EU COMPANY LAW PACKAGE

European Commission finally published its Company Law Package regarding incorporation and international transactions

This company law package consists of two proposals, of which the second one offers the most interest for EU global companies.

Proposal 2018/0114 brings a new legal framework to cross-border conversions, mergers and divisions.

Directive 1132/2017already included rules for internal mergers and divisions and also for cross border mergers. The proposal introduces minor changes in this existing regulation : among others, it requires a new report for the information of employees and gives non-conforming shareholders the right to exit the company. But the real novelty is the introduction of common procedures for cross border divisions and conversions and divisions. Cross border conversions had been expressly admitted by the Court of Justice of the EU,  and divisions implicitly admitted in a few case. However, the lack of EU harmonization created uncertainties. The proposal creates a uniform procedure to facilitate these transactions while at the same time protecting the rights of minority shareholders, creditors and employees.

The procedure for both cross border conversions and divisions follows closely the existing one for cross border mergers. In summary, the steps would be the drawing up of the draft terms and the administrator´s and expert´s reports, disclosure of these documents, shareholder approval, examination by the competent authority of the home member state and registration in the host member state.

The most important -and potentially controversial- difference is a new requirement aimed at avoiding the abusive use of these transactions. In conversions and divisions, an independent expert must express an opinion on  “the accuracy of the reports and information submitted by the company” . The purpose of this opinion is to enable  the authority of the country of origin to control not only the formalities of the operation –as it does in mergers- but also whether the transfer or division is “an artificial arrangement aimed at obtaining undue tax advantages or at unduly prejudicing the legal or contractual rights of employees, creditors or minority members”.  To that effect, the report must refer at least to “the characteristics of the establishment in the destination Member State, including the intent, the sector, the investment, the net turnover and profit or loss, number of employees, the composition of the balance sheet, the tax residence, the assets and their location, the habitual place of work of the employees and of specific groups of employees, the place where social contributions are due and the commercial risks assumed by the converted company in the destination Member State and the departure Member State".

Is this ex ante control by the expert and the authority an efficient way of preventing the abusive use of these transactions ?

It is debatable.

Firstly, because the expert report´s content is complex, so it will take time and money to complete. Once it has been obtained, the competent authority designated in each Member State has to determine, based on the report, if the operation “constitutes an artificial arrangement” that unduly avoids tax or harms stakeholders. This implies further delays. The authority has one month to decide on this matter, but in case of serious doubts an in-depth investigation can take two additional months. In addition, if the authority is not a judge, there is a right to judicial review of the decision. All this imply legal and business uncertainty, as the timeline of the operation becomes absolutely unpredictable and potentially very long.

Secondly, it is doubtful that the system can fulfill its objective, because the concept of “artificial arrangement” is quite unclear and because it is extremely difficult to determine the intention to defraud tax or other stakeholders before the transaction is effective (ex ante). For example, the tax consequences of a cross border division or conversion are impossible to assess without full knowledge of the entire corporate structure of the group and of the tax legislation of each jurisdiction where the group has subsidiaries or branches. This seems impossible to do accurately by the expert or by the competent authority in the brief delay the proposal establishes.

Although the report is not necessary for small and micro companies, the uncertainty regarding the outcome of the transaction remains, as the competent authority must in any case make the judgment about the abusive nature of the operation. In this case, it will be even more difficult for this authority to give an opinion as it will not be able to rely on the expert´s report.

A further concern is that this procedure might lead to arbitrary decisions, as judging ex ante the intentions of the company is so difficult. Some States might be tempted to pressure the national authority to be strict, to prevent the flight of companies to other member states.

The procedure also implies risks for stakeholders because it establishes that the operations that have “taken effect in compliance with the procedures transposing this Directive may not be declared null and void” . The reason behind this is that the ex ante control should offer a total guarantee that the operation complies with the law and is not fraudulent, and therefore should not be challenged. But this can amount to a blessing of fraud if the company has been able to hide its real intentions from the expert and the competent authority.

The conclusion is that the new Directive -with a procedure that is essentially common to cross border mergers, conversions and divisions- would reduce uncertainties and facilitate these operations. However, it seems that the ex ante control of abusive operations by the competent authority creates costs and uncertainties while not ensuring the absence of fraud.