Specific Performance

What does specific performance mean?

Specific performance (German: Erfüllung in Natur) refers to the claim to demand from the other contracting party the agreed performance itself, instead of merely receiving damages in money. German law speaks simply of the claim to performance (Erfüllungsanspruch); it is enforced by an action for performance (Erfüllungsklage, suit for specific performance). In a company purchase, it concerns above all the buyer's obligation to pay the purchase price and take delivery of the shares, and the seller's obligation to transfer the shares.

Anyone who has bought a particular plot of land wants to get the land and not merely money for not getting it. This difference between the performance itself and its monetary value is what specific performance is about.

The term comes from the common law, the law built on court decisions in England, the USA and other English-speaking states. There, specific performance is the exception. Under German law, by contrast, the claim to performance is the rule. The question has practical significance when a party no longer wishes to complete after signing (signing) although all closing conditions have been met. In the purchase agreement, the relevant rules are found in the rights for breaches of duty, in compensation payments and in the clause on governing law and jurisdiction.

The claim to performance under German law

From an obligation, the creditor can demand performance (Section 241(1) of the German Civil Code, BGB). In a sale, the seller is obliged to transfer the object of sale, and the buyer to pay the purchase price and to take delivery (Section 433 BGB). For the purchase of shares in a company, these provisions apply accordingly (Section 453(1) BGB). Both performances are to be rendered concurrently (Zug um Zug), that is, performance against counter-performance; a court accordingly orders performance against receipt of the counter-performance (Section 322 BGB).

Damages in lieu of performance are tied to additional conditions, as a rule a period for performance that has expired without success (Sections 280, 281 BGB). Once the creditor has demanded damages in lieu of performance, it can no longer return to performance (Section 281(4) BGB). A purchase agreement under German law therefore needs no special clause for performance to be demanded. Conversely, the parties can restrict the claim to performance by contract, for example by agreeing a payment as the final legal consequence.

Common law and international contracts

In English and US law, damages are the primary remedy. There, specific performance stems from equity, a separate branch of English law. The court grants it at its discretion if money does not adequately compensate the loss. In company purchases, this is more readily assumed because of the uniqueness of the object of sale. US purchase agreements therefore regularly contain a clause in which the parties acknowledge in advance that damages are not sufficient and grant each other the right to performance and injunctive relief. In purchases by financial investors, it is common in the US market that the seller can demand performance only if the debt financing is available and is otherwise limited to a compensation payment.

For a contract under German law, such a clause has only clarifying significance. If the contract is subject to foreign law, for example because a US buyer insists on it, that law determines whether and under what conditions performance can be demanded. The choice of law and jurisdiction (governing law and jurisdiction) thus has a direct effect on the legal consequences of a breach of contract.

Enforcement

Purchase price and shares

The claim to the purchase price is enforced by an action for payment and executed like any monetary claim. It is worth only as much as the buyer's assets. If a specially formed acquisition vehicle without assets of its own acquires, sellers therefore demand security: a financing commitment from the shareholders, a guarantee from the parent company, a bank guarantee or a deposit in an escrow account. The buyer enforces the claim to transfer of the shares by a judgment ordering the seller to make the assignment declaration; once the judgment becomes final, the declaration is deemed to have been made (Section 894 of the German Code of Civil Procedure, ZPO). Often this is not even necessary: German purchase agreements frequently declare the assignment already in the deed, subject to the condition precedent of payment of the purchase price. If the buyer pays, the share then passes without further cooperation by the seller.

Cooperation and services

Non-substitutable acts, that is, those that only the obligated party itself can perform, such as providing information, are enforced by coercive fines or coercive detention (Section 888(1) ZPO). Enforcement is excluded where someone has been ordered to render services under a service contract (Section 888(3) ZPO). Founders and managing directors therefore cannot be compelled by a court to continue working. Their commitment after the sale is therefore structured economically, for example through an earn-out (a part of the purchase price dependent on later business success) or retention bonuses.

Duration and procedure

An action for performance can drag on for a long time. Company purchase agreements often provide for arbitration, which is confidential and can lead to a decision more quickly. Interim legal protection, that is, a provisional order in expedited court proceedings, remains possible before state courts alongside it, for example to prevent a seller from disposing of the shares elsewhere.

Worked example: specific performance or damages

A buyer has committed to acquire a company for EUR 30 million. All closing conditions have been met, but the buyer nevertheless refuses to complete. The seller compares its options:

• Performance: action for payment of EUR 30 million concurrently against transfer of the shares.
• Damages in lieu of performance after an unsuccessful setting of a deadline for performance: The seller sells the company nine months later to another buyer for EUR 26 million. In addition, it incurs transaction costs of EUR 0.6 million. Loss: 30 minus 26 plus 0.6 = EUR 4.6 million.
• Final compensation payment: If the contract provides for a reverse break-up fee of EUR 1.5 million as the sole legal consequence, the seller receives only this amount. That is EUR 3.1 million less than the calculated loss.

Benefits that accrue to the seller in the nine months, such as profits of the company, would be credited against the loss in a dispute; the example disregards them for simplicity. It shows why sellers pay attention to whether a compensation payment excludes the claim to performance, and why the value of an action for performance depends on the buyer's ability to pay.

Distinctions: specific performance, damages and withdrawal

• Damages in lieu of performance: replaces the performance with money and as a rule requires a deadline to be set. After that, performance is excluded.
• Reverse break-up fee: an agreed payment for the failure of the transaction. Whether it stands alongside the claim to performance or replaces it is determined by the contract.
• Withdrawal: ends the performance obligations and leads to unwinding. After closing, purchase agreements regularly exclude it.

Common mistakes

• Compensation payment unintentionally final. If a payment is formulated as the sole legal consequence, the claim to completion lapses.
• Acquisition vehicle without security. A claim to performance against a company without assets and without a commitment from its shareholders is economically empty.
• Premature switch to damages. Anyone who demands damages in lieu of performance loses the claim to performance for good.
• Binding individuals through the purchase agreement. The cooperation of founders cannot be enforced and must be secured through incentives.
• Choice of law without regard to the legal consequences. Under foreign law, performance may depend on conditions that German law does not know.

Frequently asked questions

Does specific performance have to be agreed in a German purchase agreement?

No. Under German law, the claim to performance exists by operation of law. A clause is needed only if the contract is subject to foreign law or is meant to restrict the claim.

Can the seller force the buyer to complete?

In principle yes. It can sue for payment of the purchase price concurrently against transfer of the shares. Economically, success depends on whether the buyer is solvent or has provided security.

Can the buyer enforce the transfer of the shares in court?

Yes. The court orders the seller to make the assignment declaration, which is deemed to have been made once the judgment becomes final.

Can founders be obliged to continue working after the sale?

By contract yes, but the obligation cannot be enforced. The law excludes enforcement of services under a service contract.

Does an agreed compensation payment exclude the claim to performance?

Only if the contract designs it as the final legal consequence. If it is agreed as a contractual penalty, the creditor can demand it instead of performance under Section 340(1) BGB, but must decide on one of the two.

The Roemer Capital view

When comparing offers, we ask what a claim to performance against the respective bidder is worth economically. That depends on which company buys, what assets it has and what evidence of financing is available. A bid through an acquisition vehicle without a commitment from its shareholders is weighted differently by us from a bid with a parent company guarantee.

When compensation payments are negotiated, we work through with the client what loss they cover in the worst case and whether they should leave the claim to completion unaffected. The wording of the contract text is for the client's law firm.