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«Legal Update EU Cross-Border Merger Directive and “SEVIC” – Implications for Corporate Restructurings in Europe by Robert Heym (Partner) and by ...»

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Legal Update

EU Cross-Border Merger Directive and “SEVIC” –

Implications for Corporate Restructurings in Europe

by Robert Heym (Partner) and by Constantin Conrads (Senior Associate),

Reed Smith LLP, Munich, Germany *

Robert Heym

I. Introduction

Partner, Munich

+49 89 20304 122

There are numerous reasons to initiate corporate restructuring activities and once started, such


activities appear to be an ongoing process that never finds an end. For example, restructuring activities driven by business reasons only will often impose legal and in particular tax risks.

Restructuring activities are often also driven by M&A activities as post-closing restructuring activities by the purchaser and/or pre-closing restructuring activities by the vendor. The increasing number of changes in tax legislation internationally questions previous restructuring activities and will often give cause to rethink previous decisions or initiate, from a strategic perspective, even new restructuring activities.

Constantin Conrads From a pure business perspective, the restructuring of business operations often appears as Senior Associate, Munich a simple operative process with clear objectives and responsibilites. However, cross-border +49 89 20304 123 restructuring activities are restricted in various ways because they often involve the coordination cconrads@reedsmith.com of the tax and legal regime of several jurisdictions that are usually not adapted to each other. Once all these issues and associated risks come on the table, the verve to implement restructuring activities often diminishes significantly so that eventually either nothing happens or only a second best alternative is pursued.

With regard to the European Union, ongoing legislative activity enhances and eases cross-border restructuring activities already now. On October 26, 2005, the EU Parliament and the EU Council passed the EU Directive regarding cross-border mergers of corporations (EU Directive 2005/56/ EG) which became effective on December 15, 2005 (the “EU Merger Directive”). The EU Merger Directive obliged all member states of the European Union to adapt the directive to their national

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B. United Kingdom Save for the new EU Merger process described below, there are no comprehensive provisions under UK company law relating to mergers. In particular, there is no concept of a “legal merger”, in which one entity disappears. The usual process in the UK is to begin with a share acquisition in order to bring the acquired company within the same group as the acquiring company. This may then be followed by a transfer of business or assets between companies within a 100% owned group in order to avoid many of the company law and taxation complexities otherwise arising. Therefore, the most commonly used restructuring and acquisition structures in the UK are a transfer of either the shares of the target company or a transfer of the assets or business of a company.

It is possible to structure a share acquisition as a “takeover offer”. This is much more common for public company acquisitions but is sometimes also used for private companies especially if there are a larger number of target company shareholders and/or if less than 100% of the target company’s shareholders are willing to sell on the same terms. The English Companies Act 1985 enables a buyer who has made an offer to acquire all the shares of a particular class or classes Legal Update (or all the shares of a company that has only one class) that has been accepted by the holders August 2008 of 90% of each class to which the offer relates to “squeeze out” the minority on the terms accepted by the majority.

reedsmith.com Another possible structure is a “scheme of arrangement” under which (among other possibilities) a target company’s existing shares can be cancelled and replaced by new shares issued to the buyer either in exchange for a cash consideration to the target company’s shareholders or the issue of debt or equity securities of the buyer to the target company’s shareholders. Among other things, this requires the target company shareholders’ approval in the form of a 75% majority vote (and similar majorities at separate class meetings if applicable) and the approval of the Court. A scheme of arrangement is relatively rare but might typically be used if less than 90% (therefore meaning that the squeeze out procedure described above cannot be used) of the shareholders are willing to sell on the same terms.

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B. The European Stock Corporation Companies with registered offices in the EU have another option with regard to the choice of the legal form since the end of 2004: The European Stock Corporation (SE). The introduction of the SE by the European Union in 2004 allowed to some extent for the concept of cross-border mergers within the territory of the European Union as stock corporations residing in different member states of the EU then had the possibility of a cross-border merger for the purpose of incorporating a SE. One advantage is that this does not require a unanimous approval of the shareholders, but only a two-third majority. However, the cross-border merger is only feasible in connection with the incorporation process of the SE and cannot be done separately.

Furthermore, this option is only available for stock corporations.

C. The EU Merger Directive On October 26, 2005, the EU Parliament and the EU Council passed the EU Directive regarding cross-border mergers of corporations (EU Directive 2005/56/EG) which became effective on December 15, 2005. As a directive, it had no immediate legal effect, but obliged the member states of the EU to implement the content of the directive into their national law by December 2007 at the latest (see Art. 19 of the EU Merger Directive).

Legal Update The EU Merger Directive intends to allow for the merger of corporations that were established August 2008 pursuant to the laws of an EU member state and that have their registered office, their administrative office or their principal place of business in the European Community. As reedsmith.com possible merger alternatives, the EU Merger Directive refers to a merger by way of absorption (Verschmelzung durch Aufnahme), a merger by way of incorporation (Verschmelzung durch Neugründung) and intra-group mergers (Konzernverschmelzung) as feasible cross-border merger alternatives. The EU Merger Directive does not permit cross-border demergers (Spaltung) and cross-border changes of the legal form (Formwechsel).

IV. Employee Co-Determination Employee co-determination was a major point of discussion during the legislative procedure of the EU Merger Directive as this issue is treated very differently in the EU member states.

According to the EU Merger Directive, employee co-determination applies in cross-border mergers if at least one of the participating companies is subject to employee co-determination.

According to the Directive, the form of co-determination in the new company shall in principle be a matter of negotiation.

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A. Germany In Germany, the EU Merger Directive was implemented by respective amendments to the German Transformation Act. The German Department of Justice issued the first draft of the bill (Referentenentwurf) amending the German Transformation Act on February 13, 2006. The German Bundestag debated the amendments of the German Transformation Act in a first and second reading on February 1, 2007. Finally, the amendments of the German Transformation Act became effective on April 25, 2007.

Only corporations can participate in a cross-border merger. The respective legal entities in Germany are the limited liability company (GmbH), the stock corporation (AG), the association limited by shares (KGaA) and also the SE with its registered office in Germany. The new legislation is not applicable to parnerships.

The part of the EU Merger Directive treating the issue of co-determination was implemented into German law by an own “corollary act” to the amendments of the German Transformation Act which is the Act on the Co-determination of Employees in Connection with a Crossborder Merger (Gesetz über die Mitbestimmung der Arbeitnehmer bei grenzüberschreitenden Verschmelzungen, MgVG). This act already became effective on December 29, 2006. According to the MgVG, the employers and a “negotiation committee” to be constituted by the employees shall primarily decide amicably on the terms and the scope of the employee co-determination that shall apply after the merger. These negotiations may take six months with a possibility to extend this term by another six months. In the event that an amicable decision cannot be achieved those employee co-determination rules applicable to the participating company will apply which are most stringent. The parties may also decide that the most stringent rules apply without any prior negotiations.

As regards tax matters in connection with cross-border mergers, one of the disadvantages of cross-border mergers (if feasible at all) was the realisation of hidden reserves. The new taxation provisions for cross-border mergers, stipulated in the SEStEG (see above), now provide that under certain preconditions, the book value can be taken in the final tax balance sheet. Thus, a realisation of hidden reserves is no longer necessary.

B. United Kingdom The Companies Cross-Border Mergers Regulations came into force in the UK on December 15, 2007, thereby implementing the EU Merger Directive (the UK Merger Regulations). For the UK Merger Regulations to apply a merger must involve at least one company which is incorporated in the UK (a UK company) and one incorporated in a different EEA state.

The UK Merger Regulations lay down a standard procedure that must be followed by every UK company involved in a cross border merger. Briefly, the UK Merger Regulations require a UK company to prepare and allow its shareholders and employees or their representatives to inspect draft terms of the merger and reports by the company’s directors and independent auditors. Application is then made to the High Court for an order that such meetings of the company’s shareholders and creditors (or different classes of shareholders and creditors) be held as the court determines. At any such meetings, the draft terms of merger must be approved by a majority in number, representing 75% in value, of the relevant shareholders or creditors. Once these formalities have been completed, the company can apply to the High Court for a pre-merger certificate.

Legal Update The UK Merger Regulations include, as is required by the EU Merger Directive, provisions August 2008 protecting employee participation rights. This is likely to be a significant consideration for any UK company considering such a merger as employee participation rights generally do not exist reedsmith.com in the UK and a merger by way of the UK Merger Regulations could require the UK company to introduce employee participation rights.

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VI. The “SEVIC”- Decision of the European Court of Justice Cross-border cases are regularly decided by the ECJ as they have a natural nexus to the principle of freedom of establishment which is guaranteed under the European Community Treaty. A factual inability of cross-border mergers is not in line with the principle of freedom of establishment as this situation is similar to the one of a registered office of a company moving from one member state to another. The ECJ already ruled in these cases (Centros, Ueberseering, Inspire Arts) that the freedom of establishment eventually prevails.

A further decision of the ECJ in this regard was the “SEVIC”-decision that was decided by the ECJ on December 13, 2005, only a few weeks after the EU Merger Directive was issued.

This decision was based on an attempt to merge a Luxembourg stock corporation (S.A.) into a German stock corporation (AG) under application of the respective rules of the German Transformation Act. The competent German commercial register rejected the registration of the merger by referring to the prevailing opinion under German law that cross-border mergers were not covered by the German Transformation Act (see above).

The ECJ held that the denial of the registration of the cross-border merger between companies of two different EU member states was a violation of the principle of freedom of establishment guaranteed under the European Community Treaty if this denial was based only on the fact that German law did not cover non-German legal entities and such registration would have been admissible in case both companies had their administrative office in one member state provided that certain preconditions of this member state were fulfilled.

The ECJ only decided on the issue of the rejection of the registration of the cross-border merger in Germany. However, the ECJ did not comment on any other legal aspects on how such a merger could or should legally be effected as these questions did not need to be decided. The conclusions of legal annotators after the “SEVIC”-decision indicated that a cross-border merger Legal Update should – even before the implementation of the Merger Directive in other EU member states – August 2008 be based solely on the principle of freedom of establishment.


VII. Conclusion

The systematic of corporate law of the member states of the European Union is further harmonized by legislative action on the level of the European Union and the recent decisions of the ECJ. The EU Merger Directive, once implemented by all EU member states, will, from a transnational perspective, grant additional options for entering into corporate reorganization activities. However, the legal framework for European cross-border mergers may not yet be complete in the beginning, in particular with respect to tax treatment and employee co-determination issues. Also, the new German legislation on cross-border mergers is only applicable to corporations and not to partnerships. However, the principles of the“SEVIC”decision are applicable to partnerships as well. The “SEVIC”-decision and future decisions expected to be made by the ECJ (presumably being based on the principle of freedom of establishment) may further ease cross-border restructuring activities.

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