Implementing the Mobility Directive

Introduction

The German Act Implementing the Mobility Directive (EU) 2019/2121 was originally supposed to enter into force in January 2023, after the Federal Cabinet agreed on the draft bill on 6 July 2022. However, the Bundestag only adopted the draft bill on 20 January 2023. The Act entered into force on 1 March 2023, with a few minor exceptions.

The rules on cross-border conversions are now found in a new sixth volume of the Recast Transformation Act (Umwandlungsgesetz). The rules on cross-border mergers – previously found in §§ 122a et seq. of the Act – are now also regulated in the sixth volume of the Recast Act. In addition to cross-border mergers (§§ 305 et seq. of the Recast Transformation Act), the sixth volume contains rules on cross-border divisions (§§ 320 et seq. of the Recast Act) and cross-border conversions (§§ 333 et seq. of the Recast Act).

The inclusion of cross-border conversions has not generally changed the modular system of the Transformation Act; there is still a basic reference to mergers except where a specific differing or supplementary rule applies for a different form of transformation. The internal structure of the new sixth volume follows the familiar order, looking first at mergers, then divisions and lastly conversions.

Certain core elements can be summed up as follows: in the case of mergers, divisions and conversions, shareholders have a right to withdraw from the legal entity in return for cash compensation; § 313 of the Recast Act (for mergers) provides the obligation to make an offer to acquire shares in return for appropriate cash compensation.

In the case of mergers and divisions, the Recast Act provides a right to an improvement of the ratio of exchange.

The right to challenge the valuation is excluded for all three types of cross-border transformation. Instead, any challenge to the valuation should be enforced in legal proceedings (see the changes to § 1 No. 4 of the Act on Shareholder Actions under Company Law (Revised version of the SpruchG)).¹

In the following, we briefly explain a few of the central aspects of the Act to Implement the Mobility Directive (UmRUG).

Divisions

Divisions for the purpose of absorption

Generally, the EU directive only deals with cross-border divisions for the purposes of founding a new company. The new German legislation goes beyond this. The Act Implementing the Mobility Directive also deals with divisions for the purposes of absorption. In the latter case, the assets are not transferred to a company formed through the division, but to an already existing legal entity, but this is restricted: under the first sentence of § 332 No 1 of the Recast Act, in the case of the division of a domestic company, there must be fewer than 400 employees on average; this applies to both the transferring and receiving companies. This establishes a threshold of 80% of the threshold in the One-Third Participation Act (Drittelbeteiligungsgesetz, DrittelbG). Under § 320 first sentence, No. 2 of the Recast Act, in the case of absorption by a domestic company, fewer than four-fifths of the number of employees decisive for participation under the law of the State to which the transferring company is subject must be employed on average.

The Act goes further than the Directive and provides rules for divisions for the purposes of absorption. The success of these instruments will depend on the extent to which the other Member States also allow cross-border divisions for absorption. As the law already provides for domestic divisions, division for the purposes of absorption offers a high degree of flexibility because there is no need to establish a new legal entity and the assets can instead be transferred directly to a legal entity that already has an operative business. There is no - undesired – new legal entity.

The former possibility to transfer assets

Until now, shares in a company could be sold to a purchaser by way of a share deal. Certain business units could also be transferred by way of an asset deal. Finally, there was also the option of transferring a company through cross-border universal succession, by way of the so-called accrual model ² involving a partnership, typically a limited partnership in the form of a GmbH & Co KG (“KG”). Universal succession involves either the transfer of all shares in the KG to a (foreign) company or the acquisition of all the shares in the KG by that company and the withdrawal of all other shareholders from the (target) company. Transactions may still have one of these structures.

The Recast Act introduces the possibility, not previously foreseen or not explicitly foreseen under the Transformation Act, to transfer all assets by way of a partial universal succession. The advantage of this model compared to the accrual model, is that a partnership is not required. The advantage over the asset deal is obvious. Even if the assets to be transferred must be designated with sufficient precision for both asset deals and divisions,³ in the case of divisions, the assets will transfer without needing to list and transfer them all separately. This applies to liabilities and contractual relationships, which – subject to subsequent extraordinary rights to terminate in change-of-control rules – can be transferred with more legal certainty by way of partial universal succession under § 131 of the Transformation Act.

Conversion

The Recast Act provides a clear legal basis for cross-border conversions. It also eliminates uncertainties based on the lack of legal foundation.⁴

Improvement of the exchange ratio

Generally, in the case of a merger, shares are granted in the acquired stock company. Where the exchange ratio for the shares is too low, according to § 15 (1) of the Transformation Act, the acquiring legal entity can be required to provide an additional cash payment as compensation.

Sections 72a and 72b of the Recast Act supplement this rule. These provisions provide liquidity protection for both cross-border and German domestic conversions and, in the case of stock companies, allow shares to be granted in lieu of an additional cash payment to improve the exchange ratio (§ 72a of the Recast Act).

According to § 72b of the Recast Act, additional shares granted under § 72a can be created through a capital increase against contribution in kind. The purpose of the contribution in kind is to satisfy the claim of shareholders to additional shares, established by court judgment or settlement under the Act on Legal Challenges under Corporate Law (Spruchverfahrensgesetz).

The advantage of this procedure is that liquidity must be preserved when creating additional shares –through an increase in capital - in the acquiring company; payment in cash is otherwise foreseen under § 15 of the Transformation Act.

This option applies in principle to divisions, too.

Protection of creditors

The Recast Act increases protection for creditors – besides secondary liability, for example - compared to the protection provided both during earlier national conversions in Germany and cross-border mergers under §§ 122a of the Transformation Act. Upon request, the transferring company must provide creditors with security before the cross-border merger can be registered. Under § 122j of the previous Transformation Act, security had to be provided for cross-border mergers under § 232 of the German Civil Code (BGB). If the creditor generally has the right to security under § 122j, it must be provided in accordance with § 232 of the Civil Code,⁵ i.e., through a pledge or bond. When making a notification to the commercial register, the representative body of the transferring legal entity must ensure no securities have been enforced before the courts (see § 315 (3) No. 2 of the Recast Act) within three months of the announcement of the plan in accordance with § 314 (3) of the Recast Act. Creditors can block the registration where they have brought a claim for appropriate security.

Role of registry courts

The Act implementing the Mobility Directive registry gives courts a key role in cross-border conversions. They must do more than just assess whether the company was set up for abusive or fraudulent purposes (see section 7 below).

Under § 316 (1) of the Transformation Act – using a merger as an example – the court will examine within three months of the application for registration, whether the transferring company fulfils the requirements for the cross-border merger. Registration includes the determination that all relevant conditions have been fulfilled, and all necessary procedures and formalities have been performed. Registration will carry an annotation indicating the cross-border merger will be effective subject to the conditions set out in the law of the Member State where the acquiring or new company is based. The court will issue a merger certificate ex officio for the registration. Registration may not occur before the expiry of the three-month time limit for the assertion of claims for security. In Germany, under previous practice, the court normally decided much quicker. The judicial authority to conduct a review could even lead to an extension of the procedure depending on the specifics of the case.

Assessment of whether there are any abusive or fraudulent purposes

Based on the EU Directive, the Recast Act introduces a so-called assessment of abuse for cross-border conversions for the first time. The court scrutinises whether there is any indication the cross-border conversion has (1) abusive or fraudulent purposes leading to or aimed at the evasion or circumvention of EU or national law, or (2) criminal purposes. If this scrutiny reveals such purposes, the register court will reject the registration (see §§ 316 (2), 329 first sentence and 343 (3) of the Recast Act).

Examples of indications of such abuse were introduced at short notice during the legislative procedure. These include when (1) the parties only commence a necessary negotiating procedure in relation to employee participation when prompted by the court; (2) the number of employees clearly amounts to at least four-fifths of the threshold decisive for employee participation in the company, no added value is created in the target country, and the administrative offices remain in Germany; or (3) a foreign company will become the debtor for occupational pensions or entitlements through the cross-border merger and the company does not have any other operative business (§ 316 (3) No. 1-3 of the Recast Act).

Whether the impact of this additional scrutiny will be significant in practice remains to be seen. It should be noted that other legal provisions also apply, such as those to protect workers’ rights (new provisions or amended provisions; the Act on Co-determination Rights of Workers in the Case of Cross-border Conversions and Divisions (MgFSG), and the Act on the Co-determination Rights of Workers in the Case of Cross-border Mergers (MgVG). It remains to be seen whether there is room for more extensive scrutiny of possible abuse or fraud and where it should be performed in the procedure.

Practical questions on the procedure for cross-border conversions

A purely German legal view will be insufficient in some cases. Instead, the corresponding provisions of the (EU) foreign law must also be considered. Fortunately, cross-border mergers were an opportunity to become familiar with this in practice. Nevertheless, a need for clarity and coordination between the parties – such as the notary and the foreign commercial register – can still be expected in the early days. This should be kept in mind when planning the timing of any measures.

Review and outlook

One cannot help but think that the procedure will be more expensive and complex. Still, with the exception of the cross-border merger, which was already codified, cross-border conversions are now regulated by law for the first time and will have greater legal certainty. This must be recognised. In practice, some measures may now be possible for the first time, not necessarily in a legal sense, but in effect.

With the Act Implementing the Mobility Directive expanding the scope of options to other legal instruments, cross-border conversions offer new opportunities without devaluating the previous tools, which will undoubtedly still have their use. This is particularly true for the transfer of business units or departments to another Member State. Practice will show if the assessment of whether there is an abusive or fraudulent purpose will become a challenge or hurdle, and whether it will effectively prevent parties seeking to “dishonestly” move assets across borders, or whether the procedural requirements will be too complex. However, as there is a practical need for cross-border conversions, the new instruments are likely to be used in practice despite the expected hurdles.

Dr Winfried Richardt

An overview as well as the key points of the Mobility Directive can be found in the blog post by Christian Burmeister.

¹ See Bungert, NZG 2022, 1657.
² For more detailed information see Hoger/Lieder, ZHR 180 (2016), 613 et seq.
³ Semler/Stengel/Leonard-Schröer/Greitemann, UmwG, § 126 UmwG, at point 61.
⁴ Bungert, NZG 2022, at 1657.
⁵ Polley in Henssler/Strohn GesR, 5th edition, 2021, § 122j UmwG at point 9.