Cross-border mergers: recent case law upholding freedom of establishment

Introduction
Facts
Cross-border mergers
Companies Court decision
Court of Appeal decision
Comment


Introduction

In a judgment handed down in January 2018, the Court of Appeal confirmed that a company was entitled to use and benefit from the EU cross-border merger regime for its corporate reorganisation, even though the only cross-border element was the inclusion of a single, dormant foreign entity solely to allow the otherwise domestic reorganisation to benefit from the cross-border rules. In so doing, it overturned the decision of the lower court which had determined that the merger was not "in substance" of a cross-border nature. The Court of Appeal, in reviewing the relevant law, looked at the purpose behind the underlying EU directive, namely the facilitation of cross-border mergers in pursuit of the respect of the EU's principle of freedom of establishment. This purposive approach to the interpretation of the rules may be relevant in a broader context when determining the effectiveness of corporate actions.

Facts

In 2016 UK entity Easynet Global Services Ltd applied to the Companies Court to permit a meeting of its sole shareholder. This was intended to be the first in a series of steps pursuant to which 22 companies within the Easynet group would be merged into the parent UK entity. While 21 of those group companies were UK companies, a single dormant Dutch subsidiary that had never traded and had no appreciable assets, liabilities or employees was included in the reorganisation. The only purpose of including the Dutch company in the reorganisation was to make the transaction fall within the scope of the EU Cross-Border Merger Directive.(1) This regime was considered less cumbersome and expensive than the procedures available for such a reorganisation under purely domestic rules,(2) and resulted in advantageous tax treatment.

Cross-border mergers

The process for implementing an EU cross-border merger involves a pre-merger application for review and certification of the merger proposal by each party thereto with the competent authority of the state in which such party is incorporated and, assuming all such certifications are obtained, a final approval of the merger by the competent authority of the member state of the surviving entity. In the United Kingdom, the courts are recognised as the competent authority. This case originated when one of the constituent UK companies made its pre-merger application to the Companies Court. The Companies Court refused to sanction the proposal.

Companies Court decision

The judge in the Companies Court determined that this merger was not in reality a cross-border merger, and that the use of the Dutch company was a mere device intended to allow the applicant to take advantage of the preferable tax consequences of the cross-border merger regime, such that using the regime would be considered an abuse of rights. He granted permission to appeal and arguments were heard before the Court of Appeal in November 2017. The government intervened in this case through the secretary of state for business, energy and industrial strategy to make the argument that the use of the dormant Dutch subsidiary to make the transaction fall technically within the scope of the cross-border rules should be respected as an effective use of the rules.

Court of Appeal decision

The Court of Appeal sought additional submissions on the EU law engaged by the appeal and came to the conclusion that, although the cross-border element was included solely and precisely so that the cross-border regime could be used, it nonetheless fell within the scope of the rules. It further found that there had been no abuse of rights in organising the transaction to fall within this legal regime.

In its decision, the court noted as follows:

• The EU cross-border regime exists in order to facilitate the key EU objective of freedom of establishment in any EU member state. The courts should not imply additional restrictions on that freedom by imposing any practical requirements that participants must have particular capital or trading levels.
• On a plain reading of the rules, a merger involving entities incorporated in two or more member states falls within the definition of a 'cross-border merger', and the principle of legal certainty indicates that the rules should be given a straightforward interpretation.
• There is a principle of abuse of rights in EU law which "confines the exercise of legal rights to the purpose for which they exist, and precludes their use for a collateral purpose".(3) This general principle applies in the field of company law. In considering this principle, the judgment makes clear that in the court's view, this scheme was not a sham, and there was no "unexpressed collateral purpose or subterfuge".
• However, the court found that the object of the law was to facilitate cross-border mergers "for whatever purpose". Here, the operation was "designed, for legitimate commercial considerations and objectives" to take advantage of the right to use the cross-border merger regime. Those objectives included taking advantage of more favourable legislation than would be available domestically and obtaining a tax advantage, but this could not be said to be an abuse of the right. Indeed, the court reiterated the stance that "EU law, like English law, treats parties as free to arrange or structure their relationship so as to maximize its commercial attraction, including the incidence of taxation".(4)

Comment

This is a welcome and pragmatic decision that recognises the legitimacy of organising corporate actions as efficiently as possible. For at least as long as Britain remains a member of the European Union, British companies will have the right to freedom of establishment in any EU member state, and the fact that an entity may exercise that right in order to take advantage of the benefits of a particular member state does not – absent fraud – affect the valid use of the regime.

For further information on this topic please contact Joanna Valentine or Simon J Little at Davis Polk & Wardwell LLP by telephone (+44 20 7418 1300) or email (joanna.valentine@davispolk.com or simon.little@davispolk.com). The Davis Polk & Wardwell LLP website can be accessed at www.davispolk.com.

Endnotes

(1) Cross-Border Mergers Directive 2005/56/EC, implemented in the United Kingdom through the Companies (Cross-Border Mergers) Regulations 2007. These rules were consolidated in the later EU Directive 2017/1132, but this later change does not change the substance of the law.

(2) To effect this reorganisation under domestic rules, the first-instance judge indicated that the group could have effected a reconstruction scheme under Section 900 of the Companies Act 2006 or under Section 110 of the Insolvency Act 1986.

(3) Quoting Lord Sumption JSC in Revenue and Customs Commissioners v Pendragon plc ([2015] UKSC 37).

(4) Revenue and Customs Comrs v RBS Deutschland Holdings GmbH ((Case C-277/09) [2011] STC 345).