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Demerger of the Limited Liability Company in Finland

In this article demerger refers to the demerger regulated in Chapter 17 of the Limited Liability Companies Act (Companies Act, 624/2006). A demerger is a corporate restructuring in which a business is divided into different components. A demerger allows e.g., a large company, such as a conglomerate, to divide its various business units to create separate legal entities to handle different operations.

A demerger may proceed fully or partially. In a full demerger all of the assets and liabilities of the demerging company are transferred to two or more acquiring companies, and the demerging company dissolves. On the other hand, in a partial demerger only some of the assets and liabilities of the demerging company are transferred to one or several acquiring companies.

In a full demerger there has to be at least two acquiring companies, but in a partial demerger only one acquiring company is required. A demerger may proceed into an existing company and/or into a company to be incorporated.

Full demerger

Demerger is often used to prepare a change of ownership by separating a specific part from the corporate entity which is going to be transferred to the new owner. For example, in preparing a generational transfer one can separate the actual business, that is, the active assets, from the company owned by parents into its own company while the passive part of the business can be transferred into another company. After the demerger, the active business company is transferred to the children continuing the business operations. Cutting the balance sheet in this way lowers the transfer or selling prices of the shares. A similar goal can occur in an acquisition with an outside buyer.

The shareholders of the demerging company will get a demerger consideration in exchange for their shares. The demerger consideration may consist of shares or other assets of the acquiring company, or money, other assets or undertakings. Legally, the full demerger is considered as the main means for demerger. Where applicable, its procedures are used and followed in a partial demerger as well.

Partial demerger

The same procedure is followed in a partial demerger, but the main difference is that the demerging company does not dissolve. A partial demerger enables i.a. the transfer of one or more industries of a conglomerate into a separate company or e.g., the separation of marketing and production into separate companies. The acquiring company may be incorporated with the demerger, or it might already exist either as an active business or as a non-operating business, so called shelf company.

The partial demerger can be implemented by reducing the share capital of the demerging company and distributing the assets released from the reduction of share capital to the acquiring company. However, the reduction of share capital is not necessary. That is because the demerger can also be implemented by lowering the non-tied equity with the net value of the transferred assets.

In practice, the means of a partial demerger are quite often determined by tax legislation, since only a demerger implemented in a certain way can be accepted in taxation. According to the Act on the Taxation of Business Income (360/1968) in a partial demerger a business entity has to be transferred as it is, and at least one business entity has to remain in the demerging company. Thus, at least one business entity has to remain in the demerging company. A business entity refers to all assets and liabilities of a specific part of the company which constitute independent operations, i.e., an entity capable of self-sufficient activities.

Procedure of demerger

Demerger includes many steps. In addition, the processing of the demerger in the Trade Register take up to four months. The same legal provisions of demerger apply both to public and private companies. The demerger provisions of the Companies Act are drawn up mainly for public companies, and thus the provisions and procedures can be excessive in relation to the needs of a private company. However, private companies can deviate from many of the procedural provisions if the shareholders unanimously decide to do so. Thus, if necessary, the procedure can be made very flexible e.g., in family-owned companies or in other closely held companies.

Draft Terms of Demerger

The draft terms of demerger is an essential document in corporation transactions. The Boards of Directors of the companies involved in the demerger draw up written draft terms of demerger. The whole demerger is based on these draft terms. The draft terms of demerger must include numerous points, such as:

  • an account of the assets, liabilities, and equity of the demerging company and of the circumstances relevant to their valuation,
  • a proposal for the division of the assets and liabilities of the demerging company between each of the acquiring companies, and
  • a proposal for the intended effect of the demerger on the balance sheet of the acquiring company.

An auditor issues a statement on the draft terms of demerger. In the statement, the auditor evaluates a true and fair view has been provided of the grounds for setting the demerger consideration, as well as on the distribution of the consideration. In practice, the auditor’s statement is an important basis for the shareholder to evaluate the proposed consideration. In addition, in partial demerger the statement to be issued to the acquiring company shall also indicate whether the demerger is conducive to compromising the repayment of the company’s debts.

Public notice procedure

On the application of the demerging company the Trade Register issues a public notice to the creditors of the demerging company. The notice contains a mention of the right of the creditor to object to the demerger by so informing by the due date. The Trade Register publishes the public notice in the Official Gazette no later than three months before the due date and registers the notice on its own motion. No later than one month before the due date, the company shall send a written notification of the public notice to its known creditors.

Creditor protection in demerger

The creditor protection in demergers has been arranged in two ways. Firstly, the creditors’ right to object the demerger directly protects the creditors. Secondly, the creditors are protected by that the companies involved in the demerger are jointly liable for the liabilities of the demerging company. The joint liability covers the liabilities that have arisen before the implementation of the demerger has been registered if the demerging company has not obtained a full performance for the debts due.

If a creditor has objected to the demerger, the Trade Register shall notify the company of the same without delay. If the creditor objects, the companies must either pay the receivable or give it a full security accepted primarily by the creditor or lastly, if a dispute arises, by the Court.

The primary liability for the transferred debt rests with the company which, under the draft terms of demerger, becomes the new debtor. The other acquiring companies only have a secondary liability. This means that for the debt referred to in the draft terms of demerger, the creditor may claim performance from the other acquiring companies based on solidarity only when it is established that the creditor will not receive the payment from the debtor or from a security.

Implementation of demerger

The companies involved in the demerger shall notify the Trade Register of the implementation of the demerger within six months after the demerger decision. Failing this, the demerger lapses. The notification shall include i.a., a certificate of the auditor to the effect that the acquiring company has received full consideration for the amount credited to its equity and a statement regarding the account in the draft terms of demerger on the assets, liabilities and equity of the demerging company and the factors affecting their valuation. The adequacy of the funds to be transferred as an equity payment shall be assessed at the time at which the notification of demerger implementation is made.

Final accounts

In a full demerger, the Board of Directors and Managing Director of the demerging company shall as soon as possible after the implementation of the demerger draw up the financial statements and annual report for the period not yet covered by financial statements submitted to the General Meeting. This is called final accounts. Thereafter, the final accounts shall be given to the auditors, who shall issue their report on the final accounts within one month.

The effects of the demerger

Once the implementation of the demerger is registered, the assets and liabilities of the demerging company transfer to the acquiring companies. At the same time, the demerging company will dissolve in a full demerger and, in a demerger into a company to be incorporated, the acquiring company will be established.

When the implementation of the demerger comes into effect, the shareholders of the demerging company become entitled to the demerger consideration in accordance with the draft terms of demerger. The shareholders have the right to receive consideration in proportion to the share ownership. For this purpose, the consideration usually involves the shares of the acquiring company. However, as mentioned before, the consideration might consist of money, other assets, or undertakings as well.

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