Decreasing the equity of a company being demerged as part of a demerger (division) by separation – legitimate requirement or unnecessary formalism?

We are examining the potential impact of the recent changes to the Commercial Companies Code on the processes of corporate reorganization for businesses operating in Poland.

The entry into force of the Law of 16 August 2023 Amending the Law – Commercial Companies Code and Certain Other Laws (Journal of Laws of the Republic of Poland, item 1705, "the Amendment"), which introduced new types of domestic and cross-border reorganization procedures into legal order, has brought about significant changes. It has made previously unknown processes of cross- -border conversion and demerger, as well as a new type of domestic demerger – demerger by separation available to entrepreneurs. In addition, the catalog of situations in which a merger can be performed under a simplified procedure, i.e. without increasing the share capital of the acquiring company, has been expanded. The Amendment has also introduced instruments aimed at protecting shareholders, employees and creditors of companies involved in a cross-border reorganization. Given the type and scope of the introduced amendments, it is expected that the Amendment will have a positive impact on the reorganization procedures of capital groups, both domestic and cross-border ones, by providing entrepreneurs with a broader catalog of reorganization procedures that they are able to implement.

Despite the scale of the introduced changes, it is the seemingly least innovative type of reorganization – demerger by separation – that has already generated discussion among lawyers, tax advisors and accountants in the past. It is worth noting that this type of domestic reorganization has been introduced following the analogous cross-border reorganization procedure in order to avoid reverse discrimination of national law against EU law.

Demerger by separation involves the transfer of a portion of the assets of the company being demerged to an existing or newly incorporated company or companies against the shares of the acquiring or newly incorporated company or companies that the company being demerged takes up. Thus, as with the previously existing types of demergers, it results in an increase in the share capital of the acquiring company. The difference from the types of demerger available before is that the shares in the increased share capital of the acquiring company are taken up directly by the company being demerged, and not by its shareholders as was the case previously.

This type of reorganization makes it possible to transfer a part of assets of the company being demerged to a company that, as a result of the demerger by separation, will either only become its subsidiary or is already one. Thus, it is a good alternative to the separation through in-kind contribution, where a part of the parent company's assets is transferred as part of an increase of the share capital of the daughter company, and the transferred assets constitute an in-kind contribution to cover the shares in the increased share capital of the daughter company. A significant difference from the in-kind reorganization, however, is the existence of the universal succession of the daughter company with respect to the acquired assets, and thus the acquiring company will enter, as of the date of demerger, into the rights and obligations of the company being demerged, as specified in the demerger plan. From a legal perspective, the demerger by separation will certainly be frequently used in the market and will replace (in whole or to a large extent) separation through in-kind contribution, and will facilitate the transfer of assets or (parts of) businesses between companies in the same group.

The aspect that generates most con troversy when it comes to demerger by separation, however, is the question of whether the share capital of the company being demerged should be decreased as part of the demerger, or whether the demerger should be funded with other equity. It would seem that if the separation through in-kind contribution, i.e. the transfer of assets or (a part of) a business to a daughter company as an in-kind contribution to the increased share capital of the daughter company, does not require a decrease in the equity of the transferring company (the parent company), by analogy, the transfer thereof under demerger by separation should also not entail such a decrease.

Such requirement is not introduced by Directive (EU) 2019/2121 of the European Parliament and of the Council (EU) 2019/2121 of 27 November 2019 amending Directive (EU) 2017/1132 as regards cross-border conversions, mergers and divisions ("Directive"), which is implemented into Polish law by the Amendment. In this respect, of course, it refers only to cross-border demergers, but, as mentioned at the beginning, the demerger by separation is being introduced into national law, precisely following the introduction of such a demerger at the EU level.

Article 160q of the Directive provides that it is the law of the Member State governing the company subject to the cross-border demerger that determines the date as of which the cross-border demerger takes effect. Pursuant to the Commercial Companies Code, the provisions of the chapter on domestic demergers apply mutatis mutandis to cross-border demergers of companies, unless otherwise provided in the chapter on cross-border demergers.

According to Article 530 § 2 of the Commercial Companies Code, inclu ded in the chapter on domestic demergers, the separation of a new company takes place on the date of its entry in the register. Meanwhile, in the case of the transfer of a part of assets of the company being demerged assets to the existing company, the separation takes place on the date of registration of an increase of the share capital of the acquiring company or the issuance by the acquiring company of new shares without par value.

However, the requirement to decrease the equity of the company being demerged in order to fund the demerger by separation is determined by the new wording of Article 542 § 4 of the Commercial Companies Code which provides that the entry of demerger by separation in the register is to be made immediately after the registration of the decrease of the share capital of the company being demerged, unless the separation is made from the company's own capitals, other than the share capital. Therefore, the omission of information on the method of funding the demerger in the plan of de merger by separation will certainly cause objections from the registration courts and may result in the refusal to enter the demerger in the register of business entities of the National Court Register, as having been carried out contrary to the applicable regulations.

Given the specific nature of this type of demerger and the similarity to the separation through in-kind contribution that already exists in Polish law, the question arises whether the introduction of a requirement to decrease the share capital of the company being demerged or to decrease other own capitals as part of the demerger by separation is not characterized by an excessive formalism of this type of procedure. Waiving that requirement would be a novelty in Polish law and would revolutionize the way demerger procedures are carried out, especially within companies of the same group, but at the same time it would make it possible to fully replace demerger procedures based on in-kind contribution with demergers by separation. This, in turn, due to the principle of universal succession that occurs with demergers, would make it much easier for entrepreneurs to reorganize groups of companies.

Due to the fact that the provisions introducing demerger by separation has just entered the legal order recently, there has not yet been an opportunity to comment on them extensively by doctrine or jurisprudence. In the course of time, there are bound to be many commentaries both defending the current wording of the provisions and arguing for the need to further amend them and introduce further simplifications, certainly welcome by the market. But until then, lawyers will have to operate within the framework of the current regulations, which explicitly require demerger by sepa ration to be funded from either share capital or other equity.

Author: Dominika Dec, associate, Attorney-at-law, Baker McKenzie Krzyżowski i Wspólnicy sp.k.

This article comes from magazine:
FOCUS ON Business #13 November-December (6/2023)