M&A Vocabulary – Experts explain: Seller’s Knowledge

published on 11 January 2022 | reading time approx. 5 minutes

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner present an important term from the specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give or refresh a basic understanding of a term and provide some useful tips from our consultancy practice.

The terms “Seller's Knowledge” or “Seller's Best Knowledge” appear in almost all warranty schedules of sale and purchase agreements (also called “SPA”). In German-language agreements, the counterparts are “Kenntnis des Verkäufers” or “Bestes Wissen des Verkäufers”.

In the course of negotiations, however, it can be seen from time to time that both, that parties, often also including their lawyers, do not know the exact meaning of these terms and are therefore not aware of their appropriate use.

Introduction

The essential nature of warranties (Garantie) is that a warrantor is liable for a breach, regardless of whether he:

is responsible for its occurrence; and/or
knew or did not know of the underlying facts.

In the opinion of many sellers, this far-reaching liability is too extensive and they therefore seek to limit it. One way of limiting a warranty is to focus on the seller's knowledge of the subject matter of the warranty. And this is often achieved by the limiting it to the “knowledge” or “best knowledge”.

The following cases can be distinguished, which make this restriction appear reasonable:

the facts of the warranty include circumstances which are not within the purview of the seller; and
the facts of the warranty include circumstances that can hardly be fully considered by the management of a company.

How exactly these terms are used depends not least on which law governs the SPA.

Terms in German SPAs

If the terms “Kenntnis” and “Bestes Wissen” are not defined in a German law governed SPA or if the definition used is not complete, the terms are to be interpreted in accordance with the statutory German regulations.

In principle, “Kenntnis” is understood to mean the actual knowledge of information. Whereas “Bestes Wissen” also includes negligent ignorance (fahrlässige Unkenntnis) - therefore it is broader and thus less favourable for the seller.

However, it should be noted that even if a warranty is limited to “Kenntnis”, a seller cannot rely on not knowing about a fact. This is particularly true if the seller is also a (managing) director of the target company. In this case, the knowledge of his “organisation” - i.e., the knowledge available in the target company - may be imputed to the managing director. This imputation occurs if it is information that the seller, as part of the organisation, should be aware of in order to carry out his activity as managing director. Consequently, the limits of the term “Kenntnis” of a warranty are not as far as often assumed.

However, if the term “Kenntnis” is understood to go so far, the question arises as to where the difference lies between “Kenntnis” and “Bestes Wissen” - which also includes negligent ignorance. Here it is important to understand that negligent ignorance does not end with having overlooked something. Rather, the criterion of negligent ignorance results in a duty to investigate, i.e., the seller has to check whether there are facts that make the occurrence of the warranty seem likely and whether the warranty given is in order in terms of its scope. Only if this examination has been carried out successfully has the seller fulfilled his obligation in this respect.

Terms in English SPAs

With respect to SPAs governed by English law, where a warranty is qualified by “so far as the seller is aware,” “to the best of the seller’s knowledge,” or such similar language, the default position is that the seller is under a positive obligation to enquire into the subject matter of a warranty. Essentially, the seller may not escape liability by remaining wilfully ignorant of the issues affecting the target company’s business. The advantage for the buyer in this case is that the test of knowledge is a subjective one – i.e., matters that the seller should reasonably be expected to know about. This is particularly important in the context of a target company that is owned and managed by the seller; the seller may not rely on absence of knowledge as an owner when he should reasonably be expected to have the knowledge as the director. In practice, the buyer’s acceptance of a knowledge qualification will often be heavily negotiated, but is more likely to be accepted for warranties relating to forward-looking matters, than for the present or historic events in the business.

Where such a qualification has been accepted, it is important to consider what the seller must know, or is deemed to know. The seller will want to limit this to the actual knowledge he has without making any enquiries. Further, the seller will wish to avoid a definition of knowledge that includes constructive knowledge (knowledge that he ought to have) and imputed knowledge (knowledge that his advisors or agents may have, discussed further below). The buyer, in turn, will want a broad definition of knowledge, with the obligation on the seller to make all due, diligent and careful enquiries, providing the buyer with the comfort of warranties not having been given without this necessary due diligence.

In any case, if the seller accepts the obligation to conduct enquiries, it will often wish to restrict this as far as possible. Where the seller is a body corporate, it will want “seller’s knowledge” to extend only to a minimum number of individuals outside the seller organisation, if any. This may not be wholly acceptable to the buyer, who is unable to check if the list of individuals captures everyone who is likely to have knowledge of the subject matter of the warranty in question, due to its finite information about the target company at acquisition. A compromise position may involve the buyer accepting a lower standard of enquiry (i.e., reasonable enquiries), along with an express obligation to make enquiries of a non-exhaustive group including but not limited to, for example, the directors, key employees and professional advisers of the target company.

Knowledge of the seller’s representatives

Since a seller does not usually manage the sale of his company alone, the buyer has an interest in attributing the specialized knowledge of the seller's advisers to the seller. In particular, these are usually the lawyers and tax advisors advising the seller on the sale and, in addition, the management of the target company or important experts of the target company who were involved in the sale. It is in the interest of the seller to keep this group of persons as manageable as possible. After all, the seller is not always fully aware of what all these persons involved in the transaction may know.

In SPAs governed by German law, however, it is always advisable for the seller - who is also (managing) director of the target company - to allow a clause to this effect. At first sight, this seems to extend his liability; however, in the absence of such a provision, an interpretation of the terms “Kenntnis” and “Bestes Wissen” may lead to the aforementioned extension of liability for this seller if the knowledge of a further group of persons is added. In this case, the extension of liability by interpretation can be significantly wider than a balanced contractual provision.

In SPAs governed by English law, the extension of the seller’s knowledge to include seller’s representative’s knowledge would not apply, unless expressly provided for. However, sellers will usually resist such a broad definition of knowledge.

Conclusion

It is advisable, regardless of whether a contract is governed by German law or the law of England and Wales, to always define the terms “Knowledge” or “Best Knowledge” precisely in the SPA. The group of persons representing the knowledge should eventually be named too, ideally mentioning their names.