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Breaking Up is Always Hard to Do 24 April 2013 Corporate demergers and divestments Glafkos Tombolis, Michael Cashman, Paul Garland
Breaking Up is Always Hard to Do
24 April 2013
Corporate demergers and divestments
Glafkos Tombolis, Michael Cashman, Paul Garland
Dispose of non-core/low value operations
Pay down debt
Create distributable reserves
Regulatory imperative (e.g. antitrust, capital requirements for financial
institutions)
“Internal” divestment where none of the normal demerger mechanisms
are available, but tax will determine feasibility
Why divest?
1
Intermediate step to divestment, but watch tax
To facilitate tax optimal divestment
Inability to divest
Corporate group simplification
Demerged business more valuable on standalone basis
Regulatory drag
Unbundling joint acquisitions
Why demerge?
2
Divestments
Shareholders forfeit claim to future economic benefit of divested business
(unless directly/indirectly receiving purchaser paper)
Highly-negotiated definitive agreements in private M&A deals (warranties,
tax indemnity, closing accounts, working cap adjustments)
Internal due diligence and possible reorganisation - including demerger -
of group prior to sale
May give rise to a tax charge, unless losses are available to offset any
gain or relief is available (SSE if a share sale)
Key features
3
Demergers
Shareholders continue to enjoy economic benefit of demerged business
(usually on same terms as non-demerged businesses)
Demerger documentation more functional than negotiated, but beware
directors’ duties apply primarily on a per entity, not group, basis
Technical company law processes – risk of impugning transaction
Internal due diligence of group prior to sale
Important to structure demerger to avoid a current tax charge
Key features, cont’d
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Identify assets to be demerged/sold, liabilities to be retained
Structuring in contemplation of a particular buyer, or type of buyer
Gathering financial information
Dealing with management team
Contractual issues
Threshold issues
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Identifying the IP: registered (TM, patents) and unregistered (©,
database).
Assigning all IP “used” in business? Consider “and held for use”.
Shared IP:
who gets ownership?
licences – protecting the asset.
assigning all IP “exclusively used” – beware alternatives.
Documents and know-how. Making copies? Right to request more.
Removal of branding
Intellectual Property issues
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Effect on group debt financing arrangements
Shareholder approval
Rights of pre-emption
Post-deal transition support
Consider structuring to eliminate/reduce any potential tax charges
Threshold issues, cont’d
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Direct dividend demerger
Three cornered demerger
Dividend
Reduction of capital
Section 110 liquidation demerger
Part 26 (scheme of arrangement) demerger
Types of demerger
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Direct dividend demerger
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Shareholders
Parent company
Non-core
subsidiary
Dividend of
shares
The direct route involves the transfer
by a company to its shareholder of
shares in a 75% trading subsidiary
Normally only works if demerging a company, not individual assets or
whole businesses
Distributable reserves necessary: s845 CA 2006 and residual common
law
May be an “exempt distribution” and not taxable in the hands of the
shareholders
No CGT as reorganisation of share capital
No degrouping charge if exempt distribution
Transfer of the shares is a disposal for CGT purposes unless:
SSE applies
Relevant losses available
Direct dividend demerger, cont’d
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Three-cornered demerger
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Shareholders
Parent
Core subsidiary Non-core
subsidiary
Three-cornered demerger, cont’d
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Distribution
agreement
Shareholders
Parent
Non-core
subsidiary
Newco
Core subsidiary
(1) Dividend satisfied by
transfer of sub/trade to Newco (2) Issue of
shares
Transfer
Three-cornered demerger, cont’d
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Shareholders
Newco
Core subsidiary Non-core
subsidiary
Parent
Can demerge a business
Distributable reserves again
Should be treated as a tax-free share reorganisation if:
the demerger is done for the benefit of the demerging activities; and
is not done for tax avoidance purposes or to cease or sell the trade post
demerger
Three-cornered demerger, cont’d
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What are distributable reserves? ICAEW Tech 02/10 guidance
How to create them:
Sub(s) to pay dividend(s)
Sell assets
Reduce capital to create distributable reserves
Capital contribution from other group companies
Release of provision for liability/loss or impairment previously treated as
realised
Trade more profitably
If distributable reserves still insufficient:
Three-cornered reduction of capital
Liquidation demerger
Internal sale at market value
Distributable reserves problem
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What is it?
When used?
When parent has insufficient or no distributable reserves or doesn’t
want to use them
When demerger purpose is to facilitate sale
When parent or demerging sub are not trading companies
When demerging subs are not 75% subs or resident in Member State
When liquidation demerger undesirable
Company law: s654(1) CA 2006, The Companies (Reduction of Share
Capital) Order 2008 and Tech 02/10 para 2.8B
Demerger mechanism explained
Three-cornered reduction of capital
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Original structure
Three-cornered reduction of capital, cont’d
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Shareholders
Parent
Non-core Core
Incorporation of New Parent
Three-cornered reduction of capital, cont’d
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Shareholders
Parent
Non-core Core
New Parent
Transfer of core subsidiary
Three-cornered reduction of capital, cont’d
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Shareholders
Parent
Non-core
Core
New Parent
Demerged structure - before
Three-cornered reduction of capital, cont’d
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Shareholders
Parent
Non-core
Core
New Parent
New Holdco
Demerged structure - after
Three-cornered reduction of capital, cont’d
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New Holdco
Parent
New Parent
Shareholders
Core
Non-core
Liquidation demerger
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Shareholders
Parent company
Business 2
Newco 2 Newco 1
Issue
shares
Transfer
assets
Business 1
Issue
shares
Transfer
assets
Complex process
Costs of liquidator
Scope for shareholders and creditors to object
Directors’ statutory declaration of solvency
Effect on group contracts and debt financing arrangements
Liquidation demerger, cont’d
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No distribution for income tax purposes
If liquidation is a scheme of reconstruction:
No gain on transfer of assets
No tax charge on shareholders
SSE may be available on a share transfer
Watch for potential degrouping charges
Liquidation demerger, cont’d
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Used to facilitate in specie, reduction of capital and liquidation demergers;
not in and of itself a demerger route.
Examples of use:
To facilitate interposition of holdco to effect a three-cornered demerger
by reduction of capital
Interposing liquidation holdco in a s110 liquidation demerger where
existing parent has significant actual or contingent creditors
To effect partition demerger
To “cram down” dissentient creditors or shareholders in the parent
company
To effect a flip over of share options into holdco
Scheme of arrangement
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Considerable flexibility
Costs associated with court process
Mitigation of implementation risk – 75% approval of each class
No specific tax reliefs apply, so generally structured as three-cornered
demerger or combined with liquidation
Scheme of arrangement, cont’d
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Glafkos Tombolis
Partner, Corporate Group
dd +44 (0)20 7710 1672
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Mike Cashman
Head of Tax Group
dd +44 (0)20 7710 1619
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