Company Transformations, Corporate Divisions, Mergers
1. The concepts and their function
Experimentation with the optimal boundaries of the firm and the legal form of an entity are important aspects of competition between firms. Decisions on the boundaries of the firm are guided by a comparison of costs and benefits of coordination within an organization, on the one hand, and of coordination through the market on the other. Decisions on the legal form of a firm will be based, inter alia, on an assessment of the legal implications with a view to governance, liability, corporate finance and tax. In both respects, a modern corporate law will strive to provide a sufficiently simple and flexible legal framework that allows for a quick and inexpensive adaptation of the form and structure of an economic entity to the ever-changing conditions in the marketplace. At the same time, the law must control the risk of abuse in such mid-stream changes in the life of a corporation so that managers respect the decision rights of the shareholders, majority shareholders do not take advantage of minority shareholders and so that shareholders do not benefit at the expense of creditors.
The term ‘company transformation’ summarizes the various forms of corporate restructuring. In some European legal systems, the term ‘company transformation’ is also used as a technical legal term. The German law on company transformations (Umwandlungsgesetz (UmwG)) explicitly differentiates between those transactions that will change the boundaries of the firm —most importantly mergers (§§ 2–122 UmwG) and corporate divisions (split-ups, split-offs, spin-offs; §§ 123–173 UmwG)—and the mere change of legal form (ie conversion, §§ 190–304 UmwG), as these types of transformation pose different risks and regulatory challenges.
Company transformations that change the boundaries of the firm as regulated in the UmwG have the following legal effects ipso iure: all the assets and liabilities of the company being acquired are transferred to the acquiring company (Gesamtrechtsnachfolge); the shareholders of the company being acquired become shareholders of the acquiring company; and the company being acquired ceases to exist automatically, without going into liquidation. These ipso iure effects distinguish a company transformation in the technical sense—whether in the form of a merger or in the form of a division—from an asset sale. As regards mergers, the UmwG distinguishes between a merger by the acquisition of one or more companies by another (Verschmelzung durch Aufnahme) and a merger by the formation of a new company (Verschmelzung durch Neugründung). In both cases, the shareholders of the acquired company receive shares or become members of the acquiring or the new company. A complementary cash payment must not exceed 10 per cent of the nominal value of the shares. The purpose of a division is to allow the transfer of parts of a company uno actu.
The UmwG distinguishes between split-ups, split-offs and spin-offs. In a split-up, a company splits up all of its assets and liabilities and transfers them ipso iure to at least two other companies. The shareholders of the company being split up receive shares in the new or acquiring companies, and the company split up ceases to exist. In the case of a split-off, a company transfers only part of its assets and will otherwise continue to exist. A spin-off is similar to a split-off, but the shares of the acquiring or new company that are granted in compensation are given out to the company that has transferred parts of its assets and not to the shareholders of this company. Functionally, a division is a substitute for an asset sale.
The change of legal form (conversion) must be clearly distinguished from those transactions that are meant to change the boundaries of the firm: no assets are transferred here. Rather, the entity, while economically identical, opts for a different legal framework.
Generally, the various possibilities for corporate transformations provided by the law are widely used—in Germany as much as in other continental European jurisdictions that provide for a broadly similar legal framework. This is true in particular for mergers as a common option for the external growth of a firm and as an alternative to an asset deal or a share deal in those cases where the consideration paid consists mainly in shares; it is also true for corporate divisions (split-ups, split-offs and spin-offs) that are a common technique to prepare the sale of certain branches of a firm or to separate certain spheres of liability.
In all these cases, a transformation in the technical sense is not the only means for achieving the desired economic result. For example, results similar to a technical merger can frequently be achieved by way of a share deal or through the sale of essentially all assets with a subsequent liquidation of the selling firm. However, the law on corporate transformations will frequently help save transaction costs.
2. The evolution of national laws on corporate transformations on the basis of the 3rd and the 6th Company Law Directive
In the EU, the law on corporate transformations is not fully harmonized. It remains national law in important parts. However, since the late 1970s, European directives have set out a common basic framework that the Member States have had to implement. The European Commission realized early that the creation of a European internal market and the resulting widening of the firms’ geographic scope of action would call for a cross-border restructuring of firms, in particular for cross-border mergers.
The 3rd Company Law Directive of 9 October 1978 (Merger Directive 78/855) was therefore designed as a model for a European law of structural measures. It sets out the basic procedure for mergers between public limited liability companies (the German Aktiengesellschaft, the French Société Anonyme, the UK public company limited by shares and equivalent company forms in other Member States). Two types of mergers are foreseen that all Member States shall provide for: a merger by the acquisition of one or more companies by another (Verschmelzung durch Aufnahme) and a merger by the formation of a new company (Verschmelzung durch Neugründung). Both provide for a transfer of all assets and liabilities of one (or more) company/companies to another and the winding up of one or more companies without going into liquidation.
The procedural rules follow an information model: the shareholders of the merging companies are to be kept adequately informed in as objective a manner as possible so as to protect them in the use of their decision rights. The basic pillars of this model are the following: The management bodies of the merging companies shall draw up draft terms of merger in writing (Art 5), which must be published in accordance with Art 3 of Dir 68/151 (Art 6). Moreover, the management bodies of each of the merging companies shall draw up a detailed written report explaining the draft terms of merger and setting out the legal and economic grounds for them, in particular the share exchange ratio (Art 9), and make it accessible to all shareholders; independent experts shall examine the draft terms of merger and draw up a written report to the shareholders, stating whether in their opinion the share exchange ratio is fair and reasonable (Art 10). This obligation is backed up by rules on the civil liability of the independent experts vis-à-vis the shareholders of the company being acquired in case of misconduct (‘gatekeeper strategy’) (Art 22). And finally, the merger must be approved by the general meeting of each of the merging companies with a majority of not less than two-thirds of the votes attaching either to the shares or to the subscribed capital represented (or alternatively the simple majority of the votes when at least half of the subscribed capital is represented) (Arts 7–8).
Shareholders of the company being acquired receive an additional protection: the Member States must provide for a regime of civil liability of the members of the management bodies of that company in case of misconduct in preparing and implementing the merger (Art 20). As far as the interests of creditors of the merging companies are concerned whose claims antedate the publication of the draft terms of merger and have not fallen due at the time of such publication, the Member States must provide for an adequate system of protection (Arts 13–15).
The 6th Company Law Directive of 17 December 1982 (Corporate Divisions Directive 82/891) complements the 3rd Company Law Directive and at the same time aims to address the risk of a circumvention of the legal protections provided therein that result from the partial economic substitutability between corporate divisions and mergers. The 6th Company Law Directive does not require the Member States to provide for the instrument of corporate divisions. Rather, it sets out procedural rules to be implemented (only) in those Member States where the instrument of corporate divisions exists. In its structure and content, the 6th Company Law Directive closely follows the Merger Directive: only those corporate divisions fall within its scope that involve public limited liability companies covered by the 3rd Company Law Directive. Shareholder protection and creditor protection likewise follow the model of the 3rd Company Law Directive.
The Member States’ laws on corporate transformations and divisions are based on these directives. Consequently, their basic structure tends to be similar. EU law will also guide the interpretation of the national laws to the extent that they implement the Company Law Directives. A significant number of Member States (including Germany, Italy, Belgium, the Netherlands) have extended the directives’ procedural regimes also to private limited liability companies (eg GmbHs). The 3rd and the 6th Company Law Directive play a more limited role in UK company law, however, where the takeover is much more common for public limited liability companies. The ‘scheme of arrangement’, regulated in the Company Act 2006, Part 26, can, however, constitute an alternative and is more widely used today than it used to be.
In Germany, the possibility of a statutory merger has existed since the mid-19th century. In the beginning, merger procedures were regulated separately for each legal form of corporation. The Umwandlungsgesetz of 1994 brought these scattered rules together in a single law and simultaneously systematized and complemented them. The possibility of mergers and changes of legal form was now no longer restricted to limited liability companies, but extended also to partnerships. The possibility of a corporate division was newly introduced into German law. The procedural rules on corporate transformation are generally modelled upon the rules set out in the European directives, with some modifications where companies outside the directives’ scope are concerned. The German law on transformations goes beyond the EU directives in granting exit rights to dissenting shareholders: appraisal rights exist in the context of a merger into a corporation of a different legal form and in the context of a change of legal form (conversion). The draft terms of the merger or division must contain an appraisal offer in these cases. The appropriateness of the appraisal remedy is subject to judicial control.
The conceptions of creditor protection continue to differ between the Member States. The 3rd Company Law Directive sets a minimum level of protection: according to Art 13, the Member States shall at least provide that creditors are entitled to obtain adequate safeguards where the financial situation of the merging companies makes such protection necessary. The German Umwandlungsgesetz is based on this model of protection. In addition, it provides for the civil liability of the members of the management board and the supervisory board of the company being acquired vis-à-vis the creditors (§ 25 UmwG). With a view to corporate divisions, German law provides that the companies participating in the division will be jointly and severally liable for those obligations of the company being divided that antedate the point of time when the division becomes effective (§ 133 UmwG; see also Art 12(3) of the 6th Company Law Directive). Other Member States (eg the UK and France) have gone further and have granted creditors the right to veto the transaction.
The European directives do not regulate the time at which a corporate transformation will become effective. According to German law, this is the time of the registration of the transformation (§ 20 UmwG). By contrast, French law provides that a merger by the acquisition of one or more companies by another becomes effective with the last relevant decision of the general shareholder meeting.
The protection of employees in the context of corporate transformations is influenced by EU law (see eg Dir 2001/23 of 12 March 2001—Acquired Rights Directive), but has not been fully harmonized with the 3rd and the 6th Company Law Directives. The German Umwandlungsgesetz regulates the protection of employees in §§ 323 ff.
In Germany, the UmwG’s attempt to set out a general framework for corporate transformations largely independent of the legal form of the corporations concerned and to develop consistent general approaches for the protection of shareholders and creditors has initiated a debate whether the rules of the UmwG could be generalized so as to apply to all measures of corporate restructuring, even to those that currently fall outside the scope of the UmwG, in particular where such measures lead to economically equivalent results. Academic opinion tends to favour such an approach. However, the courts have been cautious in this regard so far.
3. Recent developments regarding the law of corporate restructuring in the EU
The 3rd and the 6th Company Law Directives do not explicitly provide for the possibility of a cross-border restructuring of firms. According to the original version of Art 220 of the EEC Treaty, this question was to be dealt with in an international treaty between the Member States. Attempts by the Commission to deal with the issue of cross-border mergers within the framework of the 3rd and 6th Company Law Directives were not successful, all the more in light of the Member States’ growing resistance against a harmonization of the national company law regimes from 1989 on.
In this situation, the European Court of Justice’s (ECJ) jurisprudence on the freedom of establishment became an important impetus for the European law on corporate restructuring. In Sevic (ECJ Case C-411/03 [2005] ECR I-10805), the ECJ held that the German law (see the old § 1 UmwG) and practice of reserving the possibility of mergers to companies with a corporate seat in Germany and rejecting the registration of any cross-border mergers in the national registry was incompatible with EU law, namely with the freedom of establishment (Arts 49, 54 TFEU/43, 48 TEC). The right of establishment covers all measures that permit or even merely facilitate access to another Member State and the pursuit of an economic activity in that state by allowing the persons concerned to participate in the economic life of the country effectively and under the same conditions as national operators (Sevic, para 18). Cross-border merger operations, like other company transformation operations, respond to the needs for cooperation and consolidation between companies established in different Member States, and therefore constitute an important part of the freedom of establishment, directly relevant for the proper functioning of the internal market (para 19). National rules which deny recourse to a means of company transformation like a merger where one of the companies is established in a Member State other than the host state are likely to deter the exercise of the freedom of establishment (para 22). Such a restriction can be permitted only if it pursues a legitimate objective compatible with the Treaty and is justified by imperative reasons in the public interest. While the protection of the interests of creditors, minority shareholders and employees, the preservation of the effectiveness of fiscal supervision and the fairness of commercial transactions may, in certain circumstances and under certain conditions, justify a restriction, a general refusal to register in the commercial register a merger between a company established in that state and one established in another Member State cannot be justified absent a concrete threat (para 30).
With a view to Sevic, the Member States finally approved Dir 2005/56 on cross-border mergers of limited liability companies of 26 October 2005 (Cross-Border Merger Directive). The directive deals with mergers between limited liability companies, provided at least two of them are governed by the laws of different Member States. Contrary to the 3rd Company Law Directive, the scope of the Cross-Border Merger Directive is not limited to public limited liability companies. Rather, the Member States are obliged to enable all those types of limited liability companies to participate in cross-border mergers that may merge under the national law of the relevant Member States (principle of non-discrimination, Arts 1, 4). The rules regarding the merger procedure (common draft terms of cross-border mergers/report on the merger/independent expert report/approval by the general meeting, Arts 5–9) largely follow the model of the 3rd Company Law Directive and Arts 17 ff of the Regulation 2157/ 2001 of 8 October 2001 on the Statute for a European Company (SE) (SE-Regulation) that already enables public limited liability companies of different Member States to merge cross-border to form a European Company (SE) (Arts 2(1), 17 ff SE-Regulation).
Like the 3rd and the 6th Company Law Directives, the Cross-Border Merger Directive refers in important respects to national law, eg with regard to the requisite majority for the approval of the general meetings of the participating companies and with respect to the specific rules on shareholder, creditor and employee protection. Apart from the partial harmonization of the relevant procedural rules, the Cross-Border Merger Directive primarily contains rules of private international law, ie it sets out which national law will be relevant for the assessment of the legality of the merger. In this regard, the directive distinguishes between the legality of the cross-border merger as regards that part of the procedure that concerns each merging company, which is subject to its national law (Art 10), and the legality of the cross-border merger as regards that part of the procedure that concerns the completion of the cross-border merger and, where appropriate, the formation of a new company resulting from the cross-border merger. Here, the law of the company created by the cross-border merger is applicable (Art 11). The time at which the cross-border merger enters into effect shall be determined by the law of the Member State to whose jurisdiction the company resulting from the cross-border merger is subject (Art 12).
The Cross-Border Merger Directive does not specifically deal with the principles to be applied in the valuation of the companies and in the determination of the share exchange ratio. Each party in the cross-border merger will apply those principles relevant under its own national law. This may lead to different principles being applied by the various parties. At the same time, the cross-border merger can only enter into effect if the share exchange ratio is determined in accordance with the legality requirements of all national laws concerned. The lack of harmonization in this economically and legally important respect poses difficulties. Transactional practice will have to meet the challenge of developing a common valuation standard for cross-border mergers.
The ECJ’s recent jurisprudence on freedom of establishment has revived the Commission’s long-existing plans for a directive on the cross-border transfer of registered office (see Commission Staff Working Paper of 12 December 2007: Impact Assessment on the Directive on Cross-border Transfer of Registered Office, SEC(2007) 1707). However, the Commission has not come forward with a concrete proposal so far.
In practice, the tax implications of cross-border restructurings are of utmost relevance. The tax treatment of cross-border mergers and divisions in a wide sense—ie the treatment of all those transactions in which a company or a part of a company is transferred based on the exchange of shares and without any cash payments to the selling share owners—is dealt with in the Merger Taxation Directive 90/434 of 23 July 1990. The directive prohibits the taxation of profits resulting from a cross-border transaction where the profits are not in fact realized either by the companies concerned or by the share owners. In practice, a taxation of, for example, the hidden reserves that may be uncovered in the context of a cross-border restructuring would frequently be prohibitive. According to the directive, the relevant profits shall be taxed only once they are realized. However, the Merger Taxation Directive has not yet been fully implemented by all Member States. Consequently, the ECJ’s jurisprudence on the fundamental freedoms (fundamental freedoms (general principles)) regarding the taxation of cross-border restructurings continues to be of practical relevance.
4. Effects of EU law on national laws
The Cross-Border Merger Directive had to be implemented by the Member States by December 2007. In Germany, a new chapter on cross-border mergers between limited liability companies has been introduced into the UmwG (see §§ 122a ff UmwG). Cross-border mergers between partnerships are not provided for, although they are possible for German companies. The compatibility of this limitation with the principle of non-discrimination as set out in Sevic is unclear. In principle, §§ 122a ff UmwG follow the rules on national mergers, albeit with some modifications. Special rules apply in particular with a view to the protection of minority shareholders and creditors whose interests may be particularly affected by a cross-border merger. § 122i UmwG grants dissenting shareholders a right to cash out where the seat of the new corporation will be outside Germany. No shareholder shall be coerced to accept a shift to a foreign legal form and the resulting changes in his rights and duties. The creditors’ right to safeguards for claims that a merger may put at risk (§ 22 UmwG) is strengthened in the case of cross-border mergers (see § 122j UmwG).
The special rules of protection applicable in the context of cross-border mergers point to the specificities of the interests of the various stakeholders in cross-border transactions generally. The precise conditions justifying a different treatment of national transactions and cross-border transactions, ie a restriction of the fundamental freedoms, have not yet been clarified. In light of the ECJ’s recent jurisprudence, the development of community-wide standards of protection for shareholders, minority shareholders, creditors and employees remains a challenge for European corporate law.
Literature
Alfred F Conard, ‘Fundamental changes in marketable share companies’ in IECL XIII/2 (1969) ch 6; Peter Hommelhoff and Karl Riesenhuber, ‘Strukturmaßnahmen, insbesondere Verschmelzung und Spaltung im Europäischen und deutschen Gesellschaftsrecht’ in Stefan Grundmann (ed), Systembildung und Systemlücken in Kerngebieten des Europäischen Privatrechts (2000) 261; York Schnorbus, Gestaltungsfreiheit im Umwandlungsrecht (2001); Karsten Schmidt, ‘Integrationswirkung des Umwandlungsgesetzes’ in Festschrift Peter Ulmer (2003) 557; Harald Kallmeyer, Umwandlungsgesetz (3rd edn, 2005); Maria Doralt, ‘Cross-Border Mergers—A Glimpse into the Future’ [2007] ECFR 17; Stefan Grundmann and Florian Möslein, European Company Law: Organization, Finance and Capital Markets (2007); Roger Kiem, ‘Die Ermittlung der Verschmelzungswertrelation bei der grenzüberschreitenden Verschmelzung’ [2007] ZGR 542; Marcus Lutter and Martin Winter (eds), UmwG, vol 2 (4th edn, 2008); Barbara Dauner-Lieb and Stefan Simon, Kölner Kommentar zum UmwG (2008); Marieke Wyckaert and Koen Geens, ‘Cross-border Mergers and Minority Protection. An Open-ended Harmonization’ (2008) 4 Utrecht Law Review 40; Edward Rock, Paul Davies, Hideki Kanda and Reinier Kraakman, ‘Fundamental Changes’ in Reiner Kraakman and others (eds), The Anatomy of Corporate Law (2nd edn, 2009) ch 7; EU Commission (ed), Report of the Reflection Group on the Future of Company Law, Brussels, 5 April 2011.
