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Protection of stakeholders
Nicholas Briggs (LL.M Bristol) Barrister
Guildhall Chambers, Bristol. Introduction
The High Court Chancery Division has found that reg 6 of the Companies (Cross-Border Mergers) Regulations 2007 (the ‘Regulations') does not give or seek to give the court a discretion to exercise when deciding whether to grant a pre-merger certificate. It found that the discretion is only to be exercised at the second hearing. This brief article argues that as the court did not have two counsel arguing the issue, it was not presented with extensive argument on an important jurisdictional issue. It is argued that the court has discretion to exercise at both the pre-merger certification hearing and the final hearing.
The Regulations came into force on 15 December 2007. They were long in gestation. After the consideration of a proposal for a tenth Council Directive on cross-border mergers of companies the European Commission adopted proposals as long ago as 14 December 1984. Further consultation ensued with committees of the European Parliament which eventually adopted the proposals in a report dated 21 October 1987. The matter was then referred to Parliament. Different Member States had different opinions regarding the amount and quality of employee participation in any cross-border merger. A deadlock arose due to a difference of opinion about the extent of employee participation. At the time it seemed the problem was insoluble and in 2001 the proposals were withdrawn. The Commission did not give up and a resolution to produce fresh proposals was passed on 8 October 2001. This time the Commission decided to cut back on the amount of consultation in the interests of a ‘speedy adoption'. In place of more extensive consultations a Commission communication was sent on 21 May 2003 giving Member States an opportunity to comment. After just a few more years Directive 2005/56/EC of the European Parliament and of the Council was passed. It was now the 26 October 2005. The opening words of the Directive set the scene:
‘There is a need for cooperation and consolidation between limited liability companies from different Member States. However, as regards cross-border mergers of limited liability companies, they encounter many legislative and administrative difficulties in the Community. It is therefore necessary, with a view to the completion and functioning of the single market, to lay down Community provisions to facilitate the carrying out of cross-border mergers between various types of limited liability company governed by the laws of different Member States.'
It appears that the UK government was not over enthused by the proposals or the Directive. It took another 2 years for the UK government to implement the Regulations. The explanatory memorandum to the Regulations tells its own story:
‘UK companies generally use takeover procedures rather than the type of merger procedures for company restructuring provided by this Directive. Very few domestic mergers have occurred in the UK since 2003. It is not clear whether the demand for cross-border mergers will be significantly higher than this.'
Although no empirical evidence is available, by way of observation, the Companies Court appears to be seeing more cross-border merger applications than was perhaps anticipated in the years running up to the implementation of the Regulations. It is not an exaggeration to say that applications are made for pre-merger certificates most weeks of the year.
Accordingly, the purpose of the Regulations is to provide a platform ‘through which UK companies may confidently explore restructuring opportunities in the EEA and remove uncertainties and administrative and legal barriers to such restructuring'. The advantages of the statutory merger procedure are apparent to all in that the merger infrastructure permits reasonably quick and cost efficient business and asset transfer. Sanctification by the court allows transfers without the consent of counterparties, saving time and cost. Further, the transferor company does not have to enter into an insolvency process. It is simply dissolved. The Regulations recognise that certain steps have to be taken to protect the employees, creditors, members and other stakeholders during the process. The laudable aim of process which provides for easy cost effective merger and protection of stakeholders should be borne in mind whenever a court is asked to construe their meaning.
The Merger process
The term ‘merger' is a technical one in that it is defined as a merger by (i) absorption; (ii) absorption of a wholly-owned subsidiary; or (iii) a merger by formation of a new company. The definition of company is wide and by reference to s 1 of the Companies Act 2006 includes public, private, unlimited, and unregistered companies. It also includes companies in administration and since 2009 the Regulations apply equally to LLPs. It does not apply to companies in liquidation or companies limited by guarantee without share capital.
A merger by absorption involves all the assets and liabilities of one or more of the ‘transferor companies' being transferred to a ‘transferee company' and the transferor companies being dissolved. The consideration for the transfer to be provided to the members of the transferor company is shares or other securities representing capital of the transferee company and a cash payment, if so agreed. Where there is one transferor company and all its capital and shares are held by an existing transferee company, this will be a merger by absorption of a wholly-owned subsidiary. A merger by formation of a new company arises where two or more transferor companies transfer their assets and liabilities to a transferee company formed for the purpose in exchange for securities in the transferee company receivable by the members of the transferor companies.
The procedure is divided into two distinct stages. The first stage concerns the drafting and circulating of draft terms of merger, a directors' report and, usually, an expert report to shareholders. The shareholders have to have at least one month to inspect the draft terms prior to the shareholder meeting. Greater time is given to employees of a transferor company. To facilitate this the draft terms need to be delivered to the employees (or their representatives) 2 months prior to the first shareholder meeting. Once this is done a meeting may be called and an application is made to the Companies Court. Regulation 6 informs us as to the purpose of the application:
‘A UK merging company may apply to the court for an order certifying for the purpose of Article 10.2 of the Directive (issue of pre-merger certificate) that the company has completed properly the pre-merger acts and formalities for the cross- border merger.'
It is worth mentioning both Article 10.1 and 10.2. These provide:
‘10.1. Each Member State shall designate the court, notary or other authority competent to scrutinise the legality of the cross-border merger as regards that part of the procedure which concerns each merging company subject to its national law.
10.2. In each Member State concerned the authority referred to in paragraph 1 shall issue, without delay to each merging company subject to that State's national law, a certificate conclusively attesting to the proper completion of the premerger acts and formalities.'
The second stage of the procedure involves final approval. Approval is required from the competent authority of the Member State where the merged entity will be registered. It is noteworthy that this is not always a court of law. A date has to be fixed for the merger to take place and has to be no less than 21 days after the order approving the merger. It is this date which crystallises the merger and dissolves the transferor company.
Recent cases and pre-merger certificates
There is no jurisdiction to grant a pre-merger certificate under reg 6 unless the matters contained in Regulations 7-10 and 12-15 are satisfied (the ‘Requirements'). Thus the court's function at this stage is to determine and be satisfied that the Requirements have been met. Regulation 7 provides that the draft terms of the cross-border merger should deal with 14 different matters (less if the merger is by absorption of a wholly owned subsidiary, and more where any securities of a UK transferor company (other than shares) to which special rights are attached are held by a person other than a member or creditor of the company). A well drafted statement in support of a pre-merger certificate will identify the Requirements and set out how they are satisfied in relation to each transferee and transferor company.
Further the court has to be satisfied that the directors' report complies with reg 8, that an expert report has been drafted, a valuation provided if recommended, and there has been adequate inspection in accordance with reg 10.
Regulation 12 deals with public notices and receipt of registered documents by the Registrar of Companies so that he may publish them. Regulation 13 concerns a requirement for approval of the draft terms of merger by members of the company unless the merger is by absorption of a wholly owned subsidiary. Regulation 14 deals with approval by creditors and applies only where the court has ordered a meeting of creditors: the English court has power to order a meeting under reg 11. Lastly, reg 15 concerns the provision of certain documents where a meeting of members takes place.
The difference between the first and second hearing
One question that has arisen is the extent to which the court needs to be concerned about the various stakeholders at the hearing for a pre-merger certificate. The explanatory memorandum states:
‘The Directive provides an infrastructure through which UK companies may confidently explore restructuring opportunities in the EEA and removes uncertainties and administrative and legal barriers to such restructuring. The measures are intended to protect the interests of shareholders and creditors during a merger' (emphasis supplied).
In Re Diamond Resorts (Europe) Ltd, Sales J thought that the court need not inquire at the first hearing as to the effect a merger would have on stakeholders. The hearing is constrained to ensure that only the pre-merger requirements have been completed. A tick-box exercise. If the boxes are ticked the matter may then proceed to the second stage and the court may then permit the merger having weighed the interests of the various stakeholders. In other words there is no discretion for the court to exercise at the first hearing but there is at the second hearing (pursuant to reg 16) where it weighs the interests of all stakeholders:
‘The proper function for this court in the exercise of its discretion under Regulation 16(1) of the 2007 Regulations is to examine with care the question whether, if the merger proceeds and is authorised, stakeholders in the [applicable companies] will suffer a material detriment such that the merger ought not to be approved.'
The court considered the difference in the wording between reg 16 (which governs the second hearing) and reg 6 (which governs the pre-merger certificate hearing). Regulation 16 provides that the court may approve a merger whereas reg 6(2) provides that the court must not grant a pre-merger certificate. Sales J reflected upon the difference between the hearings explaining that the second hearing is:
‘a process of review over and above simply satisfying itself that the various pre- merger steps have indeed been undertaken.'.
This explanation was obiter and made without the benefit of adversarial argument. The analysis was adopted by Roth J in Re House-Clean Limited where again only one counsel attended:
‘in my judgment it is clear that reg 6 does not give or seek to give the court the discretion provided for the different stage of the procedure under reg 16.'
The purposive approach to construction
The courts agree that the correct approach to construing the terms of Regulations is the purposive approach. In Re House-Clean Limited an issue arose as to a delay between the completion of the terms of the merger and the directors' report. The delay was about 12 months and the court was concerned creditors could not be adequately protected by the provision of stale financial information. In the event, the financial information was not stale as the company had not traded.
The question for the judge was whether, in order to comply with the relevant Regulations, and in particular Regulations 7, 8, 10 and 12, the documents provided had to be provided within a given period leading up to the date of the hearing. It was submitted that there was no requirement. There is nothing in the Regulations or the Directive imposing such a requirement. It was submitted that the Regulations are proscriptive in nature and as such the pre-merger position should be contrasted with the application for approval of cross-border merger at the second stage. At the second (reg 16) hearing there is an express time limit. Regulation 16(1)(d) provides that the application has to be made to the court on a date not more than 6 months after the making of the order granting a pre-merger certificate. As a matter of construction the court could have found that there was no time limit and no amount of delay would undermine an application. Roth J said:
‘In a case where it appears to the English court, whose pre-merger certificate is sought, that the requisite documents are so old that such a time has elapsed between their production and the application to the court to suggest there may be material changes in the relevant circumstances, the court would be entitled, in my view, to say that this does not constitute proper compliance with the relevant Regulations...' (emphasis supplied).
The passage cited above of course resonates with common sense. It could be added that as the purposive approach was employed the court was considering the interests of the stakeholders in making such a determination. It seems that regardless of the words he chose, Roth J was accepting that the court at the pre-merger stage has a residual discretion to be exercised even if there has been strict compliance with the formalities and acts of the Regulations. This, it is submitted, is the meaning of the word proper used in Article 10.2. The word would otherwise be redundant or if used differently could raise a myriad of questions regarding what is and what is not proper. Proper in this context (read together with Article 10.2) means compliance with the wording and spirit of the Regulations. Accordingly, even if there has been strict compliance, if the court is not satisfied that there is stakeholder protection it can exercise its discretion not to grant a pre-merger certificate on the grounds that compliance is not proper.
It may be that the courts are leaning towards the purposive approach at all steps of the process. In Re Honda Motor Europe Limited, Norris J considered whether an order to convene a shareholder meeting under reg 11 was warranted. Honda Europe had undertaken a wide-ranging reorganisation of its car businesses in Europe, in part by merging sales subsidiaries. It wished to do the same to its motor cycle businesses. The merger scheme was complex but the judge summarised the aim:
‘[It] is proposed to de-merge the sales business into a separate subsidiary ("Newco") and then to undertake a cross-border merger between Newco and Honda Europe. In order to avoid Newco having to undertake trading (with all of the commercial, organisational, fiscal and regulatory consequences that would follow) it is proposed that the cross-border merger should become effective a scintilla of time after the completion of the de-merger.'
Difficulties arose due to Spanish law and so to achieve the aim an Italian merger had to be interposed. This would mean that the Italian company would be an empty shell (the judge called it a ‘bucket company'), but the court found that the interposition of the Italian company could be justified on commercial grounds. The judge agreed to convene the reg 11 meeting commenting:
‘Whether the court will sanction the cross-border merger must be a matter for the judge at the sanction hearing: and nothing I say at this stage can fetter that judge's ultimate decision. But it seems to me perfectly possible so to frame the terms of the de-merger agreement that the court conducting the sanction hearing is enabled (if it so desires) to look at the reality of the transaction and then consider the interests of the stakeholders in the transferring sales business (taking a broad view of who are the relevant stakeholders in Italian Newco). The court cannot say at present that if the proposed scheme is put into effect then sanction must inevitably be withheld.' (emphasis supplied).
The judge may have been thinking of Lord Scott of Foscote's observation in the matter of Brewin Dolphin Bell Lawrie, that reality should be given precedence over speculation. The combination of giving weight to the reality of the situation and giving precedence to the interests of the stakeholders in transferring a UK company should, it is submitted, be at the heart of both hearings leading to merger.
The use of discretion at the first hearing
On the basis that the courts are using the purposive approach to construction in respect of the Regulations it is submitted that the words in reg 6(2) stating that the court must not grant a pre-merger certificate unless there is compliance should not be turned on their head to mean that the court must grant a pre-merger certificate if there is compliance. In any event the mandatory use of the language in Article 10.2 is taken at face value this does not mean that the court has to do or refrain from doing something if the consequences of doing something are contrary to the purpose of the Regulations: See R v Soneji.
In light of the High Court using the purposive approach to construing the Regulations, and the purpose of the Regulations being to ensure cost effective cross-border merger with protection being afforded to the various stakeholders, and taking account of a focus on the consequences of the mandatory language, regard must be had of the fact that the UK court will not always be the court that approves the merger on a reg 16 hearing. As such, a pre-merger certificate hearing should consider the effect on the stakeholders before granting a certificate. The hearing should not simply be a process whereby the court is satisfied that the various pre-merger steps have indeed been undertaken. A more inquiring hearing is required to ensure proper completion of the first stage.
This is particularly the case where a UK transferee company is solvent and merging with a non-UK company which is insolvent. The UK court loses control of the process once the pre-merger certificate is granted. Some EEA states use administrative bodies to undertake the reg 16 blessing of the merger. These bodies may be less likely to undertake the rigorous exercise undertaken by the UK courts where experienced counsel often present the merger application and where the adversarial system dictates a searching inquiry into the facts.
In order to protect the various stakeholders the court at the pre-merger certificate stage has to know the effect the merger will have on the stakeholders. It cannot do this without seeing the detail and cannot properly make its inquiry without having proper accounting information.
In any event it is wrong to construe the Regulations in such a way to suggest that there is no discretion to exercise at the pre-merger hearing. It is thought that Roth J thought this correct in principle but trod a careful line due to the earlier decision of Re Diamond Resorts (Europe) Ltd. The result is a rather unsatisfactory state of affairs where the High Court has said that (save for reg 11) the only discretion the court has is at the second hearing, but that the court at the first hearing may reject an application for a pre-merger certificate if it thinks that there has been improper (not incomplete) compliance with the pre-merger steps. This is a distinction without a substantive difference as the court has to scratch beneath the surface to ensure real or proper compliance. If the company had been trading in Re House-Clean Limited there would have been a real risk that, notwithstanding apparent compliance with the Regulations, creditors and other stakeholders would lose out. The court was right to inquire into the situation and be satisfied as to the trading position. Regulation 6 directs the court so that it must not grant a pre-merger certificate unless the requirements are met. It does not direct it to grant a certificate if the Requirements are met. The lacuna is where the discretion sits. It exists in order to protect the stakeholders and prevent abuse.
The court at the second stage can review the matter again and should review the matter again. Time will have moved on.
The cases show that the courts are using a purposive approach to construing the Regulations. The purpose is to provide a permissive administrative process which is efficient in terms of cost and time allowing companies to merge within the EEA. The Regulations cannot be permitted to be a vehicle for abuse where stakeholders can be forced out or be forced to lose out. In the UK it is the courts which control the process. The courts at all stages of the process should jealously guard the interests of the stakeholders by ensuring compliance with the language and spirit of the Regulations. It is suggested that the term proper completion of the pre-merger acts and formalities in Article 10.2 means compliance with the wording and spirit of the Regulations. It also suggested that this provides the court at the first hearing with a discretion to exercise so that it can properly take account of the circumstances of the case it hears, and decide whether it is appropriate to grant a pre-merger certificate. This inevitably means that even if there has been strict compliance, if the court is not satisfied that there is stakeholder protection it can exercise its discretion and not grant a pre-merger certificate.
 Regulation 2.
 Regulation 5.
 Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009.
 See Regulation 9.
 There are exceptions so that an independent report does not have to be commissioned in all circumstances.
  EWHC 3576 (Ch).
 Nomura International Plc  EWHC 2789 provides an example of the court considering the various interest groups.
  EWHC 2337 (Ch), para 30.
  EWHC 2842 (Ch).
  UKHL 2.
  UKHL 49,  1 AC 340,  4 All ER 321.
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