This article provides a preliminary checklist of legal feasibility issues when planning a section 110 demerger (also known as a ‘section 110 liquidation’) for an unlisted group. It sets out some of the most common legal issues which typically arise and which can have a significant impact on the timing of such a project, or whether it can go ahead at all. It is not a substitute for legal due diligence.
For an introduction to what a typical demerger project involves, please see this article: What is a section 110 demerger?
1. Dissenting shareholders
Although it is possible to implement a demerger with dissenting shareholders in the current holding company, it is more complicated and costly. Additional procedures may be needed, such as a court-approved scheme of arrangement.
2. Distributable reserves in the current holding company
A typical section 110 demerger involves inserting a new company on top of the existing holding company, by means of a share-for-share exchange. The existing holding company would then hive up assets or shares to the new topco by way of a distribution in kind. The existing holding company must have sufficient distributable reserves to do this. It would also need to have authority in its articles of association to make a distribution in kind.
3. Indemnity in favour of liquidators
Usually, the demerger happens soon after the liquidation of the new topco is commenced. This means that the liquidators will not have completed the usual process of advertising for creditors. The liquidators will therefore typically require indemnities from the ultimate shareholders against claims made by any creditors. In practice, this is usually not an issue, because by definition new topco has not previously traded.
4. Consents from third party lenders and charge holders
The consents of banks or other third party lenders or charge holders may be required in order to implement the demerger.
5. Change of control issues on a transfer of shares
Where shares are being transferred as part of the project, there may be change of control issues. This can be the case even if the ultimate ownership of the companies concerned is not changing. For example, a subsidiary company may be a party to a joint venture. The shares in that subsidiary may be transferred by the existing holding company to a newco as part of the demerger. That change in shareholding may trigger change of control provisions in the joint venture documentation. Whether this is an issue in practice depends on how those provisions are drafted, and whether the arrangements affected are material in the context of the group.
6. Transfer of a trade or assets
If a trade and/or assets are to be transferred as part of the project, then third party consents may be required. For an overview, see this article: Legal feasibility checklist: Intra group transfer of UK trade and assets.
7. Large numbers of shareholders
If there is a large number of shareholders in the existing holding company, there is the question of whether the demerger will involve an “offer of securities to the public” for the purposes of the Financial Services and Markets Act 2000. Typically, the view is taken that it should not, but that will depend on the specific circumstances involved. In practice, if a large number of shareholders is involved, then it also becomes important to anticipate the possibility of shareholder dissent and put in place contingency plans.