I. Introduction – What is a Cross-Border Conversion?
A company incorporated under the laws of a Member State of the European Union or European Economic Association (Member State) can change its legal form and continue to exist under the laws of another Member State by means of a cross-border conversion by way of a change of legal form (Cross-Border Conversion). In the course of such conversion process no shares, assets or liabilities need to be transferred. The legal entity remains the same, i.e., the company is not liquidated or unwound, only the legal form is changed (e.g., from a German GmbH to a French S.à r.l. or vice versa).
For many years, a Cross-Border Conversion was not possible for German companies and, hence, workarounds were required to implement the envisaged structure (e.g., by means of a cross-border merger with a company from another Member State). However, in recent years the European Court of Justice (ECJ) has changed the legal landscape in a series of landmark decisions regarding the freedom of establishment (Niederlassungsfreiheit) and has laid the foundation for the Cross-Border Conversion. Nowadays, inbound and outbound Cross-Border Conversions have become more and more common practice as they provide for a lean way to change the legal form across jurisdictions.
In many cases, the change of legal form is combined with an actual relocation of the company's administrative seat (Verwaltungssitz), its business operations or headquarter to the respective target jurisdiction.
II. What are the reasons for a Cross-Border Conversion?
- Applicable company law: The Cross-Border Conversion results in a change of the applicable company law. Hence, the management or shareholders may consider a Cross-Border Conversion if they find the statutory provisions of another Member State to be better suited for a company's specific structure and needs, e.g. with respect to its corporate governance structure, limitation of liability, disclosure requirements, investor protection, etc.
- Taxation: The Cross-Border Conversion usually results in a change of the applicable tax law on level of the company which might lead to tax advantages. However, in case of a limitation of German taxation rights, it also leads to an exit taxation which potentially leads to a high tax burden and needs careful consideration.
- Clients and economic environment: Another reason for a Cross-Border Conversion and migration to another Member State may be a shift in the company's strategy and its geographic focus. Adopting a legal form of the target jurisdiction may facilitate the market entry and transferring the headquarter closer to its potential clients can be vital for its business relations.
- Judicial system: By changing the legal form and by transferring the company's seat cross-border to another Member State, the courts of the target jurisdiction will become competent to rule upon certain dispute matters. For certain corporate matters the courts will have exclusive jurisdiction according to Art. 24 No. 2 Brussels-Ia Regulation. Hence, by means of a Cross-Border Conversion a company may benefit from a more efficient and elaborated judicial system in another Member State.
III. What are the requirements for a Cross-Border Conversion?
- Case Law and Applicable Law
The basis for a Cross-Border Conversion has been laid by the ECJ in its judgments in the cases Cartesio (2008), Vale (2012) and, most recently, Polbud (2017). In these cases, the ECJ has confirmed the legitimacy of Cross-Border Conversions and provided for increasingly specific guidelines on the scope and limitations of Cross-Border Conversions. Due to the lack of Europe-wide harmonised provisions on Cross-Border Conversions, the national laws of the Member States remain applicable (in Germany Sec. 190 et seqq. Transformation Act (UmwG)) and must be construed in light of the ECJ case law to the effect that Cross-Border Conversions are to be permitted. If and to what extent certain provisions of the EU Merger Directive (in Germany implemented in Sec. 122a et seqq. Transformation Act (UmwG)) and Art. 8 SE-Regulation apply to a Cross-Border Conversion is still subject to a controversial debate in legal literature. However, the ECJ has repeatedly pointed out that restrictions on a Cross-Border Conversion are only justified by overriding reasons in public interest (e.g., creditor protection) and only to the extent that no less restrictive measures are available which could equally protect those interests. Conversions into legal forms of so-called third states (which are no Member States) are not covered by the freedom of establishment and, hence, are generally impermissible.
On the basis of the ECJ ruling, German courts have repeatedly acknowledged and permitted Cross-Border Conversions (see on inbound cases, for example, Higher Regional Court (OLG) of Nürnberg in 2013 case no. 12 W 520/13 and Higher Regional Court (Kammergericht) of Berlin in 2016 case no. 22 W 64/15; for an outbound case see Higher Regional Court (OLG) of Frankfurt/M. in 2017 case no. 20 W 88/15).
- Major Implementation Steps
The most challenging part of the Cross-Border Conversion is the lack of harmonized EU law on this matter. Hence, the applicable national provisions on (domestic) conversions form the basis for the Cross-Border Conversions and the courts/commercial registers involved need to be coordinated (a pre-coordination with the relevant judges/officials is in any case highly recommended).
- First, it needs to be ascertained that the Members States involved allow (at least on a domestic level) a conversion from the existing into the envisaged legal form.
- Second, the company needs to fulfil the conversion requirements under the law of the jurisdiction of origin (Herkunftsstaat). From a German perspective this includes, in particular, that the management draws up a conversion plan (Umwandlungsplan), which includes the draft articles of association of the new legal form, and a conversion report (Umwandlungsbericht) outlining the legal and economic rationale of the conversion and indicating its implications for the shareholders, creditors and employees. After the conversion plan and the conversion report have been disclosed and made available for at least two months (conversion plan) and one month (conversion report), respectively, the shareholders need to approve of the conversion by way of a notarised shareholder's resolution. Finally, the conversion must be registered with the company's commercial register. The conversion will, however, not become effective until the conversion has been registered with the commercial register of the target jurisdiction.
- Third, the company needs to fulfil the incorporation requirements of the target legal form (e.g., coverage of registered share capital, formation report, etc.). In principle, the relocation of the company's administrative seat (Verwaltungssitz) to the target jurisdiction is not required for implementing a Cross-Border Conversion (cf. the Polbud case); if however, the target jurisdiction generally requires that "its" national legal forms have to have their administrative seats located within the jurisdiction's territory, then both the registered seat (Satzungssitz) and the administrative seat must be transferred to the target jurisdiction. In addition to the incorporation requirements, the competent court/commercial register of the target jurisdiction needs to be presented with a conversion confirmation (cf. Art. 8 para. 8 SE Regulation) stating that the conversion requirements in the jurisdiction of origin have been fulfilled. Upon the conversion being registered with the commercial register of the target jurisdiction, the Cross-Border Conversion becomes effective.
- Fourth, the registration of the former legal form in the commercial register of origin needs to be deleted (this deletion is of declaratory nature only and, for the avoidance of doubt, does not result in a liquidation or winding up of the company).
Complexity and duration of a Cross-Border Conversion are largely determined by the size and structure of the company to be converted (number of employees and creditors, shareholder structure etc.).
IV. What are the alternatives to a Cross-Border Conversion?
A conversion is a convenient way to migrate from one Member State to another. However, depending on the current set-up and the envisaged target structure there are alternatives to a Cross-Border Conversion which should be taken into account. In light of a potential "Brexit", in particular companies from the UK should consider the following alternatives since the Companies House has recently rejected applications for a Cross-Border Conversion by UK companies.
What are the alternatives?
- Cross-border merger: One alternative is to merge a company from one Member State into the company of another Member State. Pursuant to such merger all assets and liabilities of the transferring company are transferred by way of a universal succession (Gesamtrechtsnachfolge) to the acquiring company and, upon the merger becoming effective, the transferring company will cease to exist. Unlike the Cross-Border Conversion, the cross-border merger is based on a EU directive which is implemented in Germany in Sec. 122a et seqq. Transformation Act (UmwG). With regard to the upcoming "Brexit", the German legislator intends to also allow a cross-border merger with German commercial partnerships and to introduce a transition phase for cross-border mergers which have been initiated prior to the "Brexit". From a tax point of view, tax consequences are mostly the same as for the Cross-Border Conversion. However, there are situations where a Cross-border merger might be disadvantageous vs. a Cross-Border Conversion.
- Contribution of shares: Instead of converting or merging a company across the border, the shares in such company (e.g., from the UK) can be contributed as a contribution in kind (Sacheinlage) into a company from another Member State (e.g., from Germany). As a result of such contribution, the UK company would become the subsidiary of the Germany company. The implementation of such contribution of shares is, in principle, very straight forward. However, it results in a two-layer-holding structure and does not change the legal form of the contributed company (hence, after the "Brexit" the UK company would not be recognized as such in Germany anymore). Furthermore, depending on the structure, it might lead to a 7-years' blocking-period in the contributed shares under German tax law.
- Asset deal: Another potential alternative is an asset deal. In contrast to the cross-border merger (i) all assets and liabilities are transferred cross-border by way of a singular succession (Einzelrechtsnachfolge) requiring the consent(s) of third parties (contractual partners, creditors) and (ii) the transferring company continues to exist. Hence, an asset deal is a viable option mainly for small and medium sized entities. However, from a tax perspective, the asset deal usually is disadvantageous as (i) capital gains tax is triggered on all transferred assets and (ii) an additional tax burden is likely to be triggered if the purchase price is transferred from the selling company to the acquiring entity.
- Conversion into a European Stock Corporation (SE): Instead of converting into a legal form of another Member State, a stock corporation from a Member State can also be converted into a+n SE in accordance with Sec. 37 SE Regulation. Following the SE conversion, the seat of the SE can be transferred to another Member State (resulting in a change of the applicable national law to the SE). For more information on the SE, please see the "SMP Investor's Guide to the European Stock Corporation (SE)"
For more information on the Cross-Border Conversion please contact Dr. Martin Schaper (Associated Partner / Corporate) and Dr. Malte Bergmann (Associated Partner / Tax) who have very recently advised a family office on its relocation and Cross-Border Conversion from Germany to Liechtenstein.