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Italy – Milan Courts on Forfeiture of Knowledge-Based Indemnification Claims in M&A Contracts

Ruling on a case of alleged breach of Seller's R&Ws related to the truthfulness, accuracy and completeness of the Target's financial statements, the Court of Milan on March 19th, 2021, provided – among others – some clear indications about the assessment of the expiration of forfeiture terms applicable to certain knowledge-based indemnification claims.

The legal case examined and judged by the Milan Court originated from Buyer's claim to be indemnified for certain capital losses or contingent liabilities ("minusvalenze patrimoniali"; "sopravvenienze passive") allegedly suffered by Target due to the inadequacy of the contingency funds for tax liabilities accrued in the FY 2016 financial statements in connection with some previous contributions in kind of branch of business. 

Based on the acquisition documents, the relevant indemnification claim had to be brought by the Buyer within 30 days from the knowledge of the breach, in this case from the moment when the Buyer realized the inadequacy of the specific contingency funds.

While the Buyer was of the opinion it could have appreciated the inadequacy of said contingency fund concurrently with shareholders' approval of Target's FY 2017 financial statements at the earliest, on the other hand the Seller maintained that the Buyer knew or should have known about said alleged breach earlier, i.e. not later than Target's board resolution approving the draft financial statements to be then proposed for approval to Target's shareholders' meeting.

Having considered the contractual forfeiture term of 30 days as lawful and reasonable under Sec. 2965 of the Italian Civil Code, the Milan Court focused on identifying the very moment when Buyer's knowledge about the alleged breach was actually acquired, thus going beyond a conservative interpretation of the "actual knowledge" concept, hence without fully reaching the field of the "constructive knowledge" one.

Although not fully relying on the degree of knowledge actually or possibly acquired by the Buyer through a thorough acquisition review, which included a detailed accounting and tax due diligence also on FY 2016 accounts and financial statements, the Milan Court focused on Buyer's preferred access to the relevant information, in its capacity as controlling shareholder, appointing – and in this case also employing – Target's directors.

The judges took the approach that Buyer, as controlling shareholders and employer of Target's sole director, had or could have had full knowledge of the controversial inadequacy of the contingency fund already when the draft FY 2017 financial statements had been prepared and approved, fairly before they had been proposed for approval to Target's shareholder's meeting.


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