Until recently, Britain had no process by which companies, including Canadian multinationals operating there, could engage in a true merger through the absorption as opposed to the acquisition of another business.
Accordingly, pure mergers, even in the domestic context, have been relatively rare in Britain.
But the arrival of new regulations in 2007 made mergers possible in the cross-border context. The regulations implemented the European cross-border mergers directive of 2005, which allows companies incorporated in any country within the European economic area to merge with businesses incorporated elsewhere in the region.
The regulations apply to three types of mergers:
• Merger by absorption where companies in states within the economic zone absorb businesses in another member state.
• Merger by absorption of a wholly owned subsidiary where a company absorbs subsidiaries in another state.
• Merger by formation of a new company where an entity absorbs two or more businesses in different states.
For Canadian businesses, it’s important to note that in all of these cases, the absorbing company need not be the parent. For example, the subsidiary of a Canadian business incorporated in any state within the economic zone could use the regulations to create a single European-wide branch of the parent company.
“What we have now is a court-approved process for cross-border mergers that has distinct advantages over other available options,” says Gary McLean, a mergers-and-acquisitions partner at Allen & Overy LLP in London, England.
“The very distinct advantage of the regulations is that they incorporate the concept of universal succession by operation of law, which means the elimination of the cumbersome steps - including liquidation of the transferor - typically required to efficiently amalgamate businesses following acquisition.”
Uptake, however, has been slow with nary a transaction using the new procedure in the year after it came into force. But thanks to the advantages of a merger over the traditional acquisition or transfer process, the trend is on an upswing.
“Companies started to use these regulations early in 2009, but there have been only about a dozen cases to date [that took advantage of the process],” says Helen Johnson, a corporate partner at CMS Cameron McKenna LLP, also in London. “So while the regulations remain largely unknown, there have been an increasing number of cross-border mergers sanctioned recently by the English courts.”
Using the regulations involves a court process that occurs concurrently in the jurisdictions of the transferee (the absorbing entity) and the transferor (the entity being absorbed). Each of the merger companies must obtain a “pre-merger certificate” from the appropriate court or tribunal in its country of incorporation.
The British procedure requires the company to present a merger report containing the draft terms of the deal; a directors’ report citing the effect on shareholders, creditors, and employees; and an independent expert’s report confirming that the valuation methods and share exchange ratios are reasonable.
The company can waive the expert’s report, however, if the shareholders unanimously agree to do so and if the merger is an absorption of a wholly owned subsidiary or the transferee already holds at least 90 per cent of the transferor’s securities.
Seventy-five per cent of shareholders, by value, of each shareholder class must approve the merger. Creditors can also ask the court for a separate vote.
After obtaining the pre-merger certificates from all the relevant jurisdictions, the transferee applies for final approval to its domestic court. Once the court approves the transaction, the assets and liabilities, including employees of the transferor, automatically transfer to the transferee. No further liquidation or transfer proceedings are necessary, and the shareholders of the transferor automatically become shareholders of the transferee.
U.K. tax relief provisions may also apply to cross-border mergers, making them tax-neutral. As well, the creation of a single corporate entity can generate business efficiencies. Nevertheless, the fact that the new process involves court intervention may have impeded its acceptance.
“Courts scare a lot of people,” Johnson says. “You have to retain counsel, and there are usually a couple of hearings, meaning that using the regulations could potentially be more expensive than going the traditional acquisition route.”
Indeed, the notion of a court process brings the prospect of undue delay to the minds of many.
“You could be looking at a six- to 12-month delay if you used this process in a typical [merger] transaction,” says Tom Mercer of Ashurst LLP.
There’s also a degree of inflexibility to the scheme.
“It’s true that after you jump through the hoops and get your approval, all the assets and liabilities transfer automatically,” says Nigel Gordon, a partner in the London office of Fasken Martineau DuMoulin LLP. “But what if you didn’t want to transfer all the assets and liabilities, as might be the case for the transferor’s pension liabilities?”
The process also requires the protection of any employee-participation rights (to board-level representation, for example) that exist in any of the merging companies.
“This could result in employee-participation rights being given to U.K. employees where none previously existed, as where a company incorporated in a country such as Germany or Sweden that mandates employee-participation rights merges with a U.K. company,” McLean says.
Finally, the regulations may not deal adequately with third-party contractual provisions prohibiting a transfer of the rights and liabilities imposed by the agreement. While the regulations provide for the transfer of all assets and liabilities, they also require that the transferee take the legal steps necessary for the deal to be effective in relation to other persons.
“Our view is that to give effect to contractual provisions that prohibit transfer would defeat the purpose and intent of the directive and the regulations and that third parties affected by the transfer would be limited to suing for damages for breach of contract if they could prove losses from the transfer,” McLean says.
The upshot is that the regulations may not be the most effective tool for typical merger-and-acquisition transactions. But they would seem particularly suited to situations where shareholder and third-party consent are not live issues.
“Initially at least, the greatest use of the regulations has been in intra-corporate group cross-border mergers, where it is advantageous to have one entity operating branches in different jurisdictions as opposed to having separate corporate subsidiaries in each of those jurisdictions,” McLean says.
Intra-corporate cross-border mergers in regulated industries, such as banking and insurance, may find the greatest benefits in the regulations. Indeed, the Goldman Sachs investment bank, HSBC Group, XL Capital Ltd., and several international fund managers are among those that have used the process so far.
“Financial institutions can benefit from having fewer regulated subsidiaries, particularly where capital has to be allocated separately to those subsidiaries or where the regulatory regimes governing the subsidiaries are otherwise stricter than the one governing the parent,” McLean says. “Reducing the number of subsidiaries can also reduce an organization’s compliance burden.”
The regulations could also assist in the restructuring of insolvent companies.
“It would certainly give parties to an insolvency proceeding a greater choice regarding the most appropriate jurisdiction in which to carry out their restructuring,” McLean says.
Accordingly, pure mergers, even in the domestic context, have been relatively rare in Britain.But the arrival of new regulations in 2007 made mergers possible in the cross-border context. The regulations implemented the European cross-border mergers directive of 2005, which allows companies incorporated in any country within the European economic area to merge with businesses incorporated elsewhere in the region.
The regulations apply to three types of mergers:
• Merger by absorption where companies in states within the economic zone absorb businesses in another member state.
• Merger by absorption of a wholly owned subsidiary where a company absorbs subsidiaries in another state.
• Merger by formation of a new company where an entity absorbs two or more businesses in different states.
For Canadian businesses, it’s important to note that in all of these cases, the absorbing company need not be the parent. For example, the subsidiary of a Canadian business incorporated in any state within the economic zone could use the regulations to create a single European-wide branch of the parent company.
“What we have now is a court-approved process for cross-border mergers that has distinct advantages over other available options,” says Gary McLean, a mergers-and-acquisitions partner at Allen & Overy LLP in London, England.
“The very distinct advantage of the regulations is that they incorporate the concept of universal succession by operation of law, which means the elimination of the cumbersome steps - including liquidation of the transferor - typically required to efficiently amalgamate businesses following acquisition.”
Uptake, however, has been slow with nary a transaction using the new procedure in the year after it came into force. But thanks to the advantages of a merger over the traditional acquisition or transfer process, the trend is on an upswing.
“Companies started to use these regulations early in 2009, but there have been only about a dozen cases to date [that took advantage of the process],” says Helen Johnson, a corporate partner at CMS Cameron McKenna LLP, also in London. “So while the regulations remain largely unknown, there have been an increasing number of cross-border mergers sanctioned recently by the English courts.”
Using the regulations involves a court process that occurs concurrently in the jurisdictions of the transferee (the absorbing entity) and the transferor (the entity being absorbed). Each of the merger companies must obtain a “pre-merger certificate” from the appropriate court or tribunal in its country of incorporation.
The British procedure requires the company to present a merger report containing the draft terms of the deal; a directors’ report citing the effect on shareholders, creditors, and employees; and an independent expert’s report confirming that the valuation methods and share exchange ratios are reasonable.
The company can waive the expert’s report, however, if the shareholders unanimously agree to do so and if the merger is an absorption of a wholly owned subsidiary or the transferee already holds at least 90 per cent of the transferor’s securities.
Seventy-five per cent of shareholders, by value, of each shareholder class must approve the merger. Creditors can also ask the court for a separate vote.
After obtaining the pre-merger certificates from all the relevant jurisdictions, the transferee applies for final approval to its domestic court. Once the court approves the transaction, the assets and liabilities, including employees of the transferor, automatically transfer to the transferee. No further liquidation or transfer proceedings are necessary, and the shareholders of the transferor automatically become shareholders of the transferee.
U.K. tax relief provisions may also apply to cross-border mergers, making them tax-neutral. As well, the creation of a single corporate entity can generate business efficiencies. Nevertheless, the fact that the new process involves court intervention may have impeded its acceptance.
“Courts scare a lot of people,” Johnson says. “You have to retain counsel, and there are usually a couple of hearings, meaning that using the regulations could potentially be more expensive than going the traditional acquisition route.”
Indeed, the notion of a court process brings the prospect of undue delay to the minds of many.
“You could be looking at a six- to 12-month delay if you used this process in a typical [merger] transaction,” says Tom Mercer of Ashurst LLP.
There’s also a degree of inflexibility to the scheme.
“It’s true that after you jump through the hoops and get your approval, all the assets and liabilities transfer automatically,” says Nigel Gordon, a partner in the London office of Fasken Martineau DuMoulin LLP. “But what if you didn’t want to transfer all the assets and liabilities, as might be the case for the transferor’s pension liabilities?”
The process also requires the protection of any employee-participation rights (to board-level representation, for example) that exist in any of the merging companies.
“This could result in employee-participation rights being given to U.K. employees where none previously existed, as where a company incorporated in a country such as Germany or Sweden that mandates employee-participation rights merges with a U.K. company,” McLean says.
Finally, the regulations may not deal adequately with third-party contractual provisions prohibiting a transfer of the rights and liabilities imposed by the agreement. While the regulations provide for the transfer of all assets and liabilities, they also require that the transferee take the legal steps necessary for the deal to be effective in relation to other persons.
“Our view is that to give effect to contractual provisions that prohibit transfer would defeat the purpose and intent of the directive and the regulations and that third parties affected by the transfer would be limited to suing for damages for breach of contract if they could prove losses from the transfer,” McLean says.
The upshot is that the regulations may not be the most effective tool for typical merger-and-acquisition transactions. But they would seem particularly suited to situations where shareholder and third-party consent are not live issues.
“Initially at least, the greatest use of the regulations has been in intra-corporate group cross-border mergers, where it is advantageous to have one entity operating branches in different jurisdictions as opposed to having separate corporate subsidiaries in each of those jurisdictions,” McLean says.
Intra-corporate cross-border mergers in regulated industries, such as banking and insurance, may find the greatest benefits in the regulations. Indeed, the Goldman Sachs investment bank, HSBC Group, XL Capital Ltd., and several international fund managers are among those that have used the process so far.
“Financial institutions can benefit from having fewer regulated subsidiaries, particularly where capital has to be allocated separately to those subsidiaries or where the regulatory regimes governing the subsidiaries are otherwise stricter than the one governing the parent,” McLean says. “Reducing the number of subsidiaries can also reduce an organization’s compliance burden.”
The regulations could also assist in the restructuring of insolvent companies.
“It would certainly give parties to an insolvency proceeding a greater choice regarding the most appropriate jurisdiction in which to carry out their restructuring,” McLean says.
