Conversion Directive Implementation Act adopted: Legal framework for cross-border changes of legal form and divisions of corporations – simplification of mergers – acceleration of shareholder compensation appraisal proceedings

The Bundestag adopted the Act Implementing the European Conversion Directive (EU) 2019/2121 (Gesetz zur Umsetzung der europäischen Umwandlungsrichtlinie (EU) 2019/2121) on 20 January 2023. The Act was also passed by the Bundesrat on 10 February 2023.

The German Transformation Act (Umwandlungsgesetz, “UmwG”) provides, for the first time, a legal framework for cross-border divisions and cross-border changes of legal form of corporations in the EU and the EEA. In addition, cross-border mergers have been simplified and changes have been made to accelerate shareholder compensation appraisal proceedings. On 1 December 2022, the Bundestag also enacted amendments to the Act on Employee Participation in the Event of a Cross-Border Merger (Gesetz über die Mitbestimmung der Arbeitnehmer bei einer grenzüberschreitenden Verschmelzung, “MgVG”) and adopted a new Act on Employee Participation in the Event of a Cross-Border Change of Legal Form or Cross-Border Division (Gesetz über die Mitbestimmung der Arbeitnehmer bei grenzüberschreitendem Formwechsel und grenzüberschreitender Spaltung, “MgFSG”).

The amendments to the MgVG and the MgFSG came into force on 31 January 2023. The new provisions in the UmwG will come into force on the day after they are promulgated, probably in mid-February.

I. Framework for cross-border conversion measures

The provisions on cross-border conversion measures are brought together in a new sixth book of the UmwG, with the provisions on cross-border mergers serving as a model for cross-border divisions and cross-border changes of legal form:

• In Germany, the provisions on cross-border conversion measures apply to stock corporations (AG), Societates Europaeae (SE), partnerships limited by shares (KGaA) and limited liability companies (GmbH). Partnerships continue to be covered only in the case of cross-border mergers into a general partnership (OHG)/limited partnership (KG) with, as a rule, fewer than 500 employees, and are otherwise referred to Articles 49, 54 TFEU and the case law on freedom of establishment. Without complementary provisions in other Member States, a provision for partnerships introduced by the German legislator would hardly have been of any practical use.

• The Conversion Directive itself only regulates divisions for the formation of a new company. This means that there might not be complementary provisions in other Member States governing divisions for absorption. Moreover, the UmwG only allows cross-border divisions for absorption if, in the case of an outbound division, the transferring company and the receiving company have each employed fewer than 400 employees in the six months prior to the announcement of the draft terms of the division. Inbound division for absorption is limited to companies that employ, on average, less than four-fifths of the number of employees that would trigger employee participation in the departure Member State.

• A prerequisite for cash compensation for shareholders exiting the company on account of a cross-border conversion measure is that the absorbing or new company is not subject to German law and an objection to the relevant shareholders’ resolution has been lodged in writing. A two-stage procedure is laid down in this regard: the respective shareholder must submit a corresponding declaration of intent one month after the resolution on the conversion measure and acceptance must be declared at the latest two months after the resolution. The exiting shareholders may demand security.

• In the case of cross-border mergers and divisions, it is possible – in the event of an inappropriate exchange ratio – for an AG/SE/KGaA to (also) provide for compensation for shareholders by granting additional shares instead of a cash payment, in order to preserve its liquidity and facilitate investments in the context of restructurings. This possibility must however be laid down in the draft terms of the conversion. In shareholder compensation appraisal proceedings, the court may increase the number of shares to be granted. Complex adjustment mechanisms are set out for interim dividend payments, capital increases, conversion measures, etc. It is not specified whether a non-cash contribution review is required in the case of compensation in shares and whether the shares can be created using authorised capital. Moreover, there is no cross-border harmonisation of procedures concerning the necessity and amount of a compensation (in particular no cross-border erga omnes effect), but only a requirement for cooperation.

• As far as the protection of creditors is concerned, the underlying system has been changed, with creditors’ rights being strengthened. The draft terms of the conversion must specify what security will be offered to the creditors of a German transferring or form-changing company for claims that arose before the draft terms were announced but have not yet fallen due and whose fulfilment is jeopardised by the conversion measure. If no security is offered or this is, in the creditors’ view, insufficient, the creditors may demand the provision of adequate security within three months of the announcement of the draft terms. If a claim for the provision of security is asserted in court, the registration of a conversion measure cannot take place. The court in whose district the registry court responsible for issuing the pre-conversion certificate is located will have exclusive jurisdiction over disputes concerning the claim for the provision of safeguards. This centralisation of jurisdiction, which was only introduced by the Rechtsausschuss (Committee on Legal Affairs of the Bundestag), eliminates the risk of a multitude of court proceedings in Germany and abroad dealing with the creditors’ entitlement to security. 
  
  The registry court may not issue the pre-conversion certificate for registration of the cross-border conversion measure until the creditors’ application period has expired, their application has been rejected with final and binding effect or the specified security has been provided. In addition, the members of the representative body must, at the request of the court, affirm that the security offered has been provided to all creditors. Providing a false affirmation is punishable by law. With creditor protection as a prerequisite for registration and an instrument for blocking entry in the register, there can be a considerable delay until the conversion measure is registered.

• A procedure with EU-wide compatibility will be introduced in which the participating commercial registers or competent foreign agencies communicate directly with each other digitally through the European Business Register Interconnection System (BRIS). In this context, the pre-conversion certificate concerning the respective domestic prerequisites for a conversion measure will also be adapted and issued ex officio in future.

• One novelty is the (substantive) abuse test to be carried out by the German registry court or the competent foreign agency for all cross-border conversion measures as part of issuing the pre-conversion certificate. It must be checked whether the cross-border conversion measure is set up for abusive or fraudulent purposes leading to or aimed at the evasion or circumvention of EU or national law, or for criminal purposes, if there are factors indicating that this may be the case.
  
  The lack of detailed requirements for abuse control (the Act only mentions three examples involving employee participation, the handling of pension liabilities, and disadvantaging of creditors) may lead to problems, especially in the case of crisis-related restructuring, and may also hinder reorganisation measures given that the check may cause a delay of up to six months. Especially when it comes to employee participation, minimum levels of capital and creditor protection, the different degrees of protection offered by the Member States should be respected by the registry courts in the context of freedom of establishment. In addition, creditor protection is sufficiently covered by the obligation to provide security.

• When registering the cross-border conversion measure, the members of the representative body must in future give assurances that there are no grounds for insolvency proceedings to be opened in respect of the transferring or form-changing German company. If such assurances cannot be given, the grounds for insolvency must be stated, as well as whether insolvency proceedings have been applied for or opened.

II. Corporate co-determination aspects in the case of cross-border conversion measures

The protection of corporate co-determination for employees in cross-border conversion measures is – in the case of cross-border mergers – ensured by the negotiation model stipulated in the MgVG with a statutory fall-back provision that has now been adapted. Where cross-border changes of legal form and divisions are concerned, the newly created MgFSG also provides for a negotiation model with a statutory fall-back provision:

• Accordingly, negotiations on employee participation are now already required if one of the companies involved has a number of employees that corresponds to at least 4/5 of the threshold that triggers corporate co-determination in the outbound Member State, which in Germany is 400 employees (4/5 of the threshold of 500 employees under the One-Third Employee Representation Act). If no agreement is reached in the course of the negotiations, the employee participation regime of the transferring company will apply on a permanent basis in the absorbing company.

• This is not entirely persuasive, particularly if a division gives rise to small companies that are permanently subject to the employee participation regime of the transferring company. Moreover, in the case of cross-border changes of legal form and divisions, companies not subject to employee participation will be forced to enter into time-consuming negotiations, at the end of which the statutory fall-back solution will confirm that such companies are still not subject to employee participation. Unlike in the case of mergers, where cross-border changes of legal form and divisions are at issue, there is no possibility to apply the statutory fall-back provision without prior negotiations.

• The MgFSG also provides for protection of corporate co-determination in subsequent conversion measures. If, after a cross-border change of legal form or a cross-border division into Germany, employee participation exists in the resulting company and a further domestic conversion measure is adopted in this company within four years, the MgFSG will apply to this measure accordingly.

• The MgFSG applies for an unlimited period of time to scenarios in which a company resulting from a cross-border conversion measure carries out a further cross-border change of legal form or a further cross-border division and the resulting company has its registered office in Germany. Employee participation in the German company according to the MgFSG must then be negotiated.

III. Significant changes in the case of domestic conversion measures

The implemention of the Conversion Directive will also give rise to changes to provisions for domestic conversion measures, which from a practical standpoint will lead to simplifications:

• In the UmwG, the mandatory information, the structure, as well as the provisions on exceptions to the report and the audit report on conversion measures will be amended. In the future, the report will not be necessary for a legal entity in respect of which all the shareholders have, by means of a notarised declaration, waived reimbursement without the situation of other legal entities involved having any influence on this. In addition, there will be simplifications with respect to intragroup conversion measures such as parent-subsidiary mergers, mergers of sister companies, and for single-member companies. In the case of stock corporations (AG)/partnerships limited by shares (KGaA)/Societates Europaeae (SE), the conversion measure will still have to be audited unless all shareholders waive this requirement.

• In the future, also the shareholders of an absorbing company – as has already been the case for the shareholders of a transferring company – will no longer be able to challenge the adoption of a conversion measure by arguing that the exchange ratio is inadequate. This means that there will no longer be a block on entry in the register due to valuation complaints. Instead, it will only be possible to review the adequacy of the cash compensation and the exchange ratio for all legal entities in a uniform manner after a conversion measure has taken effect in the shareholder compensation appraisal proceedings. In order to avoid contradictory decisions, the intention is for cases to be joined and judicial jurisdiction centralised at the court first seized of the matter.

• To speed up shareholder compensation appraisal proceedings, an obligation to be represented by a lawyer and the jurisdiction of the Division for Commercial Matters will be introduced and the – often time-consuming – redress proceedings abolished. In addition, when the court is assessing adequate compensation, it will be possible for a settlement with at least 90% of the parties to the proceedings to be taken into account. This will provide a legal basis for the majority consensual assessment, which has previously been rejected by the courts.

• If a compensation requirement is determined in the shareholder compensation appraisal proceedings, a stock corporation (AG)/Societas Europaea (SE)/partnership limited by shares (KGaA) will not have to provide the compensation as cash compensation only, but will also have the option of granting additional shares, even in the case of domestic changes of legal form and divisions. However, compensation in shares by means of a capital increase against non-cash contribution of the compensation claim must already be provided for in the conversion agreement in this case as well.

• The joint and several liability – of all legal entities involved in a division process – for the liabilities of the transferring legal entity is generally maintained. In the future, however, the joint liability of the legal entities for liabilities of another legal entity involved will be limited to the value of the “net assets” (“Nettoaktivvermögen”) at the date on which the division takes place. The liability periods will remain unchanged. This limitation of liability is generally appropriate. In practice, the challenge is to clarify the term “net assets” (“Nettoaktivvermögen”), which is taken directly from the Conversion Directive and has previously not been used in German Law. However, the German Federal Ministry of Justice is of the opinion that the term has the same meaning as the German term “Reinvermögen”, i.e. net assets.

The changes will come into force on the day after the promulgation of the Act, probably in mid-February. Provided that the other Member States have implemented the Conversion Directive in a timely manner, the first conversion measures under the new regime could start as early as the first quarter of 2023. Conversion measures that are adopted before the changes come into force can be concluded under previous law, provided that they are filed for registration in the commercial register by the end of 2023.

IV. Our assessment

The far-reaching reform of conversion law fits in with the general scheme of the UmwG from a conceptual standpoint and is to be welcomed from a practical point of view. For the first time, it creates a unified legal framework for cross-border divisions and changes of legal form of corporations in the EU and the EEA, which framework will facilitate cross-border transactions and restructurings, particularly in groups, and in many cases make them more legally secure. A (court) practice has yet to evolve for the new mechanisms for creditor protection and control of abuse in the case of cross-border conversion measures. The simplifications for domestic conversion measures are also helpful, even if there are still some ambiguities in the details, in respect of which an established case law and practice must also still evolve.

Cross-border conversion measures will remain technically demanding and complex. In view of the necessary coordination with the registry courts as well as the various submission, information and publication deadlines and waiting periods, they must in any case be prepared in a careful and timely manner.