Using cross-border mergers within groups of companies in the EEA

When groups of companies want to reorganise themselves one option is to conduct mergers between companies within the group. If those companies are in the European Economic Area (EEA) then they may be able to use the mechanisms set out in the European Directive on cross-border mergers (Directive number 2005/56/EC).

In the context of a group reorganisation, the word 'merger' can cover a range of different situations. From a legal perspective, it is helpful to distinguish between:

• a 'true' legal merger, where two or more legal entities cease to be distinct and where assets and obligations transfer automatically to a surviving entity. The other entity or entities will cease to exist without going into liquidation.  In many continental European countries, true mergers have been possible under domestic company law for many years.
• a 'de facto' merger. where the commercial effect of a merger is achieved by transferring trade and assets. The transferring entities are then eliminated by a solvent winding up.

There are other methods companies can use to reorganise, but this guide deals only with 'true' cross-border mergers within the EU. The EEA comprises the 27 member states of the EU plus Iceland, Liechtenstein and Norway.

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 EEA and where at least two of the companies are governed by the laws of different member states. It is possible to use the Directive to achieve a domestic merger by forming a new company in another member state which also participates in the merger.

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.

Overview of the process

The main legal document in the legal process is called the 'Draft Terms of Merger'. This 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 below under 'key issues')

A 'pre-merger certificate' must be issued by the competent authority in each jurisdiction to confirm 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 are required to 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.

Key issues

Pre-steps – if the participating entities are not already in a direct parent company/subsidiary relationship or are not immediate subsidiaries of the same holding company then it may be advisable to carry out share transfers prior to the cross-border merger to achieve this. This may simplify 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.

Alternative options

The following approaches may be considered as alternatives to a cross-border merger under the European Directive:

• transfers of trade and assets, following by a solvent liquidation/dissolution of the transferring entities.
• creation of a “European Company” or “Societas Europeae” by way of merger of two or more public limited companies.

Pros and cons

There are advantages and disadvantagesto using the cross-border merger as a tool for reorganisation, when compared to a transfer of trade and assets.

Advantages

- Assets and liabilities transfer by operation of law, and this generally avoids the need for novation of contracts or other actions to perfect the transfer of individual assets.

- A cross-border merger can be used to achieve a migration of the statutory seat of a company.

- The use of a merger under the European Directive avoids the needs to deal with assets trapped in a transferring entity after a transfer of trade or assets – for example, by way of a solvent winding up or a reduction of capital.

Disadvantages

- 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.

This guide provides an overview of legal considerations only. Tax and accounting considerations should also be taken into account.