Structuring the Transaction and Operational Unbundling
In addition to the regulatory framework, which we already analysed in Part Iof our specialist article, the structuring and operational implementation of a carve-out in the A&D sector is highly complex. Typical issues relate to the choice of transaction structure, the handling of overarching structures (e.g. services, IT systems, IP rights) and the treatment of regulatory and governmental mandates. Errors or omissions in this area can lead to considerable delays and costs. The most important aspects of successful structuring and unbundling are outlined below.
Asset Deal vs. Share Deal
A key structural aspect is how the carve-out is legally implemented. There are basically two approaches:
Share Deal
The business division to be spun off is first transferred to a separate subsidiary (through a spin-off or acquisition in kind) and then transferred to the buyer through the sale of the shares. The legal ownership of the contracts, licences and employees remains unchanged at the company - only the shareholders change.
Advantages: Current contracts (e.g. with customers, suppliers, employees) continue to exist, licence and export permits remain valid for the time being and operational continuity is easier to ensure.
Disadvantage: The buyer takes over the company including all liabilities, which requires comprehensive due diligence and possibly guarantees/spin-off agreements to cover risks (legacy liabilities, pension obligations, etc.).
Asset Deal
The individual assets and contracts of the business unit are transferred directly from the previous owner to the buyer.
Advantages: Specific assets can be acquired and problematic items can be excluded; in addition, the former shareholder remains responsible for historical liabilities.
Disadvantage: An asset deal is operationally extremely complex - all contracts (including customer orders, supply contracts, leases, licences) must be transferred individually or newly concluded, often with the consent of the respective contractual partners. In Germany, Section 613a of the German Civil Code (BGB), which provides for the automatic transfer of employment relationships, applies to transfers of business operations, but information requirements for employees and co-determination bodies must be observed. In addition, certain public contracts or licences cannot be transferred without further ado.
In practice, companies often opt for a share deal approach as this reduces complexity - especially when it comes to larger organisational units with hundreds of contracts and employees. A carve-out is therefore often structured in such a way that an internal spin-off into a limited liability company takes place first and then the shares in this new unit are sold. Nevertheless, a detailed carve-out plan that identifies all elements to be transferred is necessary in every case, regardless of the deal form. It is also important to note that in the case of international groups, several jurisdictions may be affected - e.g. Airbus had to carve out the French part of the company separately in the Hensoldt carve-out, as its own local regulations applied there. The choice between asset and share deal should always consider tax aspects, liability issues and regulatory considerations.
Transition services and TSAs
Carve-outs inevitably lead to the previously shared structures between the parent company and the divested business having to be unbundled. As this process cannot be completed overnight, transitional service agreements (TSAs) play an important role in almost every carve-out. In TSAs, it is agreed that the former owner will continue to provide services for the carved-out unit for a certain period after the closing - typically in areas such as IT operations, accounting, HR administration, logistics or facility management. The transition phase is particularly critical for groups where many support functions were centralised to ensure that the day-to-day business of the new unit does not suffer.
It is important to clearly define these transitional agreements in the contract: Which services will be provided and on what terms? What is the maximum duration? What service levels apply? Experience has shown that lengthy TSAs can be costly and delay the independence of the carve-out company. It is therefore advisable to work towards establishing your own structures where possible before completion. Best practice is to prioritise the separation of critical systems and processes or to set them up externally to minimise dependence on the parent company. Nevertheless, TSAs are often unavoidable - it is then important to ensure that they also function adequately in a sensitive sector: for example, it must be regulated how IT service providers of the parent company deal with confidential defence matters, or how access to personal data is controlled in accordance with data protection and confidentiality. Clear governance for the transition period (including regular coordination between the companies) is essential here.
Separation of IP rights and IT systems
A frequent stumbling block in technical terms is the unbundling of intellectual property (IP) and IT infrastructure. In Aerospace & Defence, which is a technology-heavy industry, patents, licences, trademark rights and confidential know-how are often spread across various group units. A thorough IP inventory must be drawn up for the carve-out: Which patents or software belong to the business to be carved out? Are there any co-utilisation rights or joint developments with the parent company? It must be contractually stipulated which rights are also transferred and where permanent licences can be granted - for example, if the parent company can continue to use certain technologies or the carve-out is dependent on IP held by the group. Without clear rules, there is a risk of later disputes or gaps in the authorisation of use that could impair the new company's business.
The IT spin-off is closely linked to this. The spun-off unit usually requires its own IT environment, separate from the systems of the previous group. New ERP systems, communication networks and databases must often be set up. The migration of data is time-consuming and requires good project management, especially if historical databases need to be split up or access rights need to be reorganised. Studies show that IT and ERP migrations are particularly expensive and prone to errors. During the transition period, it is often agreed that the new unit can still use certain systems (see TSAs). However, there should be a cut-over plan that defines when the complete replacement will take place. In the A&D sector, IT systems must sometimes have to be security-certified - these certifications must remain valid after the spin-off or be reapplied for if an independent system is set up. Finally, cybersecurity must not be neglected: Interfaces and transitions arise during the carve-out phase, which can be vulnerable. It is advisable to take protective measures together with the IT and security departments to ensure that neither the parent company nor the carved-out company fall victim to data leaks or cyberattacks.
Dealing with government and public contracts
Many companies in the defence sector work primarily on the basis of contracts with government customers (German armed forces, other authorities or international organisations). Such government contracts are often subject to special rules, for example regarding changes in order fulfilment or the contractor itself. In the case of a carve-out, it must be carefully examined how public contracts can be transferred or continued.In the case of a share deal, the contracting party formally remains the same (the legal entity), but many government contracts provide for change of control clauses. This means that the contracting authority must be informed when a new owner takes control and may have special cancellation rights if the new owner is deemed unreliable or detrimental to the security interest. A transparent dialogue with the contracting authority is therefore advisable to create trust in the continued reliable provision of services - ideally before the change becomes public.
In the case of an asset deal (or if certain contracts are not to be transferred to the new entity), it should be noted that public contracts are generally not freely transferable. An approval procedure is often required or a formal transfer of contract (novation) must be agreed, to which the contracting authority expressly consents. In some jurisdictions - such as the USA - there are established procedures for a novation agreement in the case of government contracts and during company takeovers; in Germany, you have to rely on contractual consent and, if applicable, admissibility under public procurement law. Either way, enough time must be allowed to obtain the approval of the contracting authority. No procurement office wants to be surprised that its contractual partner is suddenly a different one - especially not in safety-critical projects. This is why public customers need to be involved at an early stage: They should be informed of the intended carve-out (while maintaining confidentiality), and it should be explained how contract fulfilment will be guaranteed in the future (e.g. by keeping the core staff, by guarantees from the parent company for a transitional period or by presenting the new owner). Experience has shown that public sector clients are willing to co-operate if they can see that their interests are protected - for example, that no security-relevant skills are lost or transferred abroad. Nevertheless, these consultations are often lengthy, so they must be an integral part of the carve-out project plan.
Role of state involvement and special governance requirements
The state and politics traditionally play a major role in the A&D sector, not only as a regulator and customer, but sometimes as an owner or at least a co-determiner in corporate structures. Carve-out plans should therefore always consider the state participation and governance aspects that may arise.
In some cases, the state directly holds shares in companies in the aerospace and defence industry (or acquires such shares as part of the transaction, as the example of Hensoldt shows). A carve-out from a company in which the state holds a stake generally requires the approval of the public shareholder. In addition to economic considerations, political aspects are also relevant here. The public authorities ensure that a carve-out does not lead to a loss of strategic influence. For example, the state could demand that it continues to hold a minority stake with blocking rights in the carved-out company, e.g. to have a veto right on important decisions. KfW's 25.1 % stake in Hensoldt, which gives the federal government a blocking right in decisions made by the annual general meeting, is a prime example of this. The United Kingdom used to handle defence companies in a similar way with so-called "golden shares", which gave the state veto rights on certain strategic issues - a concept that is, however, viewed critically at EU level.
Indirect influence is also an issue: some defence companies are subject to special governance requirements based on government regulations or laws, even if there is no state ownership. For example, it may be stipulated that certain board positions must be filled with security clearance, or that only nationals may have access to certain technologies in international joint ventures in the defence sector. If a sub-business is separated from such a construct, these governance rules must be re-worked. For example, the question arises as to whether the spun-off company must maintain its own compliance structures (e.g. a confidentiality officer, export control officer, etc.) and how co-operation with authorities is regulated. In some cases, there are contractual public security agreements between the company and the state, which are intended to ensure that national security concerns are safeguarded even in the event of changes in ownership. Such agreements can include conditions on location loyalty, restrictions on the outflow of information abroad or reservations of consent in the event of resale.
For investors, this means that transparency towards the state is essential in the A&D sector. It is advisable to sound out before a transaction whether the state wishes to participate (e.g. via state development banks or partially nationalised defence companies) or whether certain controlling interventions are to be expected. In Germany, for example, the Federal Ministry of Economics and the Ministry of Defence coordinate closely when security-related corporate transactions are pending. The result can also be that the state unofficially signals which group of buyers is acceptable. It is crucial for the success of a carve-out to correctly assess this political environment and take it into account in the structure (e.g. through suitable governance concessions in the purchase agreement or shareholder agreement). Active communication with the government - where permissible - can help to build trust in the transaction. If this is successful, state actors can even have a supportive effect, for example through rapid approvals or political support for sensitive decisions.
In Part III of Carve-outs in the Aerospace & Defence Sectorwe consider the success factors in the preparation and implementation of carve-outs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
