Background
On 23 January 2017, the UK High Court approved a reverse cross-border merger in which a UK parent company (Formenta Ltd) was absorbed by its Italian wholly owned subsidiary (Newco Immobiliare S.R.L.). The ruling has cleared the way for UK companies to be absorbed by European subsidiaries as they restructure in response to Brexit. The mechanism of a ‘reverse cross-border merger’ is set out in the European Commission directive on cross-border mergers (2005/56/EC), but had not previously been permitted under English law. The reverse merger could potentially be the first of many, although it is our view that it is unlikely.
Such mergers are relatively uncommon in a group context. Usually, a parent company absorbs a wholly owned subsidiary, or sister companies merge and may or may not create a new holding company.
The Companies (Cross-Border Mergers) Regulations 2007 (SI 2007/2974) (the "Regulations") provide for three different types of cross-border merger:
- merger by absorption (the existing company absorbs one or more other merging companies);
- merger by absorption of a wholly-owned subsidiary; and
- merger by formation of a new company (two or more companies merge to form a new company).
Broadly, the effect of a cross-border merger under the Regulations is that:
- the assets and liabilities of the non-surviving entity and the rights and obligations arising from its employment contracts, are automatically transferred to the surviving entity; and
- the non-surviving entity is dissolved without going into liquidation.
In the case of a merger by absorption or a merger by formation of a new company, the members of the non-surviving entity become members of the surviving entity.
Why was this different?
It is the ‘reverse’ element of the transaction that is notable. Reverse cross-border mergers have two key additional complexities:
- potentially violating laws that prevent a company from acquiring shares in itself; and
- determining the merger process, since the formalities depend on the type of merger.
The UK Regulations do not address the situation in which a subsidiary absorbs its parent company or the potential infringement of laws preventing a company from acquiring shares in itself.
The two issues were addressed as follows:
- Prohibition on a company acquiring its own shares: as is the case in the UK, Italy bars companies from acquiring their own shares. To manage this, all of the Italian subsidiary’s share capital was cancelled and its net assets were cancelled to create a surplus. New shares were then issued to the shareholders of the UK parent and the subsidiary’s share capital was restated to reflect the net assets contributed by the parent. The parent’s share capital was also cancelled.
- Determining the merger ‘type’: EU legislation was implemented differently in Italy to the UK. In Italy, the merger needed to follow provisions governing ‘mergers by absorption of wholly owned subsidiaries’, whereas, in the UK, the acquisition constituted a ‘merger by absorption’. The UK court ruled that the laws applicable to the surviving company should prevail; consequently, the formalities associated with mergers by absorption of wholly owned subsidiaries would apply.
Brexit
This is a significant case. It established how a reverse cross-border merger could take place and it provided another way to cross-transfer activities rather than using other options, such as the transfer of seat using a Societas Europaea or a business transfer and liquidation.
While the Regulations increase the options available to UK companies looking to restructure European operations, a cross-border merger is unlikely to be the first choice. The extent to which UK companies will be able to continue to rely upon this regime after Brexit remains unclear and will depend upon the Brexit model ultimately adopted.
Howes Percival
Howes Percival’s Corporate lawyers Edward Lee and Venetia Phipps have particular expertise in multi-jurisdictional transactions. To contact Edward, please email [javascript protected email address] or call 01908 872203.
