IN THIS ISSUE
While global uncertainties have negatively impacted mergers and acquisitions (M&A) activity in nearly every region in recent years, the emergence of buyers from the Asia-Pacific region, in particular from China, Japan and Korea, has led the region to buck the recent downward trend. According to an Ernst & Young report citing United Nations Conference on Trade and Development, the International Monetary Fund (IMF) and Oxford Economics, Foreign direct investment (FDI) outflows from East and Southeast Asia recorded a compound annual growth rate of 22.9 percent in 2005-2011, rising from $70 billion to $242 billion in that period. While a significant portion of this activity represents “greenfield” cross-border investments in new assets, a rising portion of this activity represents acquisitions of a controlling interest in an existing, often Western, company with significant historical operations. The emergence and increasing relevance of Asian buyers has focused attention on the special characteristics, issues and challenges facing transactions that involve such buyers and how M&A professionals can anticipate and address them.
While general conclusions cannot be meaningfully made about all buyers from Asia-Pacific region, the Republic of Korea (Korea) can be seen as a bellwether for the emerging trends that are driving outbound M&A activity throughout the region. This article focuses on some of the major issues and challenges facing M&A transactions involving buyers from Korea. Namely, while the Asian business model was once—and in some Asia-Pacific countries, still is—focused on low cost manufacturing, certain large scale Korean conglomerates, like their Japanese counterparts before them, have moved up on the growth and value curve and now boast world class sophistication and quality in their product, service and technology offerings. Given these strengths and a perceived saturated domestic market, Korean companies are focused on expanding overseas for growth, diversification, access to markets and resources, and access to technologies.
Challenges Facing Korean Buyers
The hurdles that Korean buyers must navigate in a cross-border acquisition are many. With the exception of cross-border acquisitions involving resources, such as mining and metals where national security of supply concerns and synergies often override all other factors, including the metrics inherent in the deal itself, closed acquisitions of operating companies in sectors outside of this privileged space are relatively few even though the levels of mutual interest among potential Korean buyers and sellers are relatively high.
Complex issues impact the ability of Korean buyers and Western sellers to bridge the gap from initial interest to actual closing. This article will focuses on three key practical issues and considerations that deal practitioners may try to anticipate, recognize, address and hopefully resolve in order to get the deal done.
1. Process Differences
(a) M&A Auctions “Korean Style”
The domestic Korean M&A market is sophisticated, active and robust. With transaction values in excess of $52 billion in 2011, M&A is a well accepted corporate strategy in Korea. As in the rest of the developed world, most large M&A transactions are conducted through auctions involving multiple bidders. Bidders include both strategic buyers as well as a number of increasingly active Korean private equity (PE) funds. While M&A market practices and overall regime are influenced by global intermediaries (e.g., global investment banks and law firms) and resemble Western practices, there are some important differences.
One of the main differences is that M&A auctions in Korea almost always involve the selection and designation of a single “preferred bidder” after one or more rounds of bidding by interested bidders. This preferred bidder will effectively have an exclusive right to negotiate final terms of a definitive acquisition agreement with the seller parties. The designation of preferred bidder status is an important milestone in the Korean M&A process and preferred bidders will significantly increase (and often only meaningfully commence) their legal, financial and operational diligence review, fundraising activities (if outside financing is required as will be the case for many PE bidders) and other activities only after receiving this designation.
Once designated as a preferred bidder(or if the process is not an auction, some other exclusive or similar arrangement having been reached), a Korean board/officer, PE, or other relevant body or entity may properly present the target and overall deal as being ready for evaluation and confirmatory review by the relevant board/shareholders, debt and/or equity syndicate, etc. Indeed, many deal practitioners in Korea have likened the overall Korean M&A regime to a process of sourcing, preparing and presenting a “product” (i.e., target company and deal terms) for evaluation and approval by the main body or entity in control of the purse strings, whether that body or entity is a shareholder, board, lender, etc.
(b) U.S. Style Contrasted
This “product” approach to M&A evaluation can contrast sharply with the more fluid, interactive and dynamic process often seen in Western M&A transactions, particularly auctions involving U.S. targets. First and most importantly, bidders in the U.S. often have no assurance that they are exclusive, preferred or special in any way and are often pitted against one another until the very end of the selection process when a definitive acquisition agreement is executed. Bidders will accordingly attempt to distinguish their bids, first by attempting to obtain credible information about their standing vis-à-vis other bids, and then either adjusting the overall value of their proposed bids or their overall contract terms, such as improving antitrust or indemnification provisions or post-closing employment covenants.
This fluid give-and-take process may be difficult for a Korean bidder that has not been designated as a preferred or exclusive because the bidder may not have conducted sufficient degree of diligence to give it enough confidence to improve certain contract terms or if the “product” presented for the relevant decision maker’s approval has now changed and thus the prior approval must be obtained anew or is thrown into question.
2. Post-Closing Management Integration and Control
Different organizational structures, different management systems and cultural differences can lead to Korean buyers either not pursuing or abandoning otherwise promising acquisitions due to what they perceive as insurmountable issues in post-closing management integration and control. Korean companies, as is the case with many Asian companies, are very tightly and often very vertically organized and controlled with central headquarters positioned as the apex and “control tower.” As these companies cross borders, however, the need for local knowledge, autonomy and nimbleness to respond to local needs increases dramatically.
From the Korean side, however, shifting to local autonomy can stir fears that they may be unable to ensure that Western managers are meeting their standards. The Korean side’s lack of familiarity or comfort with the Western/U.S. style management culture can also impede communication.
Vastly different compensation schemes, levels and mindsets between Western, particularly U.S., management and Korean/Asian management also create potential fissures. Specifically, complicated employment benefit plans and compensation structures are difficult for Korean executives to understand and reconcile, given their well-defined organizational hierarchy, particularly if the compensation level of an overseas U.S. or Western executive who is purportedly subordinate exceeds the compensation levels of many of the Korean executives. Moreover, while stock options and other forms of equity or equity-like compensation schemes have taken greater root in Korea recently, their prevalence is not as common as in the U.S., and the concept of granting equity to salaried executives may not fit well within many Korean corporate entities.
3. Seller Perceptions – the Korean Discount
Differences in the various systems and approaches as well as differing language, contract forms, communication and other styles, can lead to a steady erosion in the confidence of various seller parties and their intermediaries in the Korean side’s seriousness, level of interest and execution abilities. These factors, coupled with a lack of sufficient knowledge about the Korean party’s business reputation and financial strength, ultimately could cause many sellers and their intermediaries to devalue or discount an otherwise healthy bid. While this is changing now that some recent acquisitions by Korean buyers have successfully closed, in the eyes of some, a bid by a Korean bidder may still be less attractive when compared to a well known and seasoned U.S. buyer. In the most competitive bidding situations, without effective understanding and communication channels, this could make a significant impact on both the seller parties’ willingness to continuing to talk to the Korean bidder and the Korean bidder’s faith and trust in the fairness of the bidding process.
Bridging the Gap
The answers and approaches to addressing the issues and challenges described above will have far-reaching and long-term implications for corporate boards, governments and dealmaking intermediaries throughout the world. No one-size-fits-all solution, however, can resolve every issue described above (and many others that will undoubtedly arise). To be successful, the deal practitioners should try to understand the expectations on both sides and attempt to bridge the gap in trust. With the stakes high, efforts on both sides to understand one another can determine the success of a deal.
Engaging a professional with knowledge of cultures and languages on both sides, and can act as an ambassador, is critical to bridge the divide, come to terms on the details of the deal and ensure that the terms and risks are understood by parties.
While bridging the gap may not be a simple task, the rewards can be great as Korea buyers and buyers from other Asian countries - armed with huge capital surpluses, expanding consumer markets, and a hunger for new markets, technologies and brands - look to move further along the development curve to fully utilize and reap the benefits of M&A.
The threat of Foreign Corrupt Practices Act (FCPA) successor liability is a growing concern for U.S. buyers in cross-border deals. U.S. companies can no longer afford to acquire a foreign asset or enter into a foreign joint venture (JV) with the assumption that they can simply address any anti-bribery law violations post-closing. In this heightened FCPA enforcement environment, the U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission (SEC) are holding corporate buyers liable for prior FCPA violations, whether or not they were known at the time of sale. Therefore, it is mission critical for U.S. companies contemplating a cross-border transaction to conduct adequate FCPA-specific due diligence and to address and remediate any issues before entering into the deal.
The FCPA is a U.S. law that bans international bribery of foreign government officials. The statute has a broad reach and covers all U.S. companies, persons and issuers (including their consolidated foreign subsidiaries) as well as foreign companies with sufficient contacts with the United States to support jurisdiction (e.g., those companies trading on U.S. exchanges or that use U.S. banks to transact business). Foreign persons and companies that commit FCPA violations while in the U.S. are also subject to prosecution under the FCPA.
The FCPA prohibits corrupt payments and gifts to foreign officials as a way to get or keep business (whether or not the bribe resulted in any actual business). U.S. regulators have also held companies liable for improper payments or gifts provided by agents, consultants or other third parties working on a company’s behalf. The FCPA also has accounting provisions for U.S. issuers that require them to keep accurate books and records and to maintain sufficient internal controls over corporate assets. The FCPA’s definition of a “foreign official” is quite broad and covers not only those holding public office but also local persons affiliated with foreign state-run or owned organizations (e.g., doctors at a public hospital in Brazil or employees of a state-owned oil company in China). Depending on the geographic market and industry involved, the FCPA risks can be high and any issues should be addressed and resolved in the pre-acquisition phase.
Big Penalties For FCPA Violations
In recent years, U.S. law enforcement authorities have given heightened priority to FCPA investigations and prosecutions, resulting in record-breaking fines and penalties, lengthy prison sentences for individual offenders, and costly and intrusive investigations for companies who find themselves under government scrutiny. In 2010, for example, U.S. regulators assessed a record-breaking $1.8 billion in FCPA penalties and, in 2011, a U.S. court handed down the longest prison sentence in FCPA history – 15 years.
FCPA enforcement of anti-bribery violations is a growing trend that shows no sign of slowing down any time soon. Last year, the DOJ and SEC collected over half a billion dollars in penalties and disgorgements, which marks the fourth consecutive year where such fines exceeded this amount. Currently, there are reportedly over 150 FCPA cases pending.
FCPA Risks In The M&A Context
In the mergers and acquisitions (M&A) context, FCPA successor liability is a real issue. “Buying an FCPA violation” has become a reality for some acquiring companies who fail to conduct adequate pre-merger FCPA diligence or to incorporate the newly acquired entity into an existing compliance program. Buyers of newly acquired assets face potential FCPA liability not only for anti-bribery violations that occurred on their watch but also for pre-closing conduct that they may not have known about. In the worse case scenario, the entire value of the acquisition can be lost. Getting ensnared in an FCPA probe can be costly to resolve and can also lead to parallel investigations in foreign jurisdictions. Moreover, the occurrence of shareholder derivative suits relating to suspected FCPA violations is also increasing.
Importantly, FCPA successor liability is not reserved for only those investors acquiring a majority equity stake in a deal. The U.S. government has aggressively pursued theories of FCPA liability against investors who acquire less than a 50 percent ownership interest, depending on the level of control they exercise (e.g., if an investor has seats on the board of directors or active involvement in managing the investment).
Large FCPA penalties have also been assessed in the M&A context. Indeed, four of the top ten largest FCPA penalties ever assessed relate to a single JV involving four multi-national oil companies where the JV authorized improper payments to foreign officials in order to gain lucrative government contracts. Millions in FCPA sanctions were levied against each of the four JV partners, even though the improper payments were paid through third parties and other agents. One of the JV partners was a subsidiary of a large U.S. oil company. Following a corporate reorganization of this subsidiary in which the improper payments were revealed, the U.S. parent and reorganized subsidiary were assessed $579 million in civil and criminal fines and penalties for the misconduct engaged in by the old subsidiary. These stiff fines were levied even though there was no evidence that the new board or management of the reorganized subsidiary had actual knowledge of any FCPA violations found to have been committed by the old subsidiary. As was the case for this U.S. company and its JV partners, FCPA liability cannot be avoided by a corporate reorganization or by using third parties to make the improper payments. Such strategies proved to be as futile as rearranging the deck chairs on the Titanic.
The clear lesson here is that U.S. companies should understand that FCPA successor liability is very real and acquiring parties need to conduct adequate pre-acquisition due diligence and take affirmative steps to ensure the new company is FCPA compliant and that its employees and other relevant parties are provided anti-corruption training and are fully incorporated into an effective anti-bribery compliance program.
In addition to the high fines and penalties, FCPA violations can result in collateral consequences such as debarment or suspension (e.g., inability to do business with U.S. government), loss of valuable licenses (e.g., export license) or exposure to civil or shareholder class action lawsuits. In the M&A context, failure to detect, isolate and resolve FCPA violations at the pre-acquisition stage can also result in expensive and lengthy investigations, intrusive compliance monitors, negative tax treatment or a potential negative impact on market value or the stock price of the asset(s) recently purchased. Government investigations involving FCPA violations are not only costly, they are also disruptive, causing senior executives and their staff to take time to gather documents and answer questions from investigators instead of focusing on their core business. In order to avoid these unwanted events, it is important for FCPA due diligence to be an integral component of the overall pre-acquisition due diligence plan.
FCPA Implications for U.S. Companies Involved in Cross Border M&A Deals
For U.S. corporations doing business beyond America’s shores, the issue of FCPA successor liability is currently an area of much debate. The U.S. Chamber of Commerce has led an extensive lobbying effort to reform the FCPA. It seeks to limit the extent of FCPA successor liability for acquiring companies, particularly as it relates to pre-closing conduct, and is requesting more clarity in terms of how much pre-closing diligence companies need to undertake to avoid liability. In November 2011, a bill was introduced in the House of Representatives that proposed amendments to the FCPA that included elimination of criminal penalties for successor liability. While the bill did not become law, the legislation is supported by those who feel that the FCPA is being unfairly used to stop or slow U.S. involvement in large international transactions, which they argue impairs U.S. growth and puts U.S. firms at a disadvantage. In response, the U.S. Department of Justice has promised that it will be issuing long-awaited guidance later this year on the FCPA, which will presumably touch on FCPA successor liability issues and other concerns raised by FCPA critics (e.g., the scope of the FCPA’s definition of foreign official; more clarity on the government’s cooperation program, i.e., specific benefits to be gained by self-reporting a suspected violation).
For now, the pace of international deals continues to grow. As U.S. companies continue to search for global opportunities to increase their bottom line, they should plan on including FCPA and anti-bribery due diligence as standard items in their pre-deal diligence plans and move quickly integrate the new company into its compliance program, with a particular focus on providing FCPA training to employees and other relevant parties.
The recent liberalization of the Chinese health care sector offers tremendous opportunities for foreign investors to tap the huge health care service market—which has been long dominated by Chinese state-owned enterprises, without any considerable foreign investment. However, foreign investors should be mindful of the potential issues and risks when considering an investment in the health care sector in China.
Liberalization of the Chinese Health Care Sector
The Chinese health care industry has traditionally been heavily regulated and dominated by Chinese state-owned enterprises. Around the time of China’s entry into the World Trade Organization (WTO) in 2001, the Chinese central government began to liberalize the health care industry by issuing relevant regulations to allow foreign investors to set up joint venture (JV) health care institutions in China. However, various technical restrictions in the actual implementation of these regulations, such as the maximum equity ownership restriction for foreign investors and strict approvals by the central government approvals, did not trigger any significant foreign investment in this sector.
In November 2010, about nine years after China’s entry into WTO, in order to accelerate the stagnated national Medicare reform, the Chinese central government issued the Opinions on Encouraging and Guiding Non-State-Owned Funds to Establish Medical Institutions (Circular 58) to encourage private and foreign investment in the health care sector. Concurrently, the Chinese central government also delegated the authority to approve the foreign invested JV health care institutions to the provincial approval authorities in a bid to facilitate the establishment of foreign invested health care institutions in China. The Chinese central government also issued various special policies to allow qualified health care service providers from Hong Kong, Macau and Taiwan to set up wholly-owned medical institutions in mainland China.
In early 2012, the State Council also promulgated the roadmap and implementation plan on health care reform for the 12th Five-Year Plan period (2011–15), which sets forth the objectives and benchmarks of the reform, as well as the goals to be accomplished during 2012–2015. According to the roadmap, the Chinese Government will continue to encourage the establishment of non-public medical facilities and strives to achieve the goal of having non-public medical facilities provide 20 percent of the total hospital beds and medical services in China by 2015.
Key Issues in Investing in the Chinese Health Care Sector
Despite the Chinese central government’s effort to promote foreign investment in health care sectors, pending Circular 58 implementation rules and given various political and cultural reasons, foreign investors should be mindful of and prepared for the following issues before investing in medical institutions in China.
1. Regulatory Maze
Like foreign investment in other Chinese industries, a health care foreign investment project will be subject to complicated layers of regulation on foreign investment activities, which China established along with its rapid economic development. These regulations mainly include industry access review, foreign investment review and approval, antitrust review, national security review, tax and foreign exchange regulation or supervision of the sale of state-owned assets, depending on the specific conditions of the deal structures and the nature of the specific target businesses or JV partners.
The principal government agencies responsible for reviewing and approving a health care foreign investment project may include the Ministry of Health (MOH), Ministry of Commerce (MOFCOM); Ministry of Human Resources and Social Security (MOHRSS); the State Administrations of Industry and Commerce (SAIC), of Foreign Exchange (SAFE) and of Taxation (SAT); the State-Owned Assets Supervision and Administration Commission (SASAC); and the China Securities Regulatory Commission (CSRC). It is never an easy task for a foreign investor to navigate through red tape for a variety of approvals, and to make things worse, foreign investors often have to face the ambiguity of the law and the contradictory views and practices of different government agencies, which result from a combination of fast-changing and unclear laws and regulations and a lack of unified and detailed implementation rules.
It is important to note that, in practice, the relevant governmental authorities, including MOH and MOFCOM, are reluctant to approve direct equity acquisition of the existing medical institutions by foreign investors.
2. Maximum Foreign Ownership Restrictions
Although the Chinese central government has amended China’s Catalogue of Foreign Investment Industry Guidelines in 2011 (2011 Catalogue) to remove the restriction on the maximum equity ownership of the foreign investors in medical institutions, pending the corresponding revisions in the implementation rules governing the review and approval on the establishment of the foreign invested health care institutes, foreign investors (except those from Hong Kong, Macau and Taiwan, who may enjoy the special policies to establish wholly-owned health care companies in mainland China), are currently still restricted to a maximum foreign equity ownership of up to 70 percent in a foreign invested health care institution. Only in certain provinces in central and western China, where foreign investments are more encouraged, will foreign investors be allowed to own up to 90 percent of the equity interest in a foreign invested health care institution.
Qualified service providers in Hong Kong, Macau or Taiwan can set up 100 percent owned medical institutions in mainland China. If a foreign investor intends to acquire an entity in Hong Kong, Macau or Taiwan, through which it could enter into mainland China’s medical service market, they should bear in mind that there is a one year phase-in requirement before the acquired company would be considered a Hong Kong or Macau health care service provider.
3. Minimum Total Investment Requirement
According to Chinese laws, a foreign invested enterprise (FIE) must specify its total investment and registered capital in their legal documents. The total investment is defined as the total capital a FIE will need to finance its operations, including the share capital or commercial loans, while the registered capital is defined as the share capital the shareholders must pay. The ratio between the total investment and the registered capital of a FIE must be consistent with the statutory percentages.
In accordance with the Chinese regulations on establishing foreign invested health care institutions, the minimum total investment requirement for each JV medical institution is RMB 20 million (around US $3.15 million), of which US $2.1 million must be paid by the shareholders as registered capital. According to the recent Administrative Measures for Joint Venture Medical Institutions (Draft circulating for comments) issued by MOH on April 13, 2012, the requirement of the total investment may be raised to RMB 100 million for establishing any JV medical institutions. Whether or how soon these draft measures will be enacted remains to be seen.
Notably, “chain licensing” is currently not available for foreign invested medical institutions. Each individual clinic or hospital must be established as a separate JV medical institution and the minimum total investment requirement must be satisfied for each institution.
Registered capital may be paid in installments during the first two years following the establishment of the FIE, and it may be used to finance the operations of the FIE (e.g., paying staff salaries and purchasing operational equipment). However, a foreign investor planning to start with a small-scale health care institute, may have legitimate concern that unused excess capital will become entrapped in FIE bank accounts in China because they are not allowed to use these funds for other investment or financing projects in China, nor can they repatriate such paid-in registered capital back to their home office without going through the lengthy and complicated approval process for a capital reduction or liquidation of the company.
4. Access to the National Health Care Reimbursement System
Circular 58 states that non-state-owned medical institutions may be admitted to the health care reimbursement system (HRS) so that patients could get reimbursed mostly, if not totally, for the medical costs from social security funds. Admission to the HRS is only possible after meeting certain statutory criteria, including adopting health care service and medicine pricing policies as regulated by the government and passing the statutory accreditation tests. These admissions may be obtained regardless of whether it is state-owned, privately-owned or foreign-invested, and whether it is for a for-profit or a non-profit entity. However, given the restricted margins in the service pricing policies adopted by the Chinese government, as well as various compliance issues relating to such medical cost reimbursement, foreign investors must be extremely careful when they decide to participate in the HRS.
5. Compliance Issues
As discussed above, foreign invested medical institutions are, in practice, mainly limited to Sino-foreign JVs. As a result, to establish a new JV medical institution, a foreign investor must cooperate with a local Chinese partner with experience investing in or managing medical institutions. However, foreign investors may choose to not rely heavily on their Chinese partners when handling the complicated processes for obtaining licenses or managing financial matters, particularly the medical cost reimbursement activities. In this case, foreign investors’ compliance risks arising from the U.S. Foreign Corrupt Practices Act (FCPA) and Peoples Republic of China Anti-corruption laws are relatively high because of the unsatisfactory overall compliance environment of medical institutions in China.
The opportunities within the health care service market in China, the world’s most populous country with more than 1.4 billion population, are too large to be ignored. Given the complex regulatory environment and business regulations discussed above, foreign investors should consult with experienced professionals to hammer out their China strategy early in any deal process.
International relocation of companies is becoming more frequent. Most companies choosing to relocate to another country are looking for a better and more attractive environment in terms of regulatory framework, taxation and labor regulation. As the advantages of relocation are often overestimated, it is important to carry out a precise analysis of the pros and cons of relocation. This article, based on the example of relocation of a French company, explains why and how a French company would relocate to another country and the consequences that may arise.
Key Objectives of Company Relocation
Relocating a French company abroad may be driven by interest in seeking more flexible regulatory framework and less restrictive governance standards; seeking more favorable tax rates and system and/or attempting to avoid certain taxes (like the financial transaction tax imposed on listed companies in France); and avoiding the application of strict labor laws and a heavy burden of social contributions.
Ways in Which a Company Can Initiate Relocation
One way in which a French company can initiate relocation is by transferring its registered office. In this scenario, the French company cancels the registration of its registered office in France and registers it in another country. This may be accompanied by the physical relocation of employees and/or assets.
Another option is a cross-border merger. In this scenario, the French company is merged into a foreign company, as a result of which all the assets and liabilities of the French company are transferred to the foreign company. The structure resulting from this operation is comparable to the structure resulting from a transfer of the registered office.
A third option is for shareholders of the French company contribute their shares to a foreign company, in consideration of which they receive shares of the foreign company. The registered address of the French company remains in France but the foreign company may become the new registered address by means of transferring over some employees and/or assets from the French company.
Legal Consequences of Transferring a Registered Office
The transfer of a French company’s registered office has to be decided by a unanimous resolution of all shareholders. In principle, the cancellation of the company’s registration in France can be carried out without having to wind up the company, provided that the receiving country agrees to register the company. In practice, it means that the French company may have to adapt to the corporate forms existing in the receiving country (e.g., conversion into a new corporate form, appointment of additional directors/offices).
The transfer of the registered office of a “European Company” (known as societas europaea, a form of company governed by European Union (EU) law and introduced in 2001) to the territory of another EU country is made easier by EU law. In this situation, a resolution to transfer the registered office must be approved by a qualified majority vote of two-thirds of the shareholders. Minority shareholders are granted a right to be bought out and creditors of the company can challenge the transfer (which may lead to their receivables being paid back).
In general, the relocation of the registered office involves the continuation of contracts entered into by the French company. Therefore, the French company should pay careful attention to the content of such contracts, which may continue subject to the prior approval of the counterparties.
Legal Consequences of a Cross-border Merger
The main obstacle to a cross-border merger is the necessary compatibility between the laws of the original and receiving countries. In practice, the concept, the conditions and the effects of the merger must be recognized by the law of the receiving country and be compatible with French law. Because they are complicated and legally uncertain, cross-border mergers are therefore rarely implemented.
On the contrary, the rules governing the merger between two companies incorporated in two different EU countries are provided under EU law. These rules, which are enforceable in each and every EU country, harmonize the regime of cross-border mergers. The merger decision has to be approved by a qualified majority vote of two-thirds of the shareholders of the merged company. Unlike in the case of transfer of registered office, minority shareholders are not granted a right to be bought out.
As a result of the merger, all of the French company’s assets and liabilities would be transferred to the foreign beneficiary company. One should keep in mind that the contracts entered into by the French company with third-parties would also be transferred to the beneficiary unless they contain a provision prohibiting their assignment or unless they are intuitu personae agreements, i.e., they were entered into in consideration of the identity of the other party, in which case the approval of the counterparties may be necessary.
Legal Consequences of a Contribution of Shares
In general, the contribution of the French company’s shares should not raise any significant difficulties. The law of the receiving country may nevertheless impose specific requirements, such as the intervention of a third party expert to provide a valuation of the contributed shares.
In addition, the contracts entered into by the French company must be examined as they may contain a change of control provision giving counterparties the right to terminate the contracts.
Tax Consequences of Transferring a Registered Office
From a tax point of view, the transfer of a French registered office is treated as a liquidation, which triggers the immediate taxation of the French company’s profits and latent capital gains on assets. Shareholders would also be deemed to have received the liquidation proceeds, which is a taxable event.As an exception, such transfer occurring within the EU benefits from a tax neutrality regime regarding profits. The French tax authorities consider the tax neutrality regime to be applicable only if the assets of the French company are registered on the balance sheet of a permanent establishment located in France. As a consequence, the tax neutrality regime would be ineffective because the capital gains on said assets would be taxable in France despite the head office having been relocated. However, the Court of Justice of the European Union has ruled that a similar requirement applicable in Portugal was unlawful. Consequently, the tax neutrality regime should apply to the relocation of a French company’s registered office within the EU when such relocation is followed by a partial or complete relocation of employees and assets in the receiving country.
In addition, such relocation may trigger the payment, under certain circumstances, of a transfer tax on the value of the business and the real estate transferred at the rates of 5 percent and 5.19 percent.
Tax Consequences of a Cross-border Merger
A French company merged into another company established in a EU country may benefit from the tax neutrality regime (avoiding the immediate taxation of the French company’s profits and latent capital gains on assets), subject to an approval of the French tax authorities, which is granted provided that (i) the operation is economically justified, (ii) it is not fraudulent or motivated by tax evasion and (iii) capital gains on a future sale of the assets remain taxable in France notwithstanding the merger, which in practice means that the French company’s assets should be registered by the beneficiary company on the balance sheet of a permanent establishment located in France.
Tax Consequences of a Contribution of Shares
Relatively favorable taxation conditions may be applicable to the realization of such transfer. Under certain conditions, only 10 percent of the amount of the capital gain realized by the shareholders of the French company who are subject to French corporate income tax is taxable. As far as individuals and non-resident shareholders are concerned, the contribution may be subject to a tax deferral under certain conditions.
Therefore, the subsequent transfer of assets to the beneficiary company may lead to the taxation on latent capital gains and to the application of transfer tax.
Other Tax Effects
The relocation may have adverse tax consequences, which must be anticipated. First, the relocation of a company that is the head of a tax group may trigger the breaking up of such tax group (and the taxation of certain operations neutralized for the determination of the tax group’s global income).
Secondly, the relocation of a French company’s headquarters may affect the deductibility of interest incurred for the acquisition of investment shares, if this acquisition occurred shortly after the relocation.
Finally, the profits of a company relocated out of France will be taxable in the receiving country if the company’s center of main interest, including part of its employees and assets are actually relocated to the receiving country
Labor and Employment Consequences of Transferring a Registered Office
The transfer of the registered office does not constitute a change of employer, and consequently employment contracts are not affected by such transfer and remain governed by French law.
If the employees are relocated abroad, it will be necessary to obtain their consent and have them sign a new employment contract subject to the law of the receiving country. Those employees who refuse to be relocated would have to be dismissed by the company, which under French law must be justified by economic grounds, namely evidence of financial losses or the necessity to reorganize the company so as to safeguard its competitiveness. If more than 10 employees are dismissed, a social plan must be implemented.
Labor and Employment Consequences of a Cross-border Merger
The merger does not put an end to the employment contracts, which are transferred to the beneficiary company, provided the merger triggers the transfer of the economic activity from the French company to the beneficiary company in an effective and permanent way. The foreign company becomes the new employer.
Although the cross-border merger involves a change of employer, its consequences on the employees are quite similar to those in the case of transfer of the registered office. In practice, the relocation of the employees requires the consent of each employee, those refusing the relocation having to be dismissed.
Labor and Employment Consequences of a Contribution of Shares
The contribution of a French company’s shares to a foreign company does not lead to a change of employer nor does it affect the working conditions of employees. Unless the contribution is followed by their relocation in the receiving country, the contribution does not affect the situation of the French employees.
The decision to relocate a French company abroad requires a precise assessment of the company’s situation.
First, it appears that the tax and labor consequences of relocating abroad can greatly outweigh the benefits of such relocation. This is particularly true when the company needs to relocate a significant number of employees and/or assets.
If the cost-benefit analysis appears to favor relocation, the benefits of relocation will in any event only materialize if it is part of a global strategy of international operational development.