Ordinary Course of Business

What does ordinary course of business mean?

Ordinary Course of Business (in German: gewöhnlicher Geschäftsgang) denotes, in a company purchase agreement, the standard by which the seller must continue to run the target company between signing and closing. Closing means the handover of the shares against payment of the purchase price. Until then, the company is to continue within the scope of its previous business operations and in line with previous practice. This standard is supplemented by a catalogue of measures that are permitted during this time only with the buyer's consent.

The principle resembles the sale of a house in which the seller continues to live until handover. The seller may live there as before but may not move walls, lease out the garden or remove the heating.

In German contracts, these provisions are called Fortführungspflichten or Verhaltenspflichten bis zum Vollzug (duties to continue the business or duties of conduct until closing); in English usage they are interim covenants, and the contract clause is called the ordinary course clause for short. They protect the value on which the purchase price is based during a period in which the seller is still the shareholder but the buyer is already bound. They matter whenever weeks or months lie between signing and closing, for example because of a merger control review. They complement the purchase price mechanism: under the locked box mechanism (a fixed purchase price based on a balance sheet from before signing), separate rules prohibit value leakage to the seller, such as distributions. The duties to continue the business, by contrast, cover the business as a whole.

Legal implementation for a GmbH

The seller does not run the target company's business itself. It therefore undertakes to ensure that the company complies with the agreed rules. For a GmbH (German limited liability company), this is done through the shareholders' rights: the managing directors must observe restrictions imposed on them by the articles of association or shareholder resolutions (Section 37(1) of the German Limited Liability Companies Act, GmbHG). Where there are several sellers, such as founders and investors, they act jointly through the shareholders' meeting.

Externally, the management's power of representation, that is, its authority to bind the company towards third parties, remains unrestricted (Section 37(2) GmbHG). If the management concludes a transaction without the agreed consent, it is as a rule effective towards the counterparty. The buyer is then dependent on claims against the seller. The management remains responsible for running the company; instructions from the shareholders are binding on it only within the limits of what the law permits.

Consent catalogue: examples and exceptions

A typical catalogue makes the following measures dependent on the buyer's consent:

• amendments to the articles of association, capital measures and the issue of new real or virtual shares
• profit distributions and other payments to shareholders
• new financial liabilities and the granting of security
• investments above an amount in an individual case or beyond the budget
• conclusion, material amendment or termination of contracts above an annual value
• hiring and dismissal of senior managers as well as pay rises outside the usual adjustment
• acquisition and disposal of participations, real estate and intellectual property rights
• initiation and settlement of legal disputes above an amount in dispute
• changes to accounting and valuation methods

Usually excepted are measures that are in the budget, required by law, provided for in the purchase agreement or that cannot be postponed in an emergency. An exception for replacement hires on comparable terms is common. So that the company remains able to act, consent is often deemed given if the buyer does not object within a few business days, and it may not be unreasonably withheld. Positive duties are added: maintaining insurance and intellectual property rights, paying invoices at the usual rhythm, not collecting receivables early. The last two points prevent liquid funds and net current assets (working capital, roughly: inventories and customer receivables less supplier payables) from being artificially shifted at the closing date and distorting the working capital adjustment of the purchase price.

Limit set by the competition law prohibition on closing

If the transaction is subject to merger control, a prohibition on closing applies until clearance (Section 41(1) of the German Act against Restraints of Competition, GWB; for EU proceedings Article 7 of the EU Merger Regulation). During this time the buyer may not exercise decisive influence over the target company, that is, may not co-determine its business policy. A catalogue that gives the buyer a say in day-to-day business, for example on prices, individual customer offers or personnel decisions below management level, can be treated as premature closing. The competition authorities can impose fines for this. Consent reservations that protect the value of the company and concern extraordinary measures are permissible.

If buyer and target company are competitors, the cartel prohibition additionally limits the exchange of information. Prices, terms of individual customers and strategic plans may be exchanged before closing only within a ring-fenced group, usually a clean team of a few persons or external advisers. Integration planning may be prepared but implemented only after closing. Investment screening has its own prohibition on closing, which among other things restricts the passing of security-relevant information to the acquirer.

Practical example: ordinary course of business until merger clearance

A software company with revenue of EUR 24 million, mainly in Germany, is sold to a competitor in March. Because of a main examination proceeding at the Federal Cartel Office (Bundeskartellamt), closing is possible only in August. The purchase price is settled as of the closing date through completion accounts. Consent is required for investments above EUR 150,000 in an individual case, contracts with an annual value above EUR 500,000 and hires with an annual salary above EUR 120,000. Until closing, the following cases arise:

• The head of sales resigns. The successor receives EUR 130,000, and the predecessor earned EUR 135,000. The exception for replacement hires applies; no consent is needed.
• A major customer offers a three-year contract with an annual value of EUR 700,000. The threshold is exceeded, and the buyer consents within the period. Because the buyer is a competitor, only its clean team sees the prices and terms.
• A server investment of EUR 180,000 is in the approved budget and is therefore permissible without consent.
• The buyer wishes to co-determine the prices of an ongoing offer. This would breach the prohibition on closing and the cartel prohibition; management decides alone.
• The finance function considers holding back supplier invoices until after closing. This breaches the duty to pay at the usual rhythm. The higher cash balance would also be largely offset through the purchase price adjustment, because the open invoices reduce working capital.

The catalogue thus lets day-to-day business continue and puts to the buyer only decisions that can noticeably change the value of the company. The line to impermissible influence is drawn by the prohibition on closing and the cartel prohibition.

Distinctions: duties to continue the business, protective provisions and leakage

• Protective provisions: permanent consent rights of investors after the closing of a financing round. Duties to continue the business apply only until closing.
• Extraordinary transactions in GmbH law: even without a purchase agreement, the management of a GmbH must, according to the prevailing view, put unusual measures of fundamental importance to the shareholders. The duties to continue the business, by contrast, are owed to the buyer and usually go further.
• Prohibition of value leakage: in the fixed-price procedure, concerns payments to the seller. The ordinary course of business covers the entire management of the business.
• Ordinary course of business in stock corporation law: at listed companies, larger transactions with related parties (related party transactions) need the consent of the supervisory board (Section 111b of the German Stock Corporation Act, AktG). Transactions in the ordinary course of business on customary market terms are excepted (Section 111a(2) AktG). There the law defines the term; in the purchase agreement the contract does.
• Material adverse change: attaches to the outcome of a deterioration, the duties to continue the business to the seller's conduct.

Common mistakes

• Thresholds too low. A catalogue that already makes usual orders or hires subject to consent paralyses the business for months.
• Say in day-to-day business. Consent rights over prices or individual offers jeopardise compliance with the prohibition on closing.
• No deadline for consent. Without deemed consent, the buyer can delay decisions by remaining silent.
• No exception for budget and replacement hires. The company then cannot implement even its own planned measures.
• Unfiltered exchange of information. Competitively sensitive data that goes to a competing buyer without a clean team creates a competition law risk.

Frequently asked questions

What belongs to the ordinary course of business?

Everything the company has regularly done so far: accepting orders, paying suppliers, hiring staff within the usual scope, developing the product further. Measures that noticeably change structure, financing or value do not belong, such as capital measures, distributions or unplanned major investments. In case of doubt, the comparison with previous practice decides.

May the company hire and dismiss employees until closing?

Yes, within the ordinary course of business. Usually only senior managers and pay above a threshold require consent. Dismissal without notice for good cause (Section 626 of the German Civil Code, BGB) is as a rule excepted, if only because it must be declared within two weeks (Section 626(2) BGB).

What are the consequences of a breach by the seller?

In the first place damages or a contractually agreed indemnity. If compliance is at the same time a closing condition, the buyer can refuse closing in the event of a material breach.

Do duties to continue the business also apply in financing rounds?

In a shorter form, yes. Even if the participation agreement and the capital increase are notarised on the same day, the capital increase takes effect only upon entry in the commercial register (Section 54(3) GmbHG). Participation agreements therefore often contain duties of conduct for the time until entry. After that, the investors' consent rights under the shareholders' agreement apply.

May the buyer take part in decisions before closing?

Not in day-to-day business. If the transaction is subject to merger control or investment screening, only consent rights that protect the company's value are permissible.

The Roemer Capital view

Roemer Capital aligns the consent catalogue with the client's budget and planning before signing. The thresholds should suit the size of the company, the budget should count as an exception, and the consent procedure must be able to run through within a few days. Planned hires, larger contracts and investments for the period until closing are listed and discussed with the buyer before signature.

If closing drags on for months because of a merger control review, Roemer Capital makes sure that the catalogue does not hold back the growth on which the purchase price is based. The drafting is done by the client's law firm.