An Effective Method Of Corporate Restructuring - M&A/Private Equity

Although benefits offered to businesses by conventional mergers, acquisitions and disposals are widely known, the benefits of the first 'true legal merger' introduced to the English legal system by The Companies (Cross-Border Mergers) Regulations 2007, (as amended by The Companies (Cross-Border Mergers) (Amendment) Regulations 2008 (Regulations), implementing the European Parliament and Council Directive 2005/56/EC (Directive)), are less well known

An increasing number of UK and other international companies with European businesses looking to restructure are able to avail themselves of the framework for cross-border mergers afforded by the Regulations, enabling two or more companies from one European Economic Area (EEA) state to merge with a company in another EEA sate, as an alternative to the conventional business transfer procedure.

The cross-border merger procedure provides a mechanism for the automatic transfer of all assets and liabilities of the transferor by operation of law and the automatic dissolution of the transferor company, without that company going into liquidation. As a consequence, there is no requirement to appoint a liquidator and commence a members' voluntary liquidation and so a cost and time saving is made.

The cross-border merger procedure has been particularly attractive to groups of companies seeking to effect a group reorganisation so as to consolidate businesses within their group and/or to:

improve capital efficiency
generate cost efficiency through economies of scale
benefit from tax reliefs, including effecting reorganisations in a tax efficient manner
achieve administrative benefits

Popularity for the cross-border merger procedure is certainly growing. Since the inception of the procedure in the UK, approximately 250 cross-border mergers have been sanctioned in the High Court of Justice. There has been a tendency for the majority of cross-border merger applications (approximately 65%) to relate to out-bound mergers to other EEA states, with approximately 35% being in-bound mergers resulting in a UK emergent company. This trend is now reversing, possibly as a reflection of the changes in tax systems across jurisdictions.

Forms of Merger

The Regulations provide for three types of merger:

Merger by absorption – where one or more transferor companies transfer all their assets and liabilities to an existing transferee company
Merger by absorption of a wholly owned subsidiary – where a wholly owned subsidiary transfers all of its assets and liabilities to its parent company (this form of merger accounts for almost all merger applications to the high court)
Merger by formation of a new company – where two or more transferor companies (at least two of which must be governed by the law of another eea state) transfer all of their assets and liabilities to a new special purpose company

Under the Regulations, a UK company can be either the transferring company, or the transferee emergent company.

Procedure

Each Member State which has implemented the Directive has its own regulations setting out the procedure for merging companies incorporated in that jurisdiction. In continental Europe the competent authority will usually be a Notary Public, whereas in the UK and Ireland the competent authority is the High Court (accordingly it is necessary to obtain the approval of the High Court), and this Court process will run in parallel with the procedure in the jurisdiction(s) of the other merging company/ies. It is therefore recommended at the outset of any cross-border merger for the legal advisors in each of the jurisdictions of the merging companies to prepare a transaction step-plan identifying interdependencies between jurisdictions and a timeline to ensure that the proposed timings for the transaction will work for all involved.

A cross-border merger from or into a UK company will take on average 5-6 months to implement in practice (although may take as little as 3 months with particularly motivated parties and advisors). The timescale may however be extended to up to 12 months if negotiations surrounding employee participation rights are involved (see section below for further information on employee participation provisions under the Regulations).

The Regulations set out the required steps that a UK company must follow in order to implement the cross-border merger which are summarised below:

The directors must draw up and adopt draft terms of merger (containing certain prescribed information in relation to the merging companies and the proposed type of merger) and a directors' report detailing the effect of the merger on members, creditors and employees
An independent expert's report as to the reasonableness of the valuation methods and share-to-share exchange ratio will be required unless the merger is: (i) a merger by absorption of a wholly-owned subsidiary; (ii) a merger by absorption and 90 per cent or more (but not all) of the transferor's shares are held by the transferee company; or (iii) where the shareholders of both merging companies agree to dispense with the requirement
The company must make an application to the court pursuant to part 8 of the civil procedure rules requesting a hearing date (it is a common misconception in continental europe that simple filings are required with the court, rather than actual hearings before a registrar or high court judge) for the first stage of the application when the court (usually before a registrar) will summon a shareholders' meeting for the shareholders to consider and approve the merger terms (although the regulations do not require the convening of a shareholder meeting in the case of a merger by absorption of a wholly-owned subsidiary, it has proved useful to nevertheless convene a shareholders' meeting as this provides a benchmark for a number of the procedural requirements under the regulations. (As an alternative, the date for the second court hearing may be used as the reference point instead of the shareholders' meeting)
At least two months before the convening of the shareholders' meeting, the draft terms of merger and the court order convening the shareholders' meeting must be delivered to the registrar of companies (together with the companies cross border mergers form cb01) which will then instruct the london gazette to publish a notice of the proposed merger. At the same time employee representatives (or employees if there are no employee representatives) must be sent a copy of the directors' report and notified that they are entitled to deliver an opinion on the report, which if provided at least one month prior to the shareholders' meeting, shall be appended to all copies of the directors' report subsequently circulated or made available;
At least one month before the shareholders' meeting the draft terms of merger, directors' report and, where applicable, the independent expert's report must be made available to the members and employee representatives (or employees if there are no employee representatives) at the registered office of the company;
The draft terms of merger must be approved by a majority in number, representing 75% or more in value of each class of members of the uk company present and voting in person or by proxy at a shareholders' meeting
Any creditor can apply to court to request the court to summon a creditors' meeting (or meeting of a particular class of creditor), and if so, the draft terms of merger must then be approved by a majority in number, representing 75% or more in value of the creditors or each class of creditors
Once these relevant approvals have been obtained, the company will attend a reconvened hearing before the court to request the issuing of a pre-merger certificate which is essentially a court order confirming that the court is satisfied that the company has complied with the required pre-merger acts and formalities
Once the pre-merger certificates have been granted in each jurisdiction of the merging companies, a joint application must then be made to the competent authority in the jurisdiction of the transferee to sanction the merger and to set a date when the consequences of the cross-border merger are to take effect. Where the transferee company is a UK registered company and the joint application is made to the Chancery Division of the High Court (and the hearing will be before a full High Court Judge), the Court will fix such a date (which must not be less than 21 days after the date when the Court has sanctioned the merger)

Employee participation

One of the key aspects of the cross-border mergers regime is the protection of employee participation rights. Employee participation rights are widely defined under the Directive to ensure that it covers the different forms of system used throughout the EEA. It is defined as the influence of the employees or their representatives in the affairs of the company (i.e. to play a role in the management of the company) by way of the right to appoint or oppose the appointment of members to the board of directors. Where employee participation rights provisions exist, these can increase the timescale and complexity of the cross-border merger.

The general principle behind the legislation is that the company resulting from the merger (the transferee company) shall be subject to the rules in force on employee participation in the EEA where it has its registered office (in the UK non-directors do not have a statutory right to participation at board level and so there is no requirement to make any provision for employee participation). However this general principle is subject to the following exceptions where a merging company: (i) has, in the six months prior to the publication of the draft terms of merger, an average number of employees that exceeds five hundred and has a system of employee participation in place; or (ii) has employee representatives amongst its directors or supervisory or administrative organ, in which case the level of employee participation in the resulting company will be determined either by negotiation between each merging company and a special negotiating body established for this purpose and with which the merging companies must negotiate for a period of between 6 and 12 months with a view to reaching an employee participation agreement, or the merging companies may elect to adopt a set of standard rules on employee participation without prior negotiation with the employee representatives.

UK companies are unaccustomed to the concept of employee participation and need to be alive to the fact that a cross-border merger may give rise to UK employees being consulted at board level for the first time. Where employee participation arrangements exist in one or more of the merging companies, final Court approval for the merger cannot be given until arrangements for employee participation in the merged entity have been agreed in accordance with the provisions of Part 4 of the Regulations. The negotiation of employee participation arrangements may take up to 12 months and this needs to be factored into the earliest stages of the merger process as the application to Court for final approval must be made within six months of the orders granting the pre-merger certificates. Accordingly, the merging companies should only seek the pre-merger certificates once they know the employee participation arrangements will be finalised within six months.

The English Courts have not yet had to consider the application of Part 4 of the Regulations, as the provisions of which have not yet been invoked in the English Courts. This has prompted discussions and certain proposals for scaling back the provisions of Part 4 of the Regulations.

Creditors & solvency

There is a presumption in the UK that in order for a successful cross-border merger application before the Court, the merging companies will be solvent. If not, then the Court will look into the likely impact on the solvency of the surviving UK company of the cross-border merger and will pay particular attention to whether creditors will be adequately protected.

As evidenced by recent cases before the High Court the UK Courts do not however reject an application for a cross-border merger simply on the basis that one (or both) merging companies are insolvent, but instead will look at each application on a case by case basis and the safeguards offered as part of the application. There have been a number of cases where, despite the surviving UK group company being balance sheet insolvent as a consequence of the merger, the Court has still sanctioned the cross-border merger on the basis that the overall impact of the merger and inter-company arrangements (i.e. through parent company support/guarantees) ensured the protection of creditors. Recent cross-border merger applications have been successful on the basis of intra-group support to protect creditors and that the overall impact of the mergers brought about an improved solvency position for the group as a whole.

What the Court will be looking for is to ensure that the creditors of a UK merging company are adequately protected if the Court were to sanction the merger. This means that the Court may require the UK merging company to provide details to the Court of its proposals for safeguarding the interests of the company's creditors and it will be up to the company as to how it presents these proposals to the Court. In this regard, it should be possible to distinguish between internal (i.e. intra-group) and external creditors and the court will seek proposals in respect of both types; they may be treated differently in the protections proposed (i.e. by way of parent company guarantees in respect of third party creditors and consent/ subordination of intra-group debt)

Counterparty consent

It is well established that all assets and liabilities are validly transferred automatically from the transferor to the transferee as a consequence of the merger. However, it is nevertheless still strongly advisable for the transferor to obtain relevant consents and approvals in order to ensure that the transferor is not in breach of any of the terms (assignment, transfer or change of control) of the agreements (including licenses and authorisations etc) to which it is party. It is advised that where for instance consent is required to the transfer of material contracts, the timescale required for doing this will be factored into the early stages of the merger process.

Mergers of insurance businesses and takeovers

The EU cross border merger process can be used for insurance companies, however depending on the jurisdictions involved, the merger process may also need to be combined with a portfolio transfer process under the EU Insurance/Reinsurance Directives (of which there are a number).

Each jurisdiction has interpreted the Insurance/ Reinsurance Directives differently and each jurisdiction will also require compliance with their implementing legislation. In the UK for example where there is a transfer of an insurance business out of the UK to another EEA jurisdiction the cross border merger process would also need to be combined with a Part VII FSMA transfer (under Part VII of the Financial Services and Markets Act 2000).

If a portfolio transfer process needs to be combined with the cross border merger process this may include additional requirements such as providing evidence of a necessary margin of solvency (of the transferee company/ surviving entity), meeting regulatory capital requirements and notification of policyholders.

To the extent that the Takeover Code applies to the proposed cross-border merger the Takeover Code will need to be considered in addition to the provisions under the Regulations.

Advantages of the cross-border merger procedure:

Automatic transfer of all assets and liabilities - all assets and liabilities are validly transferred automatically from the transferor to the transferee as a consequence of the merger and generally third party consents are not required (however see section above in respect of counterparty consent considerations)
Automatic dissolution of transferor - as the transferor company is automatically dissolved on the merger taking effect, there is no need to undergo a separate liquidation process following a merger (such as appointing a liquidator and commencing a members' voluntary liquidation), and therefore costs and timescales are reduced
Efficient method of achieving cross-border group reorganisations - the cross-border merger regime provides a convenient means of removing a corporate entity from a group as part of the group's internal corporate restructuring in order to move the jurisdictional base of a business unit
Tax relief – reorganisation tax reliefs may apply to cross-border mergers of uk companies making them tax neutral
Means of generating business efficiencies - as a cross-border merger results in only one corporate legal entity this can be used to generate business efficiencies and streamline a corporate group

Almost all the cross-border mergers heard before the High Court have related to internal group restructurings which underlines the perceived efficacy of the procedure for groups of companies.

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.

UK: An Effective Method Of Corporate Restructuring