Overview of structures for cross-border acquisitions with analysis of underlying legal, tax and accounting considerations. Country specific information (updated periodically) for Australia, Canada, China, France, Germany, Hong Kong, Italy, Japan, Mexico, The Netherlands, Russian Federation, Singapore, South Korea, UK and US (New York).
Cross-border mergers and acquisitions give rise to a number of commercial and legal considerations. Commercial factors will normally dictate the way in which the acquisition is structured but tax and legal issues are also likely to be important.
The main focus of this note (and manual) is on share purchases rather than business or asset purchases (the purchase of the underlying assets of the target business).
In any cross-border acquisition, the main issues are likely to be:
The identity of the target. If the target is a company, is it private or public, listed or unlisted? Most jurisdictions require a formal offer procedure to be followed if a target company is listed (and possibly in certain other circumstances) (see Public or private).
Are there any legal barriers to a particular structure? For example, a company's constitution may contain pre-emption rights or there may be change of control provisions in important contracts that effectively preclude a share purchase (see Legal barriers).
Does the buyer wish to purchase the shares of the target company or some or all of its underlying assets (see Shares or assets)?
How does the buyer propose to finance the acquisition and what consideration is to be offered to sellers (see Finance and consideration)?
Is the process to be structured as an auction with competitive bids or as a private treaty sale between two parties (see Private treaty or auction sale)?
What are the tax implications of the acquisition? This is likely to be the most important factor in the choice of acquisition structure outside any overriding commercial imperatives. The parties need to consider the immediate tax costs of the transaction and the post acquisition tax costs once the target is part of the buyer's group. Tax issues are considered briefly where relevant in this note but are covered in more detail in the Tax note (www.practicallaw.com/A17809).
Most jurisdictions have at least two forms of corporate vehicle. These can broadly be categorised as private companies (for example the German GmbH, French SARL, and UK limited company) and public companies or joint stock corporations (for example the German AG, French SA or SCA and UK plc).
A formal offer procedure is required in many jurisdictions for the acquisition of quoted public companies. In some jurisdictions, such as the UK, a formal offer procedure is also occasionally required for the acquisition of an unlisted public company (unless a dispensation can be obtained from the main regulator of takeover bids) or for the acquisition of a private company. The European Directive on Takeover Bids (2004/25/EC) (which has now been fully implemented) establishes standard rules on takeover bids throughout the EU. The Directive also provides important protection for minority shareholders. Key provisions of the Directive include the establishment of a mandatory bid regime, greater transparency of companies' capital structures and defensive measures and the introduction of "squeeze-out" and "sell-out" rights, to be effected at a fair price.
The European Directive on Takeover Bids (which has now been fully implemented) establishes standard rules on takeover bids throughout the EU. The Directive also provides important protection for minority shareholders. Key provisions of the Directive include the establishment of a mandatory bid regime, greater transparency of companies’ capital structures and defensive measures and the introduction of "squeeze-out" and "sell-out" rights, to be effected at a fair price.
In most jurisdictions the transfer of shares may be subject to restrictions in the target company's bye-laws or a shareholders' agreement. Common restrictions include pre-emption rights and board approval. Entities that are likely to have significant restrictions include the French SARL and Dutch BV (both private limited liability companies). Family-owned businesses and those backed by venture capital may give rise to greater complexity, while interests in partnerships and joint ventures will entail detailed third party negotiations. There may also be anti-trust or sector-specific regulatory restraints.
Share purchases are more common than asset (or business) purchases in most jurisdictions. A variety of factors will influence the decision as shown below.
Assets and liabilities. On a share purchase, all the target's liabilities will automatically pass to the buyer. But if, for example, the seller is involved in on-going litigation that may result in unquantifiable liabilities, the buyer might prefer an asset purchase.
On an asset purchase the buyer only acquires agreed and identified assets and liabilities provided these can be specified with sufficient precision as a matter of fact and drafting. This is subject to exceptions in certain jurisdictions. For example:
On the acquisition of a business as a going concern that is located in any EU jurisdiction, contracts of employees who work in the business immediately before the acquisition will automatically be transferred to the buyer (as the new employer) who must continue to employ the employees on the same terms.
A buyer of business assets may take responsibility for tax liabilities relating to the business. For example, Germany and Italy both have rules that make a buyer of assets jointly liable with the seller for some, if not all, of the tax liabilities relating to the business.
Some countries have rules to protect general creditors on an asset purchase:
in Italy, the buyer of a business becomes jointly and severally liable with the seller for all debts of the business on the books at the time of the transfer whatever the arrangements agreed between the parties. In Germany, the purchaser may become liable for the debts of the business if the business is continued under the same or a similar name. However, in both countries the buyer may seek an indemnity from the seller in respect of these liabilities;
in France, the buyer of a business does not become directly liable for the debts, but the purchase must be publicly announced in accordance with strict procedures. Creditors have certain rights to oppose the payment of the price or to make counter-offers for the business;
in the US, some states have bulk sales statutes that hold a bulk transfer of assets of a target ineffective against the target's creditors unless prior notice of the sale is given to the creditors and certain other procedures are followed. Because compliance with bulk sales statutes is cumbersome, the buyer may insist on an indemnity from claims of the seller's creditors.
A buyer may inherit liabilities with an asset (for example, environmental liabilities associated with a property) or may need to discharge liabilities to protect an asset (for example, leased assets) or to protect the goodwill of the business.
Most countries have laws protecting creditors of an insolvent seller who has attempted to sell assets at less than fair value (or in some cases, regardless of the consideration paid).
Going concern. On a share purchase, the business is transferred as a going concern (subject to change of control provisions in relevant contracts). This is not necessarily the case with an asset purchase. The interests of the parties will dictate whether this is an advantage or a disadvantage.
Complexity. A share purchase tends to be a more straightforward transaction. Only shares are transferred as opposed to all of the underlying assets of the business (for which separate transfers with different formalities may be required). The acquisition structure will not usually determine the complexity of other commercial issues, for example, due diligence and negotiation of warranties.
Tax. The tax treatment of share and asset purchases is different. Common differences are:
Transfer duties are generally lower on share purchases.
Past tax losses may be carried forward on a share purchase but not on an asset purchase (although it may be possible to re-package an asset purchase as a share purchase in some jurisdictions by doing a so-called hive down (see below)).
There is a potential double tax charge on the purchase of assets by a company - on the disposal of the assets by the company and then on the distribution of the proceeds to shareholders.
There is generally no adjustment of the book values of business assets on a share purchase but there is on an asset purchase. A step up in the book value may be advantageous for capital gains purposes (lower gain on subsequent disposal of the asset) and tax depreciation (the higher the cost the greater the permissible tax deduction).
It is quite common for complex acquisitions to combine both asset and share purchases to reflect the way in which the target group is structured and the parties' commercial objectives (for example, where a large group is divesting a division comprising certain subsidiaries and assets which are held elsewhere in the group).
The main forms of consideration that can be offered on an acquisition are cash, shares or debentures (loan notes). These are considered in the Practice Note, Consideration and acquisition finance (www.practicallaw.com/A17814).
If the buyer does not have sufficient funds to finance the acquisition the main options are to borrow cash or issue shares (either as consideration or to raise equity finance). Where the buyer is listed it may be able to issue convertible loan notes that convert into its equity, possibly on satisfaction of certain value related conditions.
The choice of consideration and funding may have an impact on the acquisition structure. For example:
One critical difference between domestic and cross-border acquisitions is that it is rarely possible to consolidate profits and losses of companies resident in different jurisdictions for tax purposes (this remains true notwithstanding the decision of the European Court of Justice in Marks & Spencer which requires member states to permit cross-border surrender of losses in limited circumstances). So, for example, interest payments on borrowings by an acquisition vehicle in Jurisdiction A cannot generally be set off against the profits of a target company in Jurisdiction B for tax purposes. A classic structure for making a foreign acquisition is therefore to set up a bid vehicle in the same jurisdiction as the target and (subject to local rules restricting the capital structure of subsidiaries with foreign parents (thin capitalisation rules)) leverage that vehicle up with debt. Profits of the target may then generally be consolidated with losses of the bid vehicle (incurred by interest payments), therefore reducing the overall tax charge.
If the buyer is issuing shares or debentures in exchange for the shares or assets of the target, it may be desirable from a tax perspective for the consideration securities to be issued by an intermediate holding company incorporated in the same jurisdiction as the target. Tax relief for sellers on capital gains arising from the sale may not be available under domestic tax legislation if the consideration securities are issued by a foreign company.
Many jurisdictions have laws that prohibit companies from giving financial assistance for the acquisition of their own shares. It may not therefore be possible for a target company to give a charge over its assets to secure borrowings made by the buyer to finance the acquisition of its shares. There are no such restrictions on asset purchases.
In France, the legitimacy of merger leveraged buyouts (that is, acquisition structures whereby the target bears the burden of the debt undertaken for its acquisition, as a consequence of the subsequent merger between the target and the acquisition vehicle) is controversial and there is no clear case law on the structure, although practical solutions exist.
Auction sales have become common not only in the US and UK, but are also used frequently in most other jurisdictions.
A controlled auction is the sale of a company or business where the seller seeks competing bidders for the target. The competitive process is used to obtain the best price and sale terms and to control the documents and timetable.
The timing and auction process differ from transaction to transaction but they almost invariably include the following:
Interested parties enter into a suitable confidentiality agreement with the seller.
The distribution of an information memorandum with a description of the target business and financial information to prospective bidders.
A first round of "indicative" bidding.
A due diligence investigation and review of draft sale documentation by a more limited number of bidders.
A second round of bidding, accompanied by their responses to the seller's draft documents.
Negotiations with one or more bidders, leading to the conclusion of the transaction.
The most significant differences in process between an auction sale and sale by private treaty are that:
The seller usually prepares the first drafts of the acquisition documents.
Due diligence is normally conducted in a data room prepared by the seller to which the buyers are given access. The seller will commonly insist that the entire contents of the data room are deemed to be disclosed against warranties given in the acquisition agreement. (See Practice note, Auction sales (www.practicallaw.com/A17816).)
More complex structures can be used for cross-border acquisitions. These are often driven by tax considerations and are more likely to be used where any inherent additional cost can be justified by the economies of scale.
The Directive on Cross-Border Mergers of Limited Liability Companies (Directive 2005/56/EC) (implemented in the UK on 15 December 2007) aims to provide a suitable legal means for cross-border mergers, particularly for entities for which the European Company Statute does not provide a satisfactory solution, and intends to remove legal barriers that previously made mergers between limited liability companies from different member states difficult.
This Directive also requires that any cross-border merger operation must take into account employee participation arrangements where these exist in one or more of the merging companies. Employee participation is a system which gives employees a statutory or contractual right to involvement at board level. The company resulting from the cross-border merger will be subject to the rules in force concerning employee participation, if any, in the EEA state where it will have its registered office.
Where employee participation does exist in any of the merging companies, each of the merging companies must hold a ballot so that the right number of employee representatives is elected from each company to form a "Special Negotiating Body". The purpose of the Special Negotiating Body is to agree with the merging companies the type of employee participation system which will exist in the new company. Merging companies are under a duty to provide the Special Negotiating Body with all relevant information to enable it to fulfil its task.
A legal merger (where two companies become one) is conceptually possible in many jurisdictions (including the US, Japan and most continental European countries).
Legal mergers commonly take one of two forms:
A new company is formed which absorbs the assets and liabilities of the buyer and target (which each then cease to exist).
One company (either the buyer or target) absorbs the assets and liabilities of the other whose shares are cancelled and therefore ceases to exist.
The procedures for legal mergers commonly entail:
A merger agreement.
Shareholder resolutions of both companies.
An independent report and valuation on the merger.
An opposition procedure for creditors to object.
They typically entail added formality and risk of challenge, and can often take longer to implement than simpler structures.
Although not a legal merger as such, in the UK it is possible to effect a merger or acquisition by way of a scheme of arrangement in the UK company. A scheme of arrangement is an arrangement between a target company and its shareholders which, if approved by a majority in number representing 75% in value of the shareholders present, in person or by proxy, and voting at a meeting convened by the court, and is subsequently confirmed by the court, becomes binding on all of the target's shareholders. It is most commonly used to eliminate minority shareholdings, to effect takeovers, mergers or demergers, and to reorganise groups.
So called "two step" acquisitions and "triangular" mergers both include legal mergers as part of the structure (see below).
Two step acquisitions and triangular mergers
In a two step acquisition, the buyer will normally incorporate a new company in the same jurisdiction as the target (Newco). Newco acquires the target and then Newco and the target merge. Advantages of this structure are that:
The merged company assumes any debt taken on by Newco. Interest payments on the debt can be set off against profits of the business formerly operated by the target before tax. Tax consolidation may otherwise have been unavailable (even between two companies resident in the same jurisdiction).
The merged company may be able to charge its assets as security for any loan taken out by Newco to fund the acquisition without infringing rules that prohibit a target company from giving financial assistance for the acquisition of its own shares.
Potential disadvantages of this structure are the effect on the target's business (for example events of default and change of control provisions in contracts) and the effect on the acquisition documents (enforceability of warranties and indemnities, impact on deferred consideration). There are also potential tax disadvantages.
Acquisitions of US public companies by foreign buyers are commonly structured as tender offers or reverse triangular mergers. Forward triangular mergers are rarely used due to adverse tax consequences. In a forward triangular merger, the buyer establishes a US subsidiary (Newco) that merges with the target under relevant state law and Newco is designated as the surviving company. Shares in the target company are cancelled in consideration for the right to receive shares in the buyer. In a reverse triangular merger, the US target merges with a US subsidiary established by the buyer but this time the target survives the merger.
More sophisticated tax planning can sometimes be required to overcome some of the inefficiencies in structuring post acquisition cross-border income flows. These are more relevant in the context of public mergers of listed entities but the techniques employed may be applied in a private context if the commercial objectives and benefits justify this. Two techniques are income access (or stapled) shares and twin holding company structures (both are considered in more detail in Practice Note, Tax (www.practicallaw.com/A17809)).
Shareholders nearly always prefer to receive dividends from companies resident in their own country rather than from abroad because of reduced rates of withholding tax, the availability of imputation tax credits (such as the avoir fiscal credit in France) and because routing dividends from one jurisdiction into another and then back to the original country will regularly lead to tax leakage.
To solve these types of problems, income access arrangements have been used. Examples include:
SmithKline Beecham (UK/US) (subsequently unravelled).
Wiggins Teape/Arjomari-Prioux (UK/France).
Royal Dutch Shell (UK/The Netherlands)
Precise details vary in each case but all share the common aim of ensuring that, so far as possible, shareholders can access profits made in their own jurisdiction. Commonly, income access shares in the target are "stapled" to consideration shares in the buyer giving shareholders a choice where to take their dividend. Shareholders that are resident in the same jurisdiction as the target will elect to take dividends from the target, the dividends on the other stapled shares are reduced accordingly (see box, Income access).
These can be used to achieve results similar to income access shares, although they are rarely chosen exclusively for tax reasons. The structure involves the retention of two holding companies in different jurisdictions. The businesses remain separate legal entities which merge operations at subsidiary level or achieve this effect synthetically through a series of contractual arrangements and constitutional amendments. Equalisation arrangements ensure that profits are distributed equitably between the two holding companies.
Well known examples of these twin holding company structures or dual listed company structures include Reed Elsevier, BHP Billiton Rio Tinto, Investec and Mondi. The Reed Elsevier merger was effected by the creation of two intermediate holding companies in which the two listed companies, Reed International PLC and Elsevier NV, hold shares and receive dividends. They then distribute these dividends to their own shareholders. The listed companies retain their separate existences and the shares are traded separately. This is known as an "intermediate holding company" structure. The BHP Billiton merger and, more recently, the Investec and Mondi dual listed company structure were effected by way of a "synthetic" merger structure. The business operations are not jointly owned but remain within the separate ownership of the two listed companies. By way of a series of contractual and constitutional arrangements, however, the two listed companies ensure that their respective shareholders are treated equivalently in economic terms and that the two groups, although legally separate, operate as if they were a single corporate group.
One of the guiding principles of the Reed Elsevier merger was to ensure that, so far as possible, UK source profits could be used to fund dividends paid by the UK holding company of the group and non-UK profits for the Dutch holding company. Although most of the group is held under a common UK intermediate company (for operational reasons), tax inefficiencies are avoided by allowing the Dutch holding company to dip directly into Dutch (and other non-UK) profits through income access shares (see box, Twin holding company structures: Reed Elsevier).
Twin holding company structures: Reed Elsevier
Accounting treatment can also have a bearing on how an acquisition is structured. The main issue is the treatment of acquisition goodwill (the difference between the price paid and the fair value of the underlying assets) and, in particular, whether it has to be written off against profits of the buyer in future years. It is likely that goodwill will have to be recognised and written off in this way in the case of asset purchases although national accounting rules are increasingly requiring this treatment for nearly all acquisitions (shares or assets). The use of International Financial Reporting Standards (IFRS) is compulsory for public companies in the EU for financial periods beginning on or after 1 January 2005 and private companies may choose to apply these standards instead of national accounting rules. This means that for companies who must or choose to use IFRS reporting goodwill will have to be recognised on all acquisitions (shares or assets) and that it will have to be revalued at least once every year. Any resulting impairment will be written off against the purchaser's profits.
Robert Cleaver and Aisling Zarraga are partners, and David Welford and Nia Dadson are associates in the London office of Linklaters LLP. Thanks to other lawyers at Linklaters LLP who contributed to the note: Bruno Derieux and Alice Magnan (France), Jochen Laufersweiler (Germany), John Goodwin, Kim Latypov and Ilya Andalashvili (Russia), Yuan Cheng and John Xu (People's Republic of China), Mas Harntha and Scott Sonnenblick (US), Peter Goes and Bauke Faber (The Netherlands), and to Ottaviano Sanseverino and Domenico Mastrangelo of Gianni Origoni Grippo & Partners.