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1 Number March 2005 Client Alert Latham & Watkins Corporate Department Establishment of a European Stock Corporation (Societas Europaea SE ) in Germany and Europe On December 28, 2004 the German Statute for the Introduction of the SE (SE- Einführungsgesetz SEEG ) was introduced. The German law amends and supplements the Council Regulation no. 2157/2001 of the Council of the European Union ( SE-REG ), which has been enacted after more than 30 years of discussions and negotiations on October 8, In order to allow member states to adjust national legislation to the SE-REG, the Statute came into force three years after its enactment, on October 8, 2004 with direct applicability in all EU member states. It comprises the Statute for a European-wide stock corporation. The rational behind the enactment of the SE-REG and the creation of a European stock corporation is the acknowledgement that in order to facilitate a common market, the mere harmonizing of national laws came to its limits. The common economic market in corporate Europe required a joint legal entity, which has been established now in form of the SE. Besides its general characteristics such as its status as legal entity, limiting its shareholders liability to their capital contribution which in total shall amount to at least EUR 120,000 and the requirement to have its registered seat within the European Union, the SE offers certain unique features, which may be of interest not only for European companies, but also for non-european, especially US businesses, who have EU operations. Labor law issues regarding the SE, such as information and codetermination rights of employees, have been addressed by Council Directive 2001/86/EC (the SE- Employee-Directive ), which is not directly applicable, but requires transformation into national law. In Germany, this has been accomplished by the SEEG. In addition to this SE-specific legislation, national laws of the respective member states applicable to national stock corporations, e.g. in Germany the Stock Corporation Act, apply to the SE. The SE s unique features include: choice between UK or US style unitary board system and German dual style management board/supervisory board system; possibility to limit codetermination rights of employees; free relocation of the company s seat within the European Union; streamlining of corporate governance and management structures; and possibility of Forum Shopping. The following shall provide a brief overview of: 1. Basics of the SE s Foundation; 2. Specific Characteristics; 3. Where to Use the SE; and 4. Tax Issues. Latham & Watkins operates as a limited liability partnership worldwide with an affiliate in the United Kingdom and Italy, where the practice is conducted through an affiliated multinational partnership. Copyright 2005 Latham & Watkins. All Rights Reserved.

2 1. Basics of Foundation The SE can be established exclusively only by way of: Merger; Foundation of a Joint Holding Company; Foundation of a Joint Subsidiary; or Conversion. In addition, an existing SE may establish its subsidiaries in the form of an SE. Merger A merger into an SE can only be executed among two or more stock corporations such as the German AG, the French SA, the Dutch NV or the Italian SA. Consequently, private limited-liability companies such as the German GmbH, the French SARL, the Dutch BV and the Italian srl cannot participate in the merger into an SE. In addition, at least two of the merging entities should come from different members states. This European Element is mandatory in one form or another to found an SE. The SE can either be established by at least two founding entities merging into a new entity, the SE, or one company is merged into another which then becomes the SE. The merger requires several formal steps and actions in order to be accomplished, such as a preparation of a merger report by the management of each of the merging companies, addressing issues such as location of the SE, its name, exchange ratios of shares etc. Further, an expert s report addressing in particular the fairness of the share exchange ratio needs to be prepared. Most important, the employees of the participating companies must be informed and a Special Negotiation Body who negotiates on behalf of all employees their involvement and representation in the SE needs to be established. Upon agreement as to employees involvement and approval by the shareholder meetings of the merging entities, the observation of all formal steps is reviewed by the respective member states authority, generally responsible for the merger among national stock corporations which then issues an approval certificate. By filing these certificates with the authority responsible for the new SE and upon registration in the respective registers, the merger takes effect. National stock corporation law applicable to national mergers providing for the protection of creditors, bondholders or shareholders of shares carrying special rights shall remain applicable to the merger. In addition, national law may provide for protection of minority shareholders objecting to the merger and foundation of the SE. In case of a merger of a German stock corporation into another company, objecting shareholders are entitled to a cash consideration for their shares. The fairness of such consideration shall be addressed in the expert s report and can be challenged in court. Only under certain circumstances, such challenge can delay the merger and foundation of the SE; usually in Germany, a special proceeding not hindering the registration of the foundation of the SE is applicable. Foundation of a Joint Holding Company The shareholders of at least two stock corporations or limited liability companies, such as German and Austrian GmbHs or French SARLs or Dutch BVs, may form a joint holding company by contributing more than 50 percent of their shares in their companies into the SE in exchange for shares in the SE. The European Element is mandatory in that limited companies involved should either come from at least two different member states, or they should have at least one subsidiary resident in another member state for a period of over two years. Otherwise, the steps are basically similar to the foundation by merger; a management report as well as an expert s report is necessary, the Special Negotiation Body needs to be established and the shareholders must resolve on the foundation, if German companies are involved at least with a 75 percent 2 Number March 2005

3 majority. Subsequently, the SE comes into existence upon its registration. In Germany, objecting shareholders are entitled to sell their shares against cash compensation; the procedure is similar to the one in case of a merger. Foundation of a Joint Subsidiary Any form of legal entity including partnerships may form a joint subsidiary by way of subscribing the shares of the SE, provided at least two of the founding companies come from different member states or have a subsidiary in another member state for a period of at least two years. Details of the founding process follow national law. The involvement of employees is again subject to an agreement with the Special Negotiation Body. Conversion Any stock corporation located within a member state may be converted into an SE, provided it has at least for two years a subsidiary resident in another member state. Management should prepare a report on the legal and economic effects of the conversion, as well as the consequences for shareholders and employees. Experts have to confirm that the assets of the company to be converted are sufficient to substitute the minimum capital of an SE of Euro 120,000. Upon resolution of the shareholders meeting and registration in the respective register, the conversion is finalized and the SE comes into existence. Employee rights such as information rights and codetermination rights remain as in the converted stock corporation and are therefore governed by the provisions of the national law of the member state in which the SE is located. The company shall not relocate its registered seat into another member state due to, or in connection with, the conversion. 2. Specific Characteristics Choice between Monistic or Dual Style Board System Contrary to the German stock corporation with its mandatory two-tier board system, the shareholders of an SE can choose at any time, even after its foundation by shareholders resolution and amendment of the articles of association, between a two-tier system, consisting of a supervisory board (Aufsichtsrat) and a management board (Vorstand), or the UK/US style one-tier system consisting of one administrative board (Verwaltungsrat) ( Board or Board of Directors ). In a two-tier system, the general meeting appoints the members of the supervisory board who then appoints the members of the management board. In Germany, the management board can be removed prematurely only for cause. It conducts the company s business within its own discretion and responsibility, and is not subject to orders by the shareholders or the supervisory board save for some provisions in the articles of association providing for supervisory board consent. Only the management board represents the company externally. In a one-tier system, the shareholders via a general meeting appoint the members of the Board. The Board is both the management body and the supervisory body with respect to all company affairs. The Board should comprise of at least three members, unless otherwise provided for in the articles of association of the SE. The entire Board is responsible for strategic business decisions and shall supervise the execution of such decisions. The Board shall appoint executive directors, responsible for the execution of the strategic Board decisions, the day to day business and the external representation of the company towards third parties. Executive directors may be members of the Board or external parties. However, the majority of the Board members shall always remain non executive members. Board members may be removed by shareholders resolution at any time and executive directors can be dismissed by Board decision. At any time, the Board may issue orders to the executive directors. In case the SE is subject to codetermination, which is dependent 3 Number March 2005

4 on the member state it is located in and the number of its employees, employee representatives including Union representatives may become mandatory members of the supervisory board (in a dualistic system) or the Board (in a monistic system) and thus, cannot be removed by shareholders vote. In Germany, the number of employee representatives in the Board or supervisory board is dependent upon the number of employees of the companies involved, and may amount up to 50 percent of the members of the supervisory board or the Board. However, in such a codetermined Board or supervisory board, the chairman retains a casting vote. The chairman is elected by members of the Board or supervisory board, and can only be a member of the shareholder-elected Board or supervisory board. Limitations on Employees Information and Co-Determination Rights As a general principle while founding an SE, the involvement of employees, including codetermination rights, shall not be less than in any of the founding companies. To achieve this goal, the decision to form an SE requires the immediate information of the employees of the involved companies. Upon such notification and except the foundation by conversion, where the requirements of employee involvement of the respective member state remain applicable, the employees shall elect a Special Negotiation Body, which shall discuss with the representatives of the founding entities the involvement of the employees and agree on such involvement. Such negotiations may take up to one year and thus, may delay the foundation significantly. Although the involvement of employees shall generally not be less than the involvement of employees in any of the founding companies, by vote with certain majorities, the Special Negotiation Body can agree on a lesser involvement of the employees, including lesser codetermination rights or a total waiver of codetermination rights. In case only companies which are not subject to employees codetermination rights are involved in the founding of the SE, the Special Negotiation Body can generally not insist on codetermination rights in the SE. If no agreement can be reached or if the Special Negotiation Body decides to terminate the negotiations, Standard Rules apply. These rules provide for codetermination rights of the employees, provided that either the registered seat of the SE shall be in a member state providing for codetermination rights or the companies involved have been subject to codetermination rights. Free Relocation Within the European Union Once established, the SE can relocate its registered seat together with its head office 2 within the European member states without the requirement to liquidate, to change or amend its corporate identity. By changing its seat from one member state into another, the secondary set of statutes governing the SE will change as well. For example, while the European-wide applicable SE- REG will apply to the SE regardless of its seat within the European Union, the German SEEG supplementing the SE- REG, as well as other German Statutes remain applicable as long as the SE resides in Germany. Upon relocation of the SE outside Germany into another member state, the application of the German SEEG will cease. Neither the SE-REG nor the SEEG contain direct provisions regarding the status of employee involvement in case of a relocation. However, since the underlying principle during the foundation of the SE is that employee rights shall not be lesser than in the founding companies, the principle most likely can be applied to the relocation as well. Thus, the relocation of a German founded SE cannot serve as tool to escape the German codetermination provisions. Vice-versa, the relocation of a UK-founded SE into Germany cannot cause the German requirements of employee codetermination rights to become applicable. 4 Number March 2005

5 Some additional steps in order to finalize the relocation, which are in general similar to the steps required for a merger need to be observed: the management board or the Board of the SE shall prepare a relocation plan addressing issues such as the new company seat, creditor and shareholder protection provisions, consequences for employees and a time schedule. Further, the management board or the Board shall prepare a report on the legal and economic consequences as well as consequences for shareholders, creditors and employees. Under the German SEEG, shareholders objecting to the relocation are entitled to sell their shares to the SE for a fair compensation, which can be challenged in court, in a proceeding similar to the one applicable in case of a merger. In addition, special German creditor protection provisions need to be observed. Streamlining of Corporate Governance and Management Structures Since an SE may establish all of its subsidiaries as SE, a company group within Europe can establish a set of subsidiaries following substantially the same or at least very similar corporate structures, even with the choice between the monistic or dualistic model. Although the SE is governed in each member state by a set of supplemental national rules, the statutes of the member states together with the directly applicable SE-REG allow to establish basically the same corporate and corporate body structure in all member states and thus, in all subsidiaries of the company group within Europe. The need for the parent companies managers to adopt to and to learn about different corporate structures in different member states becomes obsolete. Decision making processes within the group are streamlined. Possibility of Forum Shopping Since the SE is often founded by involving several companies from different member states, the decision where the SE shall be located is to some extent flexible and may take into consideration a wide set of aspects such as tax planning, economic and other effects. If the SE cannot be established in the desired member state in course of its foundation, a relocation into any member state with a more suitable economic, legal and tax environment is generally possible without liquidation or other detrimental effects, save for tax consequences, which need to be observed thoroughly. 3. Where to Use the SE Due to certain issues such as the mandatory negotiations with employees and thus, the long foundation period of possibly more than one year, the SE may not be the legal solution for every European strategy. However, certain advantages are obvious, and the following outlines certain examples that we would like to introduce you to. Flag Issue Very often while merging two entities cross boarder, the decision which legal form the surviving entity shall bear is a face and a political issue. In case of the foundation of an SE, such national motives can be disregarded, since the SE is a European form with no specific association to any member state. A good example is the foundation of the Brenner Basistunnel SE, a European stock corporation founded by way of a merger of an Austrian and an Italian stock corporation. Both companies were the national carriers of an important highway through the Alpine Mountains. Foundation of Joint Ventures Although generally not a primary issue during the foundation of a joint venture, the flag issue may be one aspect. The possibility of a cross boarder foundation makes the establishment of the new joint venture much easier. The European-wide status shall be positive for the perception by the customers of both countries involved. Especially entities with government involvement or participation may be suitable for the SE form. 5 Number March 2005

6 Merger of the German Hoechst AG with the French Rhône Poulenc The following first chart gives you an overview of the acquisition and merger structure as used due to the lack of the possibility to establish an SE by virtue of a merger. As you can see, the postclosing structure is complicated, with the old Hoechst AG still existing as a mid-level holding company not only for the former Hoechst-subsidiaries, but still having outside minority shareholders, being the shareholders who objected to tender their shares. Further, a public tender offer was necessary not only to obtain as many shares as possible, but also to comply with German Capital Market Provisions requiring the majority shareholder to launch a mandatory tender offer after achieving certain thresholds. Due to the complicated structure and the various legal steps necessary to achieve the final goal, the transaction risk and the risk of shareholder challenges was significant. In contrary, the structure after the foundation of an SE by means of a merger is simple: Former Hoechst AG and former Rhône-Poulenc SA shareholders, the SE, and subsidiaries. Although minority shareholders have the right to object, they will only obtain a cash payment and under German law not be able to challenge the transaction based on insufficient compensation. 6 Number March 2005

7 The advantages are obvious: No minority shareholders within the company group; Significant costs savings due to the termination of the redundant holding company; Uniform structure legal structure reflects economic goals; Multi national image of the new SE no flag issue ; Reduction of psychological obstacles to, and thus facilitation of the merger no winners or losers; Flexibility of structure change between one and two-tier system; Flexibility of involvement of employees chance to negotiate involvement. Thus, save for tax issues, which need to be reviewed carefully and in detail, the cross-border formation of an SE may help to accomplish larger transactions in a very efficient way. 4. Tax Issues Since the taxation of an existing SE follows the tax regime of the relevant member state of the SE, the following shall give only a brief overview of tax issues related to the SE s foundation. The taxation during the course of the formation of an SE varies dependent on the way of establishment. National provisions are partly harmonized in the EU by the Merger- Directive (Directive 90/434 EEC) (the Merger-Directive ) and the Parent/Subsidiary-Directive (Directive 90/435 EEC as amended) which have been implemented only to a certain extent into German tax law. The two directives aim at a removal of tax obstacles faced by groups of companies operating cross-border. Taxation in Case of a Merger Taxation on the company level: According to the Merger-Directive, member states shall, in general, provide for a tax neutral cross-border merger if the assets and liabilities of the transferring company are effectively connected with a permanent establishment of the receiving company in this member state and thus, are still subject to tax in the concerned member state. This is also true as far as loss carry-forwards or tax exempt provisions or reserves of the transferring company are concerned. Taxation on the shareholder level: The Merger-Directive provides for the tax neutral exchange of shares of the transferring and the acquiring company on shareholder level. This rule does not apply if cash payments are made instead of exchanging shares. The Merger-Directive has not been implemented completely into German tax law. Since the deadline for the implementation of the Merger-Directive expired on January 1, 1992, it can be argued that the Merger-Directive shall be directly applicable. However, there exists no conclusive case law yet. Therefore, German tax authorities will probably apply general rules as to the taxation in connection with the merger into an SE. Thus, we would like to briefly outline these principles of German law, which distinguish between outbound, inbound, and foreign merger. Outbound Merger: Based on current German tax provisions, it is unclear whether there will be taxation on the company level and on the shareholder level in case a resident company is merged into a non-resident company in order to found an SE. Taxation on the company level: It is unclear as to whether there will be a taxation of the resident company s hidden reserves when it is merged into a foreign company. Since the resident company is dissolved without going into liquidation, the German rules dealing with (i) liquidation taxation and (ii) exit taxation, providing for a taxation of hidden reserves, are not applicable. Consequently, there would be a tax loophole and no taxes triggered. Therefore, it is argued that an outbound merger shall be characterized as a distribution in kind of all assets 7 Number March 2005

8 (Sachauskehrung) and thus, causing full taxation of all hidden reserves. The scenario has not been tested with, or decided by, German tax authorities, yet. Taxation on the shareholder level: As a general rule, the distribution in kind triggers a dividend taxation. The exact taxation depends on the shareholder being an individual or a corporate shareholder. If the shareholder is an individual, 50 percent of the distribution is tax exempt (half-income system). As regards a corporate shareholder, 95 percent of the distributions received are de facto tax exempt. Taxation of nonresident shareholders may differ from the above mentioned rules with respect to withholding taxes and the provisions of the respective double tax treaty. Inbound Merger: Taxation on the company level: A merger of a non-resident company into a resident company in order to establish an SE is tax neutral if the assets of the transferring company have not been subject to German tax in the past. If the foreign company has a permanent establishment which is subject to German tax, the permanent establishment can, in general, be transferred tax neutral under German tax law. Taxation on the shareholder level: Resident shareholders are in general subject to a capital gains taxation. Again, the exact taxation depends on the shareholder being an individual or a corporate shareholder. Non-resident shareholders of the transferring company may be subject to sourcebased taxation after the merger. Foreign Merger: A merger of entities not resident in Germany may have tax consequences in Germany if there is a resident permanent establishment of a foreign company or a resident shareholder. Although the German Ministry of Finance has set up a working group dealing with the taxation of an SE, it is uncertain when and which form German national tax law will provide for a tax neutral cross-border merger. Probably, German tax authorities meanwhile, will take the view that national tax law is applicable. As there are no special provisions, general rules will apply. Formation of a Holding-SE Generally, the formation of a holding-se is tax neutral. If the holding SE will be a non-resident company, then, in order to remain tax neutral, a seven year holding period is required for the shares which have been received in exchange for the contributed shares in course of the foundation by the German entity involved. Further, tax neutrality is conditioned upon the German shareholders not attributing to the received shares a higher value for tax purposes than the contributed shares had immediately before the contribution (double book value roll-over). Formation of a Subsidiary-SE Taxation on company level: The are no tax implications for the contributing companies. Only if a branch of activity is contributed to a non-resident SE, the tax neutrality depends on the observation of the seven year holding of the shares received for the contribution. Tax neutrality of the formation of a subsidiary SE is moreover conditional upon the valuation of the assets received in the subsidiary SE (double book value roll-over). Taxation on shareholder level: If a subsidiary SE is set up, the participating companies contribute assets to the SE. Therefore, no tax implications arise for the contributing companies shareholders. Conversion into an SE: Generally, a Conversion Does Not Trigger Taxes In many cases in Germany, it is already possible to set up an SE tax neutral. Obviously in cases of cross-border mergers, German tax law needs to be adjusted. As far as German tax law 8 Number March 2005

9 imposes taxes on a reorganization, it may be overridden by EU law. Hopefully, the working group of the German Ministry of Finance dealing with the taxation of an SE will soon make a contribution to clarify unsettled matters. Endnotes 1 See Section Registered seat and head office shall always be located within the same member state. 9 Number March 2005

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