This article forms part of our guide to corporate simplification and legal entity reduction projects. Links to other parts of the guide are at the end of this article.
The European Directive 2005/56/EC on cross-border mergers provides a way to achieve a ‘true’ merger. It can be used as a way to remove unwanted companies from a group without having to put those companies into liquidation, transfer assets by contract or make distributions.
The procedure can deal with a number of companies at the same time. Under those arrangements, the assets and obligations of the companies to be removed will automatically transfer to the transferee company. This has an important benefit of reducing the risk of losing assets unintentionally – click here for a discussion of this issue.
When is a cross-border merger available?
This mechanism is available for companies which have their statutory seat, central administration or principal place of business within the European Union. There must be a cross-border element, so at least two of the companies involved must be governed by the laws of different member states.
It is possible to use the Directive to achieve a domestic merger between two or more UK entities, by making sure that a non-UK company also participates in the merger. So, for example, UK companies UK1, UK2 and UK3, together with Luxembourg company Lux1, could all merge into UK company UK4. The assets and obligations of UK1, UK2, UK3 and Lux1 would all transfer automatically to UK4. As part of the procedure, UK1, UK2, UK3 and Lux1 would then cease to exist.
The Directive can be used for:
- Upwards mergers – where one or more subsidiaries cease to exist and merge into the holding company
- Downwards mergers – where a holding company ceases to exist and merges into its subsidiary
- Sideways mergers – where one or more ‘sister’ companies merge into another sister company
- Merger by creation of a new holding company – where one or more existing companies cease to exist, and merge into a new holding company.
In the context of corporate simplification projects, an upwards merger is most commonly used. If necessary, the shares in the relevant companies to be removed can be transferred as a preliminary step, so that the companies are direct subsidiaries of the same transferee company.
Overview of the process
This is how it works:
- The main legal document is called the ‘Draft Terms of Merger’, which sets out the key terms of the merger, including the effective date of the merger for accounting purposes.
- The merger must be approved by the shareholders of the relevant companies. Usually this is not an issue for group reorganisations, although in some cases minority shareholdings may need to be considered.
- In some cases, the approval of creditors is also required (see the ‘key issues’ below).
- A “pre-merger certificate” must be issued by the ‘competent authority’ in each jurisdiction. This certificate confirms that the requirements of the Directive and local implementing law have been satisfied. The competent authority for England & Wales is the High Court, and various procedural applications must be made. For other jurisdictions, the “competent authority” may be a notary or a court.
- Once a pre-merger certificate has been issued by each of the competent authorities, an application is made to the competent authority in the jurisdiction of the transferee entity (i.e. the surviving entity) to sanction the merger.
- The merger then takes place on the date specified by the sanctioning authority. This has the effect that the assets and obligations of the transferring entities are transferred by operation of law to the surviving entity.
- The transferring entities cease to exist, and the relevant national authorities (e.g. Companies House in the UK) are notified of the dissolution.
Because of the court applications required, the minimum time frame to complete a cross-border merger involving a UK company is usually around 4-5 months.
- Pre-steps – if the participating entities are not already in a direct parent company / subsidiary relationship, or immediate subsidiaries of the same holding company, then it is often better to carry out share transfers prior to the cross-border merger to achieve this. This simplifies the operation of the cross-border merger itself.
- Employees – where the participating entities have employees, it is usually necessary to set up a ‘Special Negotiating Body’ in order to fulfil certain consultation requirements. This adds to the timeframe and cost of the merger.
- Liabilities – the competent authority for any participating entity may order a meeting of creditors to approve the merger. In that case, the merger would require consent by majority in number, representing 75% in value, of creditors present and voting. In practice, any actual or contingent liabilities should be considered in advance, so that appropriate arrangements can be put in place to demonstrate that creditors are protected.
- Contracts and licences – although rights transfer by operation of law, due diligence is still required in relation to any ongoing contracts and licences to ascertain whether change of control or event of default-type provisions apply.
The main alternative option would be to transfer the relevant trade and assets at an appropriate price (click here for an article on this). The price would usually be left unpaid as an intercompany receivable. A solvent liquidation or a reduction of capital may be needed in order to transfer the debt receivable up to the immediate parent company(ies).
Pros and cons
Here are some of the pros and cons of a cross-border merger from a legal perspective, as compared to a transfer of trade and assets.
- Assets and liabilities transfer by operation of law. This usually avoids the need for novation of contracts or other actions to perfect the transfer of individual assets.
- A merger under the European Directive avoids the problem of assets being trapped in a transferring entity after a transfer of trade or assets.
- Because of the court applications required from a UK perspective, a cross-border merger is often significantly more expensive than a simple transfer of trade and assets.
- For the same reasons, it usually takes longer.
- As mentioned in ‘key issues’ above, legal due diligence is still required to assess the feasibility of merger.
- Due to the employee consultation requirements, it is usually more efficient for any employees to be transferred out prior to a merger.
Read the other parts of this guide to corporate simplification projects: