A new route for the takeover bid? Implementing a public M&A deal using the European Cross-border Merger Directive

Practical Law UK Articles 1-505-9075 (Approx. 12 pages)

A new route for the takeover bid? Implementing a public M&A deal using the European Cross-border Merger Directive

by Gareth Roberts, Gillian Fairfield and Mike Flockhart, Herbert Smith LLP

The Directive

The Directive, which took effect on 26 October 2005, was intended to address perceived legislative and administrative difficulties in implementing cross-border mergers within the EU and to lay down EU-wide provisions to facilitate cross-border mergers between various types of limited liability company governed by the laws of at least two different member states. More broadly, the Directive forms part of the EU's Financial Services Action Plan and its continued work to promote the single market.

The Directive was implemented in the UK by the Companies (Cross-Border Mergers) Regulations 2007 (SI 2007/2974) (UK Regulations) and it has now been implemented in member states throughout the EU.

Since its implementation in the UK, the Directive has been used to facilitate a number of internal group restructurings but it has not yet been used to implement a public M&A transaction. Although it has been used on public M&A deals elsewhere in Europe, there is still limited precedent for this. The recent merger of Gibraltar-incorporated Partygaming and its German competitor Bwin Interactive Entertainment is the most high-profile transaction to use this structure. In October 2009, If P&C Insurance used the cross-border merger structure to carry out the corporate restructuring of its businesses in the Baltic States.

The Directive applies to three distinct types of cross-border merger:

One or more companies are dissolved without going into liquidation and their assets and liabilities are transferred to another existing company in exchange for an issue of securities and, if applicable, a cash payment (this is known as a "merger by absorption" in the UK).
Two or more companies are dissolved without going into liquidation and their assets and liabilities are transferred to a newly incorporated company in exchange for an issue of securities and, if applicable, a cash payment (known as a "merger by formation of a new company" in the UK).
A company, on being dissolved without going into liquidation transfers all of its assets and liabilities to its holding company (known as a "merger by absorption of a wholly-owned subsidiary" in the UK).

This article focuses on the first of these structures, although many of the issues described in this article apply equally to a merger by formation of a new company. Throughout this article the term "transferee" is used to refer to the company that survives following the merger and "transferor" is used to refer to the company that is dissolved as a result of the merger.

Key features of the cross- border merger structure

The Directive provides for a two-stage process:

Relevant authorities in the member state of each merging entity (which may be a court, notary or other competent authority but which in the UK is the High Court) assess compliance with certain pre-merger requirements.
The merger is then assessed by the relevant authority in the member state of the surviving entity.

While national implementing regulations may result in some variations to achieve conformity with existing national merger regimes, in broad terms the requirements of the Directive are as follows.

Pre-merger

The companies involved in the merger must prepare common draft terms of merger to be approved by shareholders of each of the merging entities. The draft terms of merger must include, among other things:

The exchange ratio and the amount of any cash payment (the amount of the cash payment must be capped at 10% of the nominal value of the share capital of the company resulting from the cross-border merger (or, if there is no such amount, 10% of the accounting value of the shares), unless the law of either of the relevant member states permits a larger cash payment).
The likely repercussions of the merger on employment.
Information on the procedures by which employee participation rights are to be determined (if any) (see below, Employee issues).
The terms for the allotment of securities or shares in connection with the merger.

In addition:

Each of the companies involved in the merger must prepare a management/administrative report explaining and justifying the legal and economic aspects of the merger and the implications of the merger for members, creditors and employees (Directors' Report).
One or more independent expert reports are required (see below).

The precise requirements for the publication and distribution of these documents are governed by national implementing regulations, subject to the Directive's requirement that each of these documents must be published or made available to members (and, in the case of the Directors' Report, employee representatives) at least one month before the shareholder meeting. The UK Regulations contain super-equivalent provisions requiring certain documents, including a copy of the court order convening the shareholder meeting to approve a merger and a copy of the UK company's Directors' Report, to be filed at Companies House and delivered to the employee representatives (or, if none, the employees) not less than two months before the shareholder meetings.

It is left to national implementing regulations to determine the required level of shareholder support. The UK Regulations require the merger to be supported by a majority in number representing three-quarters of the shares voted at the shareholder meeting. Technically no shareholder meeting is required if the pre-merger documents described above are made available in accordance with the UK Regulations and no shareholder or shareholders holding in aggregate at least 5% of the relevant company's shares request a meeting. However, in the context of a public M&A deal in which one or more of the transferor companies is subject to the UK City Code on Takeovers and Mergers (Code), the UK Takeover Panel (Panel) (see box, Application of the Code) will require a shareholder meeting in any case and in other circumstances the parties may be reluctant to risk the disruption to the timetable that a late request for a meeting would cause.

After the shareholders of each merging party have approved the draft terms of merger, each party must make an application to the relevant authority in its jurisdiction to certify that the pre-merger acts and formalities have been properly completed.

Merger completion

Once relevant authorities in each of the relevant member states have certified proper completion of the pre-merger acts and formalities (and assuming that all other conditions of the merger have been satisfied), the merging parties can apply to the relevant authority in the transferee's member state to give its final approval to the cross-border merger. This application must be made within six months of the date on which the first pre-merger completion certificate is issued.

This relevant authority, in scrutinising the merger, determines the date on which the merger takes effect. In the UK this must be at least 21 days after the date of the court hearing to sanction the merger.

On completion of the merger, the assets and liabilities of the company or companies being acquired are deemed to have been transferred by operation of law, the members of the transferor company or companies are deemed to have become members of the transferee company and the transferor company or companies cease to exist.

Key considerations involved in using the cross-border merger structure

Perception − merger of equals

In contrast to other jurisdictions (including the US and in Europe), many structures used to implement mergers in the UK involve one party being bid for by the other. As such, one possible benefit of the European cross-border merger structure is that it is more of a "true merger" than certain other structures. In the UK, that argument is counterbalanced by the number of genuine mergers that have been carried out using other structures, particularly schemes of arrangement. Investors tend to regard factors such as the relative proportions of the enlarged group owned by each set of shareholders and the composition of the board as better indicators of whether a transaction constitutes a merger in the true sense rather than a takeover. That said, the cross-border merger structure will feel familiar to companies in jurisdictions with a longer history of using domestic merger legislation and it may be the case that this structure is attractive to UK companies exploring cross-border opportunities in those jurisdictions, providing as it does a level of EU harmonisation to previously disparate merger regulations.

Change of control

As the assets and liabilities of the transferor company are transferred to the transferee company and the transferor company is dissolved at completion, the cross-border merger structure affords parties the possibility of avoiding triggering "change of control" clauses in key contracts. The legal effect of the implementation of a cross-border merger includes the assignment of contractual rights and obligations, notwithstanding any restrictions to the contrary in the contracts themselves, although the transferee company will inherit any liability for breach of contract.

Timetable

The timetable for the implementation of a cross-border merger will ordinarily be longer than the timetable for the implementation of a scheme of arrangement, although anti-trust or other regulatory clearances required on a particular deal may nullify any relative disadvantage (see table, Transaction timetables compared).

Impact of dissolution of transferor companies

A company wishing to acquire or merge with a UK company using either a takeover offer or scheme of arrangement structure may have commercial or other reasons for wishing to engage with trustees of the target's defined benefit pension schemes, particularly where the structure involves debt being pushed down into the target group or there is otherwise uncertainty as to ongoing funding requirements. However, the actual structure chosen for the transaction should not ordinarily give rise to any immediate rights for the trustees.

A technicality may, however, arise on the dissolution of the parent company in a cross-border merger if the parent company is a participating employer of the defined benefit pension scheme (or schemes), triggering a section 75 debt (or debts) payable by the parent company and therefore requiring the company either to pay that debt or (together with the other party to the merger) negotiate with the pension trustees to apportion that debt to another employer. The trustees may also have negotiation leverage on such a cross-border merger where the parent company is the principal employer of the defined benefit scheme and trustee consent is required to substitute another company in its place before the company's dissolution to avoid triggering the winding-up provisions under the scheme's rules.

The dissolution of the transferee company and the resultant transfer of all of its assets and liabilities will:

Require more extensive diligence to identify the assets held at parent company level and a workstream to perfect the legal transfer of those assets following completion of the merger.
Require detailed consideration of the impact of the dissolution of the transferee company on the material contracts of the group companies, particularly in relation to change of control, termination and assignment provisions. Among other things, the transferee will take the risk of any breach of contract occasioned by the merger and, depending on the language of the clause in question, specific issues may arise from the timing of the merger completion steps.
Significantly complicate the tax analysis, which requires detailed consideration as to potential mitigation (see below, Tax considerations).

Independent expert's report

Under the UK regulations the independent expert's report, which any UK party to a merger by absorption requires, unless every member of that company agrees that it is not required or the transferee company already owns 90% of the transferor company's shares, must:

Indicate the methods used to arrive at the share exchange ratio and the values arrived at using each such method.
Describe any special valuation difficulties which have arisen.
Give an opinion on:
- whether the methods used are reasonable in all of the circumstances of the case;
- if there is more than one method, the relative importance attributed to each method in arriving at the value decided on; and
- whether the share exchange ratio is reasonable.
The independent expert may also require an independent valuation report to be delivered to it to assist it in its work.

There is no analogous requirement on a scheme of arrangement or takeover offer.

A number of issues must be carefully considered in this respect, including:

There is a lack of practical experience in the market, which increases the challenge of finding a suitably qualified firm to take on the role.
This lack of experience will have an impact on the length of negotiations as to the scope of the role and engagement terms.
While the Directive and the UK regulations provide for the possibility of a joint appointment being made by relevant courts, it may not be practical to seek such an appointment until the transaction has been announced, creating a risk that either the appointment will not be confirmed or that circumstances will change such that the report is not subsequently issued.
The report contains a greater level of detail of the valuation analysis undertaken by the boards of the merging companies in a way which is not the case on a contractual takeover offer or a merger by scheme of arrangement.
It is likely that any subsequent revision to the merger terms will also need to be reported on, creating concerns around the deliverability of a revised merger proposal.

Overseas shareholders

Careful analysis is required to assess whether a European cross-border merger gives rise to any overseas securities law concerns, particularly in the US, where an exchange offer in a statutory merger or consolidation or similar plan of acquisition must be registered under the Securities Act of 1933 (Securities Act) unless an exemption applies.

It is common practice for parties undertaking a scheme of arrangement to rely (in accordance with a substantial body of US Securities and Exchange Commission (SEC) guidance) on the exemption provided by section 3(a)(10) of the Securities Act, which exempts an exchange offer if its terms and conditions are approved by a court or authorised governmental entity after a fairness hearing open to all offerees. However, a comparable body of guidance has not been developed in relation to European cross-border mergers. The availability of the section 3(a)(10) exemption is a significant advantage for transactions structured as schemes. In the context of a European cross-border merger, the parties must consider the extent to which mergers are analogous to schemes of arrangement, including the role the courts play in scrutinising the merger. Given that there is no precedent for relying on section 3(a)(10) in connection with a cross-border merger structure, the parties may wish to seek "no action" relief from the SEC, which may in turn have timing implications for the transaction.

If the section 3(a)(10) exemption is unavailable or presents timing issues, Rule 802 under the Securities Act may provide an alternative exemption where no more than 10% of the target's shares are beneficially owned by US residents.

Where neither exemption is available, one potential solution to US and other overseas shareholder concerns is to make an exclusionary offer, by amending the articles of association of the target to provide for a mandatory pre-completion transfer of shares held in problematic jurisdictions to a nominee who then participates in the merger on behalf of the relevant overseas shareholders and sells the shares in the market, distributing cash to the relevant shareholders. In the US, this could potentially be combined with a private placement to "qualified institutional buyers" to reduce the size of the rump required to be placed in the market.

Flexibility of merger requirements

The pre-merger requirements are jurisdictional and not discretionary in nature and as such there is a concern that the courts will not have discretion to waive minor or non-prejudicial amendments to the draft terms of merger. This, combined with the requirement to deliver an independent expert's report on the share exchange ratio, the requirement that all relevant documents are made available for a prescribed period before the shareholder meetings and the requirement that identical draft terms of the merger be approved by all merging entities, potentially makes the cross-border merger structure relatively inflexible, particularly as compared to a scheme of arrangement. It may be that in the future the courts adopt a scheme-based, similarly facilitative approach to cross-border mergers but, in the absence of precedent to that effect, inflexibility may pose a concern.

Creditor issues

Under the UK Regulations the court has power to order a meeting of creditors (or class of creditors) at the request of any creditor. If a creditors' meeting is held, then the merger must be approved by a majority of creditors representing 75% in value of each class of creditor. Even if a creditor does not ask the court to convene a creditors' meeting, the court still has a general discretion whether or not to grant a pre-merger certificate and may refuse to do so if it believes the interests of creditors are prejudiced. There is, therefore, the potential for creditors to derail the merger. It is arguable that no prejudice is suffered by creditors unless the merger results in a combined entity that is unable to pay its debts as they fall due or the merger results in a creditor being prejudiced by, for example, losing its priority ranking. A more general weakening of covenant or downgrading of the credit rating of the debtor may not of itself persuade the court to convene a creditor's meeting. Nonetheless, parties considering the European cross-border merger structure should consider this point carefully.

Employee issues

The Directive requires parties undertaking a cross-border merger to take account of statutory employee participation rights where these exist in one or more of the merging companies, although it does not impose such rights where they do not already exist. Employee participation allows the employees or their representatives to influence the affairs of the company through representation on supervisory boards or "administrative organ" (including the right to recommend and oppose appointments). The transferee company will be subject to such employee participation rules as are in force in the EEA state where it has its registered office, save for certain exceptions (broadly where this would result in lesser employee participation rights than applied pre-merger or where the pre-merger companies satisfied certain employee number and participation requirements). There are no statutory employee participation rights in the UK, but this is more common on mainland Europe.

If a UK company wishes to merge with an EEA company that has employee participation rights, the merging companies can either:

Adopt the standard rules of employee participation contained in the UK Regulations, which contain a default requirement for employee participation arrangements.
Negotiate an employee participation agreement with an elected special negotiating body.

Neither of these are likely to be attractive to a UK company, particularly in light of the impact the negotiation process may have on timetable (the merger cannot be completed until the employee participation arrangements have been settled) and where the UK company is not accustomed to employee participation.

In addition, parties undertaking a European cross-border merger will need to consider other relevant employee matters including:

The Directive's requirement to provide a copy of the Directors' Report to employee representatives (or if none, the employees) not less than one month before the shareholder meeting and to append to the report any opinion of the employee representatives received in good time (under the UK Regulations, the Directors' Report must be made available at least two months before the shareholder meeting and any opinion received from the employee representatives not less than one month before the meeting must be appended to the report, although in light of limited use of the UK Regulations employee representatives may not be aware of this opportunity).
The consequences for employees of the transferee company being dissolved on completion. Under the UK Regulations, the rights and obligations arising from the employment contracts of the employees of the transferor company will automatically transfer to the transferee company, together with the assets and liabilities of that company. If that is not desirable to the merging companies they will need to consider a pre-completion restructuring to ensure that employees are employed by an appropriate entity.
Any information and consultation requirements which may need to be complied with in relation to the cross-border merger and any pre-completion restructuring.

Tax considerations

Schemes of arrangement have become established as the structure of choice for large public M&A transactions in the UK, largely due to the tax advantages available on a cancellation scheme (including no stamp duty or stamp duty reserve tax (SDRT) and the possibility of capital gains roll-over relief for UK tax resident shareholders where shares are issued as consideration).

The UK tax code contains legislation allowing for the deferral of some taxes that would otherwise result on a cross-border merger, if certain conditions are met. That said, cross-border mergers are not tax neutral as such and pre-merger restructuring may be required to mitigate charges which would otherwise arise.

The two key tax issues to consider are:

Ensuring that the transferor's shareholders obtain rollover relief.
Minimising any tax charges arising on the transfer of the transferor's assets and liabilities to the transferee.

The usual rules that apply on a cancellation scheme in relation to rollover relief for UK tax resident shareholders also apply, in that the transaction must constitute a scheme of reconstruction and must satisfy a bona fide or no-tax-avoidance test. Under a special rule for cross-border mergers, however, the merger may be deemed to be a scheme of reconstruction even if the usual conditions are not satisfied. Care is needed to ensure that the rollover conditions are satisfied by one or other of these sets of rules.

The transfer to the transferee of the transferor's capital assets may take place on a "no gain no loss" basis, if the transferor and transferee are both either tax resident in the UK or hold the assets from a UK permanent establishment through which it carries on a trade. It is likely that one of the companies will be tax resident outside the UK, so if that company cannot satisfy the "permanent establishment" test a chargeable gain may arise to the transferor.

If the transferor is a holding company of a trading group the "substantial shareholdings exemption" may apply to exempt any such gains arising on the transfer of its subsidiaries to the transferee. If the transferor holds assets other than shares in subsidiaries, gains arising on the transfer of these assets may need to be sheltered by any available capital losses. It is likely that any tax liabilities of the transferor would pass to the transferee on the merger along with the transferor's other liabilities, including any tax liabilities that the merger triggers.

The fact that the target entities are dissolved means that no stamp duty or SDRT will be payable in respect of the target company shares. However, other transfer taxes may also be payable. Stamp duty and SDRT would need to be considered on the transfer of the transferor's UK subsidiaries, and stamp duty land tax if the transferor holds any UK land.

To minimise such tax charges some pre-merger restructuring may be required. This may include inserting a new holding company above the transferor (the new company would then merge with the transferee, transferring to it the shares in the transferor) or hiving assets of the transferor down to a subsidiary so that those assets are not transferred to the transferee when the merger takes place. Further structuring may be required to mitigate any tax issues associated with such a reorganisation (such as de-grouping charges).

It remains to be seen whether the proposed Northern Foods/Greencore group merger encourages a precedent that other merging parties will choose to follow. Practical experience so far indicates that it is fairly unlikely that the European cross-border merger structure will supplant schemes of arrangement as the structure of choice on mergers involving UK companies, at least where a UK company is the target or transferee. The structure may have a more promising future in outbound M&A, as a compromise between domestic merger structures in other EU jurisdictions.

Transaction timetables compared

Approximate Date	Cross-border merger (assuming no employee participation).	Cancellation scheme.
Prior to Announcement (A day)	UK company: Prepares draft merger terms. Prepares directors' report on merger. Commissions independent expert's report.	Directors of target company prepare scheme circular containing notice of meeting.
A-Day + 1	UK company issues application to the English court to convene the shareholder meeting (Court Meeting)
A-Day + 8	English court makes order convening Court Meeting. UK company delivers the English court order convening the Court Meeting, the draft merger terms and the other documents required by Regulation 12(1) of the UK CBM Regulations to Companies House. UK company sends the copy of directors' report to employee representatives or employees not less than two months before the shareholders' meeting to approve merger.	Company issues application to court to convene the Court Meeting to approve scheme.
A-Day + 15		Court makes order convening Court Meeting.
A-Day + 16	UK company posts merger document including the notice convening the shareholder meeting (must be within 28 days of announcement).	Scheme circular posted to shareholders (must be within 28 days of announcement).
A-Day + 39		Shareholder meeting(s) to approve scheme.
A-Day + 40	Latest date for Companies House to publish notice of proposed merger and details of shareholder meeting(s) in Gazette. Latest date for UK company to make the following documents available for inspection (not less than one month before date of shareholders' meeting): Draft merger terms. Directors' report (if employer representatives deliver an opinion on the directors' report within one month before the meetings this opinion must be appended). Independent expert's report.
A-Day + 47		Hearing for directions on adjourned claim form including directions for advertising the scheme.
A-Day + 48		Advertise hearing to sanction the scheme in national newspaper (seven clear days in advance of hearing).
A-Day + 57		Court sanctions scheme and confirms reduction of capital.
A-Day + 58		Court order sanctioning scheme and confirming reduction of capital filed and registered at Companies House. Scheme and reduction of capital effective.
A-Day + 71	Shareholder meetings to approve merger.
A-Day + 79	Court makes order certifying that pre-merger requirements have been satisfied by UK company.
A-Day + 89	Date of final hearing to sanction the merger.
A-Day + 110	Earliest merger effective date under UK Regulations.

Application of the Code

The Code will apply to any cross-border merger effected either by means of absorption or by the creation of a new company where the transferor company is a company to which the Code applies. Any such company will be treated as the offeree company for the purposes of the Code and the transferee company will be treated as the offeror. In a number of respects a cross-border merger is broadly analogous to a scheme of arrangement and as such the Panel may be influenced by the rules and practices relating to schemes of arrangement in applying the Code to cross-border mergers. For example, the Panel required Boparan to clarify its intentions in relation to Northern Foods ten days before the shareholder meetings to consider the merger, consistent with the approach it takes to applying the "Day 50" rule in the context of a scheme of arrangement. Whilst Panel Practice Statement 18 (October 2007) gives some guidance as to the application of the Code on a cross-border merger, it is likely that parties contemplating using such a structure in circumstances where the Code will apply will want to discuss its application with the Panel having regard to the specific circumstances of the case.

Contributor details

Gareth Roberts

Herbert Smith LLP

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T +44 207 466 2322
F +44 207 098 5322
E [email protected]
W www.herbertsmith.com

Qualified. England and Wales, 1985

Areas of practice. Corporate; M&A.

Recent transactions

Northern Foods on its proposed GB£400 million recommended merger with Greencore and subsequent recommended takeover by Boparan.
JJB Sports on its restructuring, refinancing, company voluntary arrangement and placing and open offer, delisting from the Main Market and GB£80 million listing on AIM.
BAA on its GB£15.6 billion takeover offer from Ferrovial and the competing bid from a Goldman Sachs-led consortium.
Virgin Group on the GB£1.17 billion recommended offer by NTL for Virgin Mobile with associated quadruple play brand licence.

Gillian Fairfield

Herbert Smith LLP

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T +44 207 466 2901
F +44 207 098 4901
E [email protected]
W www.herbertsmith.com

Qualified. England and Wales, 1999

Areas of practice. Corporate; M&A.

Recent transactions

Northern Foods on its proposed GB£400 million recommended merger with Greencore and subsequent recommended takeover by Boparan.
Arriva on its GB£1.6 billion takeover by Deutsche Bahn.
Pearson on the recommended cash takeover of Education Development International.
BAA on its GB£15.6 billion takeover offer from Ferrovial.
Lonmin on its US$477 million rights issue, its response to Xstrata's unrecommended possible offer, its placing with institutional investors and it restructuring of its black economic empowerment partnering arrangements in South Africa.
QinetiQ on its GB£700 million IPO on the London Stock Exchange.

Mike Flockhart

Herbert Smith LLP

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T +44 207 466 2507
F +44 207 098 4507
E [email protected]
W www.herbertsmith.com

Qualified. England and Wales, 2005

Areas of practice. Corporate; M&A; equity capital markets.

Recent transactions

Northern Foods on its proposed GB£400 million recommended merger with Greencore and subsequent recommended takeover by Boparan.
BlueBay on its GB£963 million takeover by Royal Bank of Canada.
Al Fayed Family Trust on the sale of Harrods.
Arriva on its GB£1.6 billion takeover by Deutsche Bahn.
HSBC and Barclays Capital on Yule Catto's EUR443 million acquisition of PolymerLatex and associated rights issue.
Lazard, Citi, Deutsche Bank and Centerview on Kraft Food's GB£11.9 billion takeover of Cadbury.

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