Handling the Notarization Requirement for Equity Commitment Letters
1. Historical Perspective: No Notarization Requirement
Traditionally, German M&A practice has held that an equity commitment letter (ECL) is not subject to notarization requirements. The ECL, typically issued by a private equity fund in favor of the acquisition vehicle (AcquiCo/BidCo), has been regarded as an independent third-party agreement which is separate from the parties to the share purchase agreement (SPA).
The prevailing opinion in legal literature (with a lack of relevant case law) emphasized that the ECL is not part of the synallagmatic equivalence relationship between buyer and seller but merely serves to secure the purchase price payment. This view also rejects the question of whether it is covered by the principle of completeness as an essential ancillary agreement.
Therefore, it was generally held that the validity of the SPA is not negatively impacted if the ECL does not have notarial form.
2. New Opinions: Notarization Requirement
Recently, however, there has been a growing body of literature advocating for a notarization requirement for the ECL. The starting point is the so-called ‘completeness principle’ (Vollständigkeitsgrundsatz) developed by the courts, according to which all essential ancillary agreements that the parties intend to be part of the main transaction must be notarized.
Especially in the case of intra-group ECLs, it is argued that, due to the close and dependent relationship between the fund and the acquisition vehicle, as well as the fund’s own interest in the conclusion of the SPA, a notarization requirement should exist. Some even argue that, in high-value transactions, the third party’s (the fund’s) intention to link the agreements should be presumed.
This approach leads to significant legal uncertainty, as the validity of the entire SPA could depend on whether the ECL is notarized.
3. Problem in Notarization: Non-Commercial Nature of the Private Equity Fund
A central practical problem arises from the tax and corporate classification of the private equity fund. Many funds are structured as asset-managing partnerships to maintain tax transparency and avoid trade tax liability (if resident in Germany). Similar tax and regulatory limitations exist for many non-German fund vehicles.
According to administrative practice and the Private Equity Decree of the German Ministry of Finance (BMF) dated 16 December 2003, a purely asset-managing fund is not permitted to participate in general legal transactions. It may in particular not provide security for liabilities of its portfolio companies or otherwise commit to undertakings within the scope of a transaction. The German tax authorities interpret the framework of a purely asset-managing set-up very narrowly, although the Private Equity Decree explicitly qualifies granting security for a bridge financing for committed but outstanding equity funding by the fund as a non-trading activity.
In light of the potential material negative impact of a classification of the Fund as trading and the narrow view generally taken by German tax authorities in this regard, many private equity funds resist the issuance of an ECL out of cautious structuring considerations or at least try to avoid a notarization.
4. Trend Among Private Equity Funds: Move Toward Commercial Character
In recent practice, however, a trend toward the deliberate commercial characterization (gewerbliche Prägung) of private equity funds is observable. To avoid tax risks and uncertainties and to increase their ability to act in legal transactions, some funds now proactively declare their activities as commercial, which creates some additional tax costs, but provides planning security and avoids unpleasant (and potentially expensive) surprises at a later re-qualification. This enables the fund itself to issue guarantees and undertakings - such as the ECL - and to have them notarized.
5. Ongoing Problem: Increased Notary Costs
Regardless of commercial characterization, notarizing the ECL remains practically disadvantageous. The notarization of a standalone ECL constitutes a separate notarization matter and leads to increased notary fees. Cost and efficiency considerations therefore continue to argue against a general notarization requirement for the ECL.
6. Proposed Solution: Guarantee in the SPA by the Fund in Favor of the Acquisition Vehicle
A pragmatic solution, at least for a commercially characterized fund, is to incorporate the capital commitment not in a standalone ECL, but as a guarantee in the SPA itself. The private equity fund provides this guarantee exclusively to its acquisition vehicle – i.e., not to the seller (but potentially as a contract for the benefit of the seller (Vertrag zugunsten Dritter)). The guarantee solely covers the contribution of the equity portion of the purchase price. As a result, the guarantee remains within the SPA, i.e. does not constitute a separate notarization matter, and is subject to the notarization of the SPA, which is required in any case. The fund’s involvement in the notarization process is thus limited to what is necessary, and notary costs are not additionally increased. At the same time, the seller’s security requirement is observed.
Conclusion
The question of the notarization requirement for ECLs remains controversial in practice. The ability and willingness of a fund to provide a (notarized) ECL depends on the specific structure of the transaction and the fund’s corporate setup and tax risk assessment. The trend toward commercial characterization of funds facilitates the issuance and notarization of ECLs. The resulting cost and efficiency considerations can be met by integrating the capital commitment into the notarized SPA.
