Reorganisations and demergers – what can go wrong?

Re-organising, re-structuring or demerging your business can solve many problems.  For example, it can open up investment opportunities for investors interested in part but not all of your business.  A re-organisation allows buyers to cherry pick assets that can be useful to secure a sale.  If there are shareholder disputes, carving up the business  is often the way to find resolution and stay out of court.  What goes wrong is the paperwork and order to steps taken to get to the end result.

We offer specialist legal, commercial and tax advice to help you navigate corporate reorganisations and capital reduction demergers. Years of experience tells us that a solid checklist focuses the mind on the order of events needed to achieve the re-organisation, re-structure or demerger and the filings needed at Companies House and or HMRC.  We take you through the key areas for a checklist and why they are important.

What can go wrong?

Based on experience, close attention with a potential demerger or restructure should be paid to :-

• HMRC clearance applications for reorganisations - Tax is usually a central factor in how corporate reorganisations are structured. Seeking HMRC clearance can provide certainty that the proposed transaction will not generate unexpected stamp duty, income tax or capital gains tax liabilities. Depending on the type of reorganisation or restructuring there may be more than one clearance application for the new structure. It is important to get the application letters right.
• Shareholder approvals and timing - shareholder approvals should not be ignored and are typically required in the context of variation of share class rights, substantial property transactions, and in certain types of demergers, approval of solvency statements and the reduction of capital. The articles, shareholders agreement or investment agreement may also set aside matters that require additional shareholder approvals to those required under the Companies Act. It is also important to get the timing of obtaining shareholder approvals right since they will be prerequisite for the execution of some steps.
• Filings - Any reorganisation and capital reduction demerger will involve various filing and reporting to Companies House and HMRC. It is essential to have all necessary forms prepared and filed on time. Not filing, or filing late can affect the validity of the reconstruction and potentially lead to company penalties and fines.
• Share for share agreement - One of the steps in creating a new group structure/inserting a new holding company is a share exchange agreement. Care must be taken when implementing the share for share exchanges to achieve tax neutrality. This is also a step where some employee shareholders need to be careful to avoid incurring a tax liability for employment related securities matters. If there is an employee share scheme in place this should not be overlooked. Some schemes can be rolled into the new parent company, but must be correctly reported to HMRC to make sure that any tax benefits are retained.
• Book value valuation - In capital reduction demergers or re-organisations it is an easy mistake to use the book value valuation for the share for share exchange. However, the number of shares issued in the new holding company should equal the market value of the assets in the subsidiary. This is because when the Holding Company then reduces its capital, if the reduction is less than this market value (e.g. if it was reduced only by the book value), there is a distribution of the difference in value and no capital gains reliefs can apply to this distribution element despite the fact there is no receipt of cash by the shareholders.
• Inter-company loans - Before starting the demerger it is important to clean up any inter-company loans and balances to ensure that there will not be tax consequences in writing off loans that are no longer within the same group of companies.
• Obtaining relevant approvals - It is important to undertake a due diligence exercise of contracts in place and consider in particular lending arrangements.  If there is security in place over a company it may be necessary to obtain lender consent to the demerger. Failure to obtain these approvals could lead to third parties challenging the transactions.
• Employee share plans - If you have awarded EMI options you need to be careful that the re-organisation does not trigger early exercise rights at a time when the EMI option holders are not receiving cash.  The other main unintended circumstance is a loss of EMI tax status which brings about income tax and national insurance bills for the employees.  It may be that options awards are rolled over as part of the re-organisation - in all events you will need to be rehearsed before you speak to the employees.
• Insurance - If there is a group insurance policy in place there is a danger that the business leaving the “group” will lose cover on the demerger.

If you need experienced, competitively priced legal and tax advice on a proposed capital reduction demerger or corporate reorganisation, please do contact us.