United States: Recent Legal Developments in The European Union Regarding Cross-Border Transactions

More than 10 years after the implementation of the European Internal Market¹, corporate law in the European Union ("EU") still varies greatly from one Member State to the next. As a consequence, transactions between companies, including reorganizations, on a cross-border European level remain difficult. A cross-border merger between a company from one Member State and a company from another Member State is not yet possible in all Member States and time-consuming asset transfers and liquidations are often required to achieve a similar result.

The European Commission recently proposed the Directive on Cross-Border Mergers of Companies with Share Capital (the "Merger Directive")², which would provide parties to cross-border business combinations with greater flexibility in structuring and implementing European acquisition and restructuring transactions. The proposed Merger Directive would enable parties to a transaction to utilize a traditional merger structure³ as the form of business combination, even if the parties to the merger are formed under, and governed by, the laws of different Member States. Such a structure would also be available to effect pre- or post-closing restructuring transactions that may be necessary for tax, accounting, or operational reasons.

The ability of "foreign" and "domestic" companies to merge has long been a common feature of the merger laws in many non-EU jurisdictions.⁴ Effecting an acquisition or corporate restructuring by way of a merger has many benfits over asset transfers and dissolutions. These include potential tax bene.ts as well as the speed and efficiency provided through a combination via merger. The effect of a merger is to transfer, by operation of law, all assets (including contracts, licenses, and permits) and liabilities (including creditor claims and contingent liabilities) and to convert the interests of all holders of shares in the disappearing company into interests in the acquiring or "new company." Because of this feature, mergers are generally viewed as minimizing the risks associated with transferring business assets — some of which are difficult to identify — and conversion of interests of all equity holders, including minority shareholders, into interests in the combined entity. If adopted by the EU and converted into the national laws of the Member States, the Merger Directive will make this streamlined acquisition structure available throughout the Member States.

The Merger Directive is not the first step the EU has taken to establish rules for cross-border business combinations. In several decisions, the European Court of Justice ("ECJ") has emphasized the principle that companies registered in one Member State should be able to do business throughout the EU without being made subject to the specific incorporation requirements in other Member States. Also, three years ago the EU adopted the Regulation on the Statute for a European Company (the "SE-Regulation"),⁵ which already permits crossborder mergers in limited circumstances and which will go into effect on October 8, 2004.

Two of the ECJ’s decisions⁶ involved entrepreneurs who formed entities in England and Wales but who were prevented from registering the companies’ branch offices to conduct business within another Member State (Denmark and the Netherlands). Another case involved a German court’s dismissal of a Dutch corporate entity from a German court proceeding on account of the failure of the entity to comply with Germany’s corporate laws.⁷

In all three decisions, the ECJ found that the principle of freedom of establishment under the EC Treaty had been violated. Thus the companies were entitled to have their branches registered in the respective Member State or, in the Überseering decision, participate in court proceedings. Based on these decisions, investors can now pick and choose among the various company forms offered by the Member States of the EU without having to consider in which Member State they plan to do business. For example, by selecting a non-German company form, business can now be done in Germany without having to adhere to the German rules on codetermination at the supervisory board level. These rules require German companies with at least 500 employees to establish a supervisory board in which one third of its members are appointed by the employees.

In 2001, the Member States adopted the SE Regulation, pursuant to which the European Company, or Societas Europaea ("SE"), will be available as a supranational European legal entity as of October 8, 2004. In the process of establishing an SE, cross-border mergers will for the first time be possible in all Member States of the EU.

Due to the hesitance of the Member States to give up their national corporate laws, the SE Regulation only lays out certain basic principles for the SE. Corporate law issues not addressed in the SE Regulation are governed by the corporate law of the Member State in which the SE has its registered office. As a consequence, there will not be a uniform type of SE, but a variety of SEs depending on the corporate laws of the Member States where the SEs have their registered offices.

The SE is designed as a public limited-liability company. Its capital is divided into shares, which can be listed on a stock exchange. As a European entity, it can be established anywhere in the EU and may relocate its principal office within the EU. An SE can only be established by combining or transforming existing legal entities. It is not possible to establish a new business as an SE, except as a subsidiary of an SE. Possible ways of establishing an SE are:

1) merger of public companies, i.e., entities designed for public listings, either a merger by acquisition and a transformation of the acquiring company or a merger by formation of a new SE;

2) formation of a holding SE by two or more public or private companies;

3) formation of a subsidiary SE by two or more companies;

4) transformation of a public company into an SE; and

5) formation of a subsidiary SE by an existing SE.

In respect to items (1) to (4), at least two of the parties to such transaction must be subject to the laws of different Member States or, if the parties to such transaction are governed by the laws of one and the same Member State, one party must have at least one subsidiary in another Member State.

The SE Regulation allows the shareholders to decide on the structure of the SE’s governing body. They can install either a US-type one-tier system, i.e. a board consisting of executive and non-executive members, or a two-tier system consisting of a management board and a supervisory board. This shareholder option constitutes a novelty in many Member States that currently offer only one of the board systems.

Special rules apply to the SE in respect to employee rights. According to the Directive Supplementing the Statute for a European Company with Regard to the Involvement of Employees (the "SE Directive")⁸, a body of employee representatives from the companies involved in the transaction must negotiate with the managements of the companies subject to the transaction about the future rights of the employees in the SE. The SE Directive contains highly complex rules on how the employees approve the agreement reached in such negotiations. If the negotiations do not lead to an agreement, a European works council must be established, which has certain information and consultation rights. Furthermore, an intricate set of rules determines in which instances employees retain the codetermination rights (meaning their rights to be represented via works councils or board representatives) they held previous to the transaction establishing the SE.

The rules on the employees’ rights in an SE require a costly and time-consuming procedure. They can also bring about some surprising results. For example, depending on where the employees are located, an SE headquartered in Ireland, and thus in part being subject to Irish corporate laws, may fall within the scope of the German codetermination rules. Such rules, on the other hand, do not necessarily apply to an SE located in Germany if most of its employees work outside of Germany. The formation of an SE may thus be less attractive for companies that are generally likely to be subject to extensive employees’ rights. Correspondingly, such companies may be less attractive as partners in the formation of an SE.

While the SE Regulation was a first step in the direction of European legislation on cross-border mergers of companies, its utility in the formation of a new company by way of merger is limited to public companies. Accordingly, the European Commission recently proposed the Merger Directive. Once the Merger Directive is adopted, it must be implemented under the laws of the Member States within a period of 18 months. As the Merger Directive must be converted into the laws of the Member States, it provides for minimum standards as to the procedure for cross-border mergers and leaves room for the Member States’ national rules on mergers to apply. These minimum standards include:

Merger Plan. The management bodies of the parties to a merger must prepare and make available to the shareholders a merger plan describing the essential aspects of the merger, including the parties to the merger, the ratio for the exchange of shares into shares of the merged entity and, if applicable, complementary compensation, the terms for the allotment of the shares in the merged entity, the articles of association of the merged entity, and the employees’ rights in the merged entity.

Experts’ Reports. One requirement for effecting a merger (other than a parent/subsidiary merger) under the Directive is that an "expert report intended for members" be prepared and "made available" for each of the parties to the merger at least one month prior to the shareholders meeting called to approve the merger. A joint expert report for all parties to the merger can be obtained if the expert is appointed by court or another authority. The qualification of the expert is subject to the laws of the Member States.

Employees’ Rights. With regard to the employees’ rights in the merged entity, the SE Directive previously described applies. Thus, the same costly and time-consuming procedure required in connection with the employees’ rights in an SE would also apply to cross-border mergers under the Merger Directive.

Shareholder Approval. The merger must be approved by the general meeting of each of the parties to the merger. If the approval is given before an agreement on employees’ rights has been reached, the shareholders may reserve the right to grant a further approval once an agreement on employees’ rights has been reached.

Effective Time. The Member States are free to determine the date on which the merger becomes effective. In any event, the merger may not become effective before public authorities have scrutinized the legality of the merger, including the agreement reached on the employees’ rights in the merged entity. Given the potential length of the period for the parties to the merger and their employees to reach an agreement regarding the employees rights, the completion of a merger under the Merger Directive may be delayed on account of labor considerations.

The forum shopping made possible by the ECJ’s decisions gives investors greater flexibility by enabling them to select the legal structure for their company that best suits their needs. As the ECJ decisions have not addressed all issues related to the transfer of registered of.ces to other Member States, the European Commission plans to present a proposal soon for a European Directive on the Cross-Border Transfer of the Registered Office of Limited Companies. As a result of the ECJ’s decisions, the national legislators in the Members States are now under pressure to make their national corporate laws more attractive to investors, much as individual state corporate laws in the U.S. are amended periodically to keep up with developments in the Model Business Corporation Act and other changes in corporate governance and director liability. While some observers fear a "race to the bottom" to the detriment of the companies’ creditors and minority shareholders, others believe that removing obstacles in cross-border activity will enhance economic activity ("race to the investor").

Since it appears that the Merger Directive may soon be adopted permitting cross-border reorganization of traditional legal entities, it is questionable which benefits the SE still has to offer in a merger context. There is also concern that the employee negotiation process required by the SE Directive will make the process too cumbersome and time-consuming. Despite these concerns, the recent and ongoing developments in European corporate law provide for a signi.cant improvement of the legal environment for cross-border transactions within the EU.

It is hoped that these initiatives will eventually provide greater flexibility in forming, reorganizing, and consolidating businesses that have operations and locations in multiple Member States. Another possible benefit would be to force Member States’ legislators to confront the limitations and burdens imposed by their own local corporate laws in favor of a "best practices" approach to doing business.