collateral, resignations from office and handover of documents.

If no approvals or consents are needed, signing and closing can fall on the same day. This is more common in funding rounds than in sales to strategic buyers, that is, to companies from the same or a related industry. To be distinguished from closing is the economic reference date from which results belong to the buyer. With the Locked Box Mechanism (fixed purchase price on the basis of a balance sheet before signing), it lies before signing. With Completion Accounts (settlement of the purchase price as at the closing date), it is generally the closing date.

Regulatory clearances

Merger control and standstill obligation

Merger control examines whether a concentration of companies significantly impedes competition. If the companies involved reach the turnover thresholds of Section 35 of the German Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen, GWB), the concentration must be notified to the Federal Cartel Office (Bundeskartellamt) before closing (Section 39 GWB). Until clearance or until the review periods expire, a standstill obligation applies (Section 41(1) GWB). Legal transactions that breach it are void, and fines are also possible. For technology companies, the transaction value threshold is also significant: with a very high purchase price, it can trigger a notification obligation even if the target company generates little revenue but is active in Germany to a considerable extent. The thresholds as currently in force are decisive.

The preliminary review phase lasts one month from receipt of the complete notification (Section 40(1) GWB). If the authority has concerns, it opens the main review phase within this period. It must then in principle decide within five months from receipt of the complete notification (Section 40(2) GWB), otherwise the concentration is deemed cleared. The period can be extended, for example with the parties' consent or if they offer commitments. Clearance can be made subject to conditions and obligations (Section 40(3) GWB), such as the sale of a business unit. How far the buyer must accept such obligations is regulated by a Hell or High Water Clause. If a concentration reaches the thresholds of the EU Merger Regulation, the European Commission in principle carries out the review.

Investment screening under foreign trade law

Investment screening protects public security. It concerns investors based outside the EU and the European Free Trade Association (Iceland, Liechtenstein, Norway, Switzerland). If such an investor acquires voting rights in a German company, the Federal Ministry for Economic Affairs can review the acquisition under the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz) and the Foreign Trade and Payments Ordinance (AWV). In security-relevant areas, such as critical infrastructure, artificial intelligence, robotics or semiconductors, a notification obligation applies from certain voting-right shares.

Until clearance, a notifiable acquisition is provisionally ineffective (schwebend unwirksam), that is, without legal effect for the time being, and a standstill obligation applies. Sectors and thresholds follow from the version of the AWV in force at the time. Funding rounds can also be covered if an investor from outside the EU takes over shares.

Approvals of bodies and third parties

Approvals under company law

Under Section 15(5) GmbHG, the articles of association can make the assignment of shares subject to further requirements, in particular the approval of the company (restriction on transfer, Vinkulierung). In companies with investors, pre-emption rights (co-shareholders may buy the shares themselves) and tag-along rights (they may sell their shares along) from the shareholders' agreement are added, which the beneficiaries must waive. Such declarations can usually be obtained before or at signing and then no longer belong in the list of conditions.

Approval reservations on the buyer's side, such as of a supervisory board or a parent company, are critical. If such an approval has to be obtained only after signing, the buyer in effect decides freely whether to complete. Sellers therefore require that it is available at signing.

Approvals of contracting parties

Customer, supplier, licence, lease and financing agreements often contain clauses for the case of a change of control (Change of Control) that give the counterparty a termination or consent right. In an asset deal, the transfer of a contract in principle requires the counterparty's consent anyway. A graduated approach is common: only indispensable consents become conditions, while for the others an obligation to use efforts applies, with separate regulation of the economic consequences of a refusal.

Further conditions, waiver and deadline

Besides clearances and approvals, purchase agreements often contain the following conditions:

• Accuracy of the warranties: The seller's warranties must be accurate in all material respects on the closing date, fundamental warranties such as ownership of the shares in full. This is confirmed by a Bring-Down Certificate.
• No material adverse change: a Material Adverse Change clause, which is agreed more cautiously in German transactions than in the US market.
• Compliance with conduct-of-business obligations: The seller has run the company in the ordinary course of business until closing (Ordinary Course of Business).

Sellers as a rule reject a financing condition. Instead, the buyer demonstrates at signing that the funds are available, for example through a financing commitment from its shareholders or a binding loan commitment.

Waiver of conditions

A condition that serves solely to protect one party can, under the contract, regularly be waived unilaterally by that party, such as the buyer waiving confirmation of the warranties. The contract should specify who may waive and in what form. Statutory clearances cannot be waived, because the standstill obligation applies independently of the contract. If a party prevents a condition from occurring contrary to good faith, it is deemed to have occurred under the legal principle of Section 162(1) BGB.

Long stop date

So that the state of limbo does not continue indefinitely, the contract specifies a latest date for the conditions to be met, the Long Stop Date. If the conditions are not met by that date, each party that is not responsible for the failure acquires a right of withdrawal. If closing fails because of a missing clearance, the buyer may owe an agreed compensation payment (Reverse Break-Up Fee).

Practical example

A software company with revenue of around EUR 25 million, most of it in Germany, is sold for EUR 90 million to an industrial group based in the US. Its products are used by grid operators in energy supply. Both sides reach the German merger control turnover thresholds. The sequence:

• Signing and notarial recording on 3 March; the assignment is subject to the condition precedent of payment of the purchase price.
• Closing conditions: merger clearance, foreign trade law clearance because the software concerns critical infrastructure, and accuracy of the warranties on the closing date.
• The largest customer, with around 14% of revenue, can terminate on a change of control. Its consent is not a condition; both parties must use efforts to obtain it. It agrees in April.
• Notification and filing on 17 March; merger clearance in the preliminary review on 10 April, foreign trade law clearance on 12 May.
• Closing on 26 May: confirmation of the warranties, payment, occurrence of the condition precedent, filing of the new shareholder list by the notary.

The Long Stop Date was 31 October, with a three-month extension if only the foreign trade law clearance is still outstanding. A main review phase that would have ended five months after notification, that is, on 17 August at the latest, would also have been covered. Exactly twelve weeks passed between signing and closing: the short list of conditions allowed a quick closing, and the Long Stop Date protected both sides against a longer review.

Distinction from related terms

• Closing actions: the steps on the closing date itself. They follow the satisfaction of the conditions.
• Conduct-of-business obligations: obligations of the seller for the period until closing. Their breach can trigger damages, whereas the mere non-occurrence of a condition does not in itself give rise to a claim.

Common mistakes

• Subjective conditions. A reservation such as the buyer's satisfaction or the later approval of its bodies turns the contract into a one-sided option.
• Financing condition accepted. The seller then bears the risk that the buyer does not obtain its financing, although the seller has no influence on it.
• Third-party consents as a hard condition. A customer or landlord on whose consent closing depends can demand new terms for it.
• No provision on waiver. If it remains open whether claims relating to the underlying circumstance still exist after a waiver, a dispute arises after closing.
• Standstill obligation disregarded. If the buyer influences day-to-day business before clearance, fines and the invalidity of the closing transactions are possible.

Frequently asked questions

What happens if a closing condition is not met?

As long as a condition is outstanding, no closing takes place. If it is not met by the Long Stop Date, each party that is not responsible for this can withdraw. Each side then generally bears its own costs, unless a compensation payment has been agreed.

Are there closing conditions in funding rounds too?

Yes, usually in smaller number. Participation agreements make the payment of the investment conditional on, for example, the approval of the existing shareholders, new employment contracts for the management or clearance under foreign trade law. For payments in tranches, milestones are added.

Does the buyer pay compensation for the period until closing?

With the fixed-price approach (locked box), often yes. Because the results belong to the buyer from the reference date, the purchase price is often subject to interest for the period until closing, called a ticker or ticking fee in the market. With completion accounts, the purchase price is adjusted on the basis of the balance sheet at the closing date, so a separate compensation generally does not apply.

How long is the period between signing and closing?

That depends on the conditions: without regulatory clearances often a few days, with a merger control notification several weeks, with a main review phase or an in-depth investment screening several months.

The Roemer Capital view

In a sale process, we compare offers not only by purchase price but also by certainty of closing. This includes which conditions a bidder requires, how reliable its financing is and which clearances will probably be needed. We weight a bid with a financing condition or open approval by bodies lower than a somewhat lower bid without such reservations.

We clarify consents from customers, financiers and co-shareholders with the client before signing wherever possible, so that the list of conditions is limited to regulatory clearances. The law firm handles the drafting. We plan the time until closing in from the start, because every week of limbo ties up management, employees and customers.