Pre-contractual negotiations
  • Is there an implied duty of good faith to continue to negotiate?

    Entering into negotiations creates a fiduciary relationship (Treuepflicht) between the parties, which solidifies with the growing intensity of the negotiations. Out of this fiduciary duty results the duty to respect the rights and interests of the other party, such as, for example, the duty to prevent the other party from incurring damages in the context of the negotiations and to inform the other party of circumstances which are material to the other party in the context of the negotiations.

    In general, there is no duty of good faith to continue negotiations under German law. Should, however, one party give the other party reason to believe that a contract will soon come into effect and still break off the negotiations without good cause, the former party may be liable for any fruitless expenditure by the other party. In case an agreement requires notarisation, this rule only applies if a party willfully breaches its fiduciary duty (vorsatzliche Treuepflichtverletzung), for example by pretending an actually non-existent willingness to conclude a contract.

    What are the consequences of termination of negotiations by one party unilaterally?

    In general, the parties are free to terminate their negotiations, as stated above. However, if a party violates a pre-contractual duty arising from the fiduciary relationship through intentional or negligent action, German law allows the other party to claim damages.

    The other party may request to be placed in the same position as it would have been without the injurious conduct of the terminating party. In case of termination of negotiations, damages are either:

    reimbursement of expenses incurred by the non-defaulting party, as a result of its reliance on the completion of the proposed transaction, or
    compensation for the damage suffered by the non-defaulting party, as a result of the deal not being completed.

    What is the potential impact on third party rights?

    Fiduciary relationships may also exist towards or in favour of persons who are not parties to the contract (third parties). In particular, this is the case, (i) if such a third party substantially influences the parties’ negotiations or the execution of the contract or (ii) if the contract was intended to be to the benefit of a third party. The termination of the negotiations itself does not have any impact on third party rights unless other circumstances are present. Such circumstances could be, for example, that the third party relied on the conclusion of the agreement and was reasonably entitled to do so.

Confidentiality agreements
  • Are there implied confidentiality obligations where there are no formal confidentiality agreements entered into by the parties?

    Yes, the duty to treat any information disclosed in negotiations as confidential and to refrain from granting third parties access to this information arises from the pre-contractual obligation and the duty of good faith, in particular where the confidentiality obligations appear evident from the nature of the contract being negotiated. Hence, there is no general requirement for parties to enter into a confidentiality agreement.

    However, for practical reasons it is advisable to enter into a confidentiality agreement. First, Statutory confidentiality obligations are only applicable under certain fields of law and are subject to specific conditions that depend on the individual case. Secondly, the scope of such obligations may not always be clear, which makes it advisable for parties to enter into a confidentiality agreement and to clearly define which kind of information is considered to be confidential and which standard should be applied to protect such information.

    What are the consequences of breach?

    A breach may entitle the non-breaching party to damages or injunctive relief but, because of the difficulty in proving damage, remedies are often set out in the confidentiality agreement itself.

    Are any specific terms/formalities required for a binding confidentially agreement?

    Confidentiality agreements are binding between the parties. There are no specific formalities to be adhered to when entering into a confidentiality agreement. It is advisable to agree that alterations and termination of the agreement can only be made in writing.

Exclusivity arrangements
  • Can an obligation to negotiate exclusively be implied where no formal agreement has been entered into by the parties?

    As a basic principle of German Civil Law, the parties enjoy contractual freedom and hence are free to make their own decisions about who to negotiate with until an agreement is concluded. However, an obligation to negotiate exclusively may arise from the duty of good faith in cases where one party indicates to the other party that no other negotiations are running or will be commenced simultaneously.

    Are any specific terms/formalities required to make exclusivity arrangements enforceable?

    As for any other contract, exclusivity agreements are binding for both parties. There are no specific formalities to be adhered to unless the parties agree on such. Exclusivity agreements often set out specific penalties for breach of exclusivity in order to make the other party refrain from continuing to negotiate with third parties. However, when a penalty for breach of exclusivity is so high that such penalty constitutes, in fact, the obligation to conclude an agreement that later on requires notarisation itself (eg a share purchase and transfer agreement in a German Limited Liability Company), the exclusivity agreement will also need to be notarised.

Heads of agreement
  • Are they legally binding?

    Whether or not “heads of agreement” (Absichtserklärungen) are binding always depends on the wording and the parties’ intention in the individual case: it has to be ascertained from the wording whether the parties only intend to summarise the results of the negotiations which were made up to that date, or whether they intend to create a binding pre-contract (Vorvertrag).

    Designating a letter or agreement as “heads of agreement” (or any similar expression for a pre-contractual document, eg "letter of intent" or "memorandum of understanding") is generally considered to create a refutable presumption that the letter/agreement is not binding, but only reflects a summary of the current status of the negotiations. However, to avoid that the parties conclude a binding pre-contract without such intention, the wording in the relevant document should be sufficiently precise. This also applies in case the parties explicitly wish a "heads of agreement" to be binding.

    Even if a “heads of agreement” is not binding (ie the parties are not committed either to continuing negotiations or to entering into a definitive contract) it may contain single binding clauses on confidentiality, exclusivity, costs, applicable law and place of jurisdiction. Such clauses do not have an impact on the binding effect of the “heads of agreement” as a whole, but bind the parties only regarding the particular aspect contained therein. 

    In any event, it is advisable to clarify, whether a “heads of agreement” (in its entirely or only specific clauses therein) shall be binding or not by explicitly mentioning this point in the wording.

    Are any specific terms/formalities required to make them legally binding?

    If the “heads of agreement” contains specific wording that indicates that it has binding effect, the Agreement is binding on the parties. In general, no specific formalities are to be adhered while entering into a “heads of agreement”. However, in exceptional cases, for example, when a “heads of agreement” already constitutes the obligation to conclude an agreement that later on requires notarisation itself, the “heads of agreement” will also need to be notarised. In such cases, the “heads of agreement” serves as a kind of binding “pre-contract” (Vorvertrag).

    What are the consequences of breach?

    If a “heads of agreement” is non-binding, a party who violates such agreement by acting in bad faith may still be liable to pay damages for breach of fiduciary duty. Under such circumstances, the same principles apply as for pre-contractual negotiations.

    With respect to a binding  “heads of agreement” (or binding parts of a “heads of agreement”), the non defaulting party may claim damages or specific performance in respect of any obligations that have been violated, in accordance with the general rules of German law regarding the consequences of a breach of contractual obligations.

    Can heads of agreement have any tax implication/adverse consequences?

    If a binding “heads of agreement” leads to specific obligations, under certain conditions and depending on the nature of the respective obligation, the “heads of agreement” may have tax implications.

    If, for example, a binding clause of the “heads of agreement” refers to the transfer of German real estate or other similar rights, then subject to certain conditions, real estate transfer tax could be triggered already in this early stage of the transfer.

Break fees
  • Are break fees usually payable?

    The parties are generally free to agree upon a break fee, payable if one party terminates the negotiations. As break fees are often agreed as being part of Standard Contract Terms (Allgemeine Geschäftsbedingungen), the rules of effectiveness of such Standard Contract Terms have to be abided by.

    What are the main legal issues to be considered eg enforceability?

    Furthermore, the agreement of a break fee may not result in breach of good faith. This could, for example, be the case, if an obvious disproportion exists between the break fee and the overall economic value of the whole agreement itself.

    Furthermore, when a break fee is so high that such break fee constitutes the obligation to conclude an agreement that later on requires notarisation itself (for example, a share purchase and transfer agreement in a German Limited Liability Company), the agreement on the break fee will also need to be notarised.

    Besides the economic decision as to whether a break fee is the adequate instrument to cover the risk of failure of negotiations, break fees should be worded in a clear and understandable way.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.