Contractual reporting obligations in cross-border corporate groups

First published in Noerr Public M&A-Report 01/2022

Flow of information essential for a group to function

After successfully acquiring a target company, a bidder may be faced with a variety of legal questions in connection with integrating the target company into the group. Establishing a functioning flow of information within the group is typically a key problem. For economic reasons, ensuring that the group’s top management receives sufficient information is vital to efficient group management. At the same time, it is a fundamental prerequisite of management’s ability to live up to its group-wide responsibility for compliance and risk management. If the parent company is required to prepare consolidated financial statements, the need for reliable information channels becomes clear at the latest in the context of group reporting. However, this can be a challenge, especially for foreign parent companies that have successfully completed a public takeover of a listed German target company.

Statutory rights to information for group accounting purposes

In principle, a parent company has various ways available to obtain information from the a subsidiary. Of course, this is largely unproblematic where the parent company has successfully worked towards establishing a contractual group and can base the right to information on a right to issue instructions under section 308 of the German Stock Corporation Act (Aktiengesetz – AktG). On the other hand, if it remains a purely de facto group, the parent company must initially rely on general instruments for obtaining information.

Against this background, the law helps parent companies by providing for information rights in relation to subsidiaries under section 294(3) of the German Commercial Code (Handelsgesetzbuch – HGB). This is intended to enable parent companies to prepare consolidated financial statements, a group management report and a special non-financial group report. However, it is problematic that the German Commercial Code only imposes the obligation to prepare consolidated financial statements and a group management report on domestic parent companies (section 290(1) first sentence of the German Commercial Code), with the result that the applicability of section 294(3) of the German Commercial Code to group parent companies domiciled abroad is questionable. Consequently, foreign parent companies with German subsidiaries that are required by accounting regulations of their domestic legal system to provide comprehensive group reporting (“global consolidation principle”) may look for ways to establish the flow of information in the de facto group, including channels other than those provided for by law, i.e. on a contractual basis.

However, even parent companies that fall under the direct scope of section 294(3) German Commercial Code may deem this necessary, considering the fact that the right to information is limited to the purposes of group accounting. It is true that section 294(3) German Commercial Code provides for relatively far-reaching claims to information, given that obtaining information can also serve to ensure complete and correct accounting by the parent company. However, it does not convey a general right to information. In addition, is also often advisable to place the flow of information in the de facto group on a contractual footing with a view to the compensation for disadvantages pursuant to section 311 of the German Stock Corporation Act, despite section 294(3) of the German Commercial Code being applicable.

Practical solution: contractual reporting obligations

In order to regularly and reliably obtain the information required for group reporting, it may therefore be advisable for the parent company to have the corresponding information rights granted to it by entering into a contract with the subsidiary.

In practice, such agreements can be components of contractual arrangements that have recently become the subject of increasing interest among experts under the terms “relationship agreements” or “group coordination agreements”. These are coordination agreements that regulate cooperation within the de facto group in even more detail and may provide for adopting uniform group guidelines and establishing group functions (e.g. for internal audit, compliance and risk management) and/or functional reporting lines. It is important that “relationship agreements” (and even more so agreements that only govern reporting for accounting purposes) are not structured as inter-company agreements pursuant to section 291 onwards German Stock Corporation Act. This ensures that they do not require the approval of the general meeting pursuant to section 293(1) German Stock Corporation Act. Instead, they are purely contractual agreements with the purpose of regulating the necessary cooperation within the group in a legally watertight manner and without resulting in a control agreement (Beherrschungsvertrag) with the corresponding obligations.

Legal barriers and legally compliant drafting of the agreement

If a parent company and a subsidiary wish to establish binding obligations to provide the parent company with information in contractual form, compliance with the restrictions arising directly from section 311 of the German Stock Corporation Act is of paramount importance. According to this provision, the controlling company in a de facto group is prohibited from using its influence to induce a dependent joint stock company to enter into a legal transaction that is detrimental to it or to take or refrain from measures resulting in a disadvantage, unless the disadvantages are compensated.

First of all, it is advisable to set out the reporting obligations and related modalities as precisely as possible in the agreement. This applies first and foremost to the matters to be covered by the reporting. Here it is advisable to include provisions that are graduated according to the relevant reporting periods, which also have to be defined. As a result, the scope and depth of information in annual or quarterly reports can be defined differently from monthly reporting obligations, if any. Furthermore, rules can be defined for any additional evidence or queries that may be required and for the applicable deadlines.

On this basis, binding stipulations are then to be agreed with regard to section 311 German Stock Corporation Act and compensation for disadvantages. For example, provisions on compensation for the costs incurred by the reporting subsidiary should be included directly in the agreement, the amount and due dates of compensation payments. However, this compensation designed to justify any adverse influence has its limits where the disadvantages are not quantifiable. But this is very likely to apply where confidential information from the sphere of the subsidiary is disclosed: it is difficult to imagine quantifiable financial compensation for disadvantages that (may) result from the disclosure of confidential information. In practice, the problem is solved by excluding any disadvantage for the subsidiary by ensuring that the parent company uses the information exclusively for the purposes of internal group control and management. To ensure this, the contract should limit the use of information by the parent company to certain purposes which rule out any use to the disadvantage of the subsidiary. Apart from this, the contract should have additional provisions intended to maintain confidentiality.

It is not only in the context of section 311 German Stock Corporation Act that the prevailing opinion sees room for a group-friendly interpretation that permits information channels to be established. If we look at other provisions that can be considered as barriers, it is also evident that leeway in favour of effective management of the group is generally recognised. In the context of section 131(4) first and second sentences German Stock Corporation Act and section 48(1) no. 1 German Securities Trading Act (Wertpapierhandelsgesetz – WpHG), which (also) aim at achieving equal treatment of shareholders in terms of information, it can also be assumed that the group situation may constitute a justification for different treatment. The prevailing interpretation of section 131(4) first sentence German Stock Corporation Act assumes that the information is not provided to the controlling company (only) in its “capacity as a shareholder” if it serves the purpose of managing the group. The law implicitly recognises this idea for necessary information provided to a parent company for the purpose of including the company in the parent company’s consolidated financial statements in section 294(4) third sentence German Stock Corporation Act – albeit primarily against the background of the parent company’s statutory reporting obligations. In the context of section 48(1) no. 1 German Securities Trading Act, which constitutes a manifestation of the principle of equal treatment in securities law, an objective reason for different treatment, which is likely to exist in the pursuit of legitimate group interests, is likewise generally sufficient.

Furthermore, for publicly listed companies, the rules on insider trading deserve special attention. If the subsidiary’s management obtain inside information, its dissemination within the group is also subject to the provisions of the Market Abuse Regulation. This means that if such information is the subject of reporting, special caution is required. However, only the “unlawful” disclosure of inside information is prohibited (see Article 10(1) no. 1 and Article 14(c) Market Abuse Regulation). In this case (as for the question of equal treatment of shareholders) it is appropriate to consider the group situation.

It is sometimes claimed that group interests and management of the group essentially follow the interests of the parent company and thus cannot justify the “upward” disclosure of inside information. However, there is at least general agreement that disclosure in order to allow the parent company to meet its legal obligations, including group reporting, is permissible.

As with section 311 German Stock Corporation Act, however, it must be ensured that the use of the information is consistent with the justification for its disclosure within the group. If disclosing inside information is only justified against the background of the group-internal (statutory) performance of duties, it must be contractually ensured that it is only used for these purposes, and in particular not for the parent company’s own economic advantage. Furthermore, the legality of the disclosure of inside information depends on whether it is proportionate. In this situation provision of a two-stage process is possible in which the subsidiary first fulfils its reporting obligations to a reduced extent, i.e. by omitting the inside information in question. Then, if the parent company believes that this is not sufficient for reporting purposes, a consensual decision must be made on careful and legally compliant disclosure of the inside information.

Conclusion

Since the flow of information within a group is indisputably essential to the functioning of the group, practical ways must be found to enable the group to be managed – including and especially across national borders. In this context, it is apparent that the current law does not place insurmountable obstacles in the way of contractual reporting obligations within the group, but it does erect barriers in various respects that must be observed when drafting such agreements. The interest of the parent company in managing the group effectively and in a legally compliant manner, which is generally recognised as legitimate, is the key factor.