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published on 16 March 2023 | reading time approx. 3 minutes
Transactions are affected by value-driving criteria, in particular by risks identified and assessed in a Due Diligence audit. CSR (Corporate Social Responsibility) and ESG (Environmental Social Governance) have been hot topics for some time now; furthered by the Corporate Sustainability Reporting Directive adopted in November 2022 by the European Parliament (CSR Directive), their significance will continue to grow over the next months and years – also in the context of transactions and Due Diligence audits.
This is because: The directive aims at supporting every aspect of corporate sustainability, in particular by imposing transparency obligations relating to ecological and social aspects. Thus, also for stakeholders, CSR and ESG are becoming the company value drivers. Companies will have to brace themselves for being evaluated based on how they meet these criteria. Therefore, this issue will be given much more focus in M&A.
On 5th January 2023, the CSR Directive entered into force on the EU level and now the member states have 18 months to implement its provisions. From 1th January 2024, the CSR Directive will apply to all companies that have already been subject to the Non-Financial Reporting Directive (NFR Directive) effective since 2017. No later than 1th January 2026 (reports will have to be produced as from 2027), the CSR Directive will cover all companies, except for the so-called micro enterprises. In Germany alone, this will affect an estimated 15,000 to 18,000 companies in the next years, and in the EU about 50,000.
According to Sec. 289 para. 1 of the German Commercial Code (HGB) "the management report is to present accurately the business development, including the business performance of the incorporated company and its position, in keeping with its actual circumstances."
A special consequence for companies covered by the CSR Directive is that they will also have to report on non-financial issues regarding CSR and ESG in the management report every year. In the context of the CSR Directive, this means that they will have to report in particular on environmental, social, and governance-related aspects, amongst others by reporting information regarding their sustainability targets.
These aspects have been specified in the European Sustainability Reporting Standards. The standards regulated therein apply to every company mostly on an individualised basis, depending on the industry and a company’s object of business. For example, if a company is in no way related to the maritime industries, it will not be subject to any reporting obligations in this respect; if the company is, however, subject to the German Supply Chain Due Diligence Act, (Lieferkettensorgfaltspflichtengesetz (LkSG)) it must prepare a relevant report.
CSR/ESG reporting will be essential for determining the value of a company. This also offers a good many of opportunities. In recent years, ecological and social aspects of companies' operations have become more important for institutions and investors, in particular also for lending banks. When preparing for a transaction or an exit, it is therefore important to diligently examine the most relevant criteria.
To read about possible issues to be analysed when examining the individual criteria during CSR/ESG Due Diligence, please refer to our article dated 6th April 2022.
CSR and ESG-related risks identified during Due Diligence may be considered in a share or asset purchase agreement in many ways.
The risks identified during Due Diligence may be factored into the purchase price. Losses that can be put into figures, e.g. impending fines, may be basically factored in via price reductions. Possible losses in revenue, in particular in connection with the so-called “bad publicity”, can be settled via flat rates. In view of the increasing significance of the CSR/ESG criteria, the fact that a company failed to take compliance measures may thus be reflected in a visibly reduced enterprise value. Alternatively (or additionally), tailor-made earnout pricing structures can be used to account for company-specific aspects or the overall economic situation in the industry.
In order to achieve CSR and ESG targets with significance for the future in the short term and/or to comply with them in the long term, CSR/ESG-related signing or closing conditions can be implemented in the contract – such conditions can include developing a corporate sustainability strategy or taking out specific insurance policies, e.g. climate risk insurance.
The obligation to eliminate already detected specific CSR/ESG risks after the closing of the company purchase can be established by agreeing on customized post-closing measures, such as the implementation of legal management or control systems. Also in this respect, (only) specifically agreed-upon measures will ensure effective implementation.
Many (liability) risks arising from CSR and ESG may be addressed by including respective warranties and indemnifications in the company purchase agreement. General warranties often provide protection only against abstract risks. As in other areas, when addressing specific ESG-related risks, it is important to agree on warranties individually tailored to the subject matter of the agreement and on specific indemnifications, for example, in respect of future fines and possible contractual penalties.
Outside or prior to a transaction it is possible to eliminate uncertainties related to CSR/ESG issues by inspecting the general contractual documentation of a company on the whole (for example, supplier contracts, financing documents, and employment contracts) and by seeking expert advice as regards the applicable specific legal requirements and individual needs.
The (early) implementation of legal management systems may be a reasonable measure; in view of other compliance issues (e.g. the Supply Chain Due Diligence Act and the Whistleblower Protection Act) and the huge number of possible overlapping issues, the development of a comprehensive corporate concept is of special importance. This requires advice tailored to the company needs which detects and combines all relevant legal aspects and opportunities.
Katrin Mikschl
Senior Associate
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Daniel Roßbach
