Downstream merger: acquisition of a parent company by a subsidiary
Although it is possible for a limited-liability company to acquire its own parent company, the transaction carries legal risk.
Companies may be combined through the acquisition of one company by another company or through a merger in which a new company is established. Transactions most frequently use the first model, where the assets of the target are transferred to the acquirer, the target is dissolved, and the shareholders of the target receive shares in the acquirer.
Acquisitions may occur within holding groups, e.g. in group restructuring the parent may take over its subsidiaries. A particular example of a merger by acquisition is the “downstream merger”—the acquisition of the parent company by a subsidiary.
There may be various motives for conducting a downstream merger. It may be a method for changing the structure of the group for organisational or tax purposes (although tax considerations cannot be the sole reason), or a simplified method for transferring the registered office of the company to another country (with an effect similar to a cross-border conversion of the corporate form). It may also be dictated by operational considerations (e.g. when the subsidiary is bound by change-of-control clauses). Thus there can be numerous economic advantages of a downstream merger, but it also carries certain legal risks.
Acquisition of a parent by a subsidiary is not governed separately by Poland’s Commercial Companies Code, but is subject to the general code regime concerning corporate mergers (Art. 491 and following). The downstream merger is a permissible form of corporate merger, and is used in M&A practice, but commentators raise certain legal doubts about this structure.
The essence of a merger by acquisition is that the entire assets of the target are taken over by the acquirer through universal succession. In the case of a downstream merger, this means that the acquiring subsidiary, as the successor of the parent company, becomes the owner of the participation in its own share capital (which indeed is often the only property of the parent). This aspect raises doubts in light of the prohibition in the Commercial Companies Code against a company’s acquiring shares in its own share capital (Art. 200 §1 in the case of a limited-liability company and Art. 362 §1 in the case of joint-stock companies).
This situation does not generate problems when the acquiring subsidiary is a joint-stock company (SA). Art. 362 §1(3) expressly permits acquisition of the company’s own shares through universal succession. It should be borne in mind, however, that the company cannot exercise any share rights under its own shares (such as the right to vote or the right to a dividend) except for the right to dispose of the shares or conduct measures intended to preserve the share rights (Art. 364 §2).
With respect to a limited-liability company (sp. z o.o.), Art. 200 §1 prohibits the company from acquiring shares in its own capital, but unlike the provisions governing joint-stock companies it does not contain an exception for acquisition of shares through universal succession. A literal interpretation leads to the conclusion that it is impermissible for a limited-liability company to conduct a downstream merger. The sanction for acquisition of shares by a limited-liability company in violation of Commercial Companies Code Art. 200 §1 is the invalidity of the transaction (Civil Code Art. 58 §1). Moreover, the members of the management board could be held criminally responsible for permitting the company to acquire its own shares (Commercial Companies Code Art. 588).
Nonetheless, a liberal approach to the issue of the permissibility of downstream mergers by limited-liability companies predominates in practice, and reorganisations of this type are in fact registered by the courts. But until this issue is expressly resolved by amending the Commercial Companies Code (at the Ministry of Justice, a proposal to do this was issued by the Civil Law Codification Commission in 2012), a downstream merger by a limited-liability company cannot be said to be an entirely secure solution. One possible way to eliminate this legal risk would be to convert the acquiring subsidiary from a limited-liability company to a joint-stock company shortly before the downstream merger is carried out.
Agnieszka Szydlik and Jacek Czarnecki, Mergers & Acquisitions Practice, Wardyński & Partners