COVID-19: Key Issues for Corporate Reorganizations in England and Wales

For additional guidance, please refer to Steptoe's COVID-19 Resource Center.

Background

Business uncertainty will continue for the foreseeable future given the impact of COVD-19. In the current environment certain businesses may consider restructuring their activities. We set out below certain preliminary and legal issues for businesses to consider in the context of any proposed corporate reorganization.

Corporate reorganizations are primarily intra-group transactions. A reorganization may be appropriate to: (a) remove an inactive company or business function from a group; (b) separate out the trading and/or certain assets in anticipation of a sale; or (c) introduce a new management team or owners into the business.

The efficient planning of a reorganization prior to its commencement is key. Accounting and tax advisers will usually prepare an outline of the reorganization (usually driven by tax and funding considerations), setting out the proposed steps required for achieving the client's objectives. Legal advisers must then analyse the proposed steps to establish their efficacy and implementation from a legal perspective. Tax and legal advisers should collaborate to create a final plan that reflects the client's objectives and the tax, funding and legal considerations.

Preliminary Issues

The rationale for the reorganization should be considered early in the planning stages and may include the following preliminary issues:

• Matters relating to the solvency of the business may require the involvement of an appropriate insolvency practitioner to consider any potential insolvency risks that may arise from the group reorganization at the outset. Transactions may be reviewable i.e., as a preference or an undervalue if an entity that is part of the reorganization subsequently falls into liquidation or administration.
• Communication needs to be undertaken with key stakeholders including lenders, shareholders, suppliers, customers and employers.
• Management of employees must be considered in the context that these individuals may be sensitive to the implications of a reorganization to their job security.
• Investigating the new financing solutions, including the availability of the Coronavirus Business Interruption Loan Scheme, should be undertaken in relation to the requirements and impact on the employees of the overall group.
• Auditors should be involved to review and assess the proposed transactions to be undertaken and the manner in which they are to be accounted. Auditors may be required to confirm that certain companies have sufficient distributable reserves for the purposes of the reorganization.
• Where a pre-sale corporate reorganization is undertaken, a prospective buyer will usually conduct extensive due diligence and will request comfort that the transactions were properly undertaken, the correct assets and liabilities are held in the relevant entities in the target group, and the reorganization has not resulted in the target group inadvertently incurring liabilities e.g., tax liabilities.
• Customers and suppliers may be concerned about their trading partners' financial stability and reliability arising from the reorganization.
• Contracts may need to be reviewed with particular regard to clauses concerning force majeure – both from the corporate entity involved in the reorganization together with the counterparty to check if there are any potential litigation issues and risks associated with such contracts.
• Contracts or assets may not be capable of transfer without a consent or waiver from contractual counterparties, particularly where prohibitions on assignment or subcontracting do not contain a carve-out for intra-group transactions.
• Property assets, particularly if there is to be a change in the entity owning or occupying the property, may raise a number of issues. Formal consent may be required from a landlord in order to transfer any leasehold property. The terms of the lease will need to be reviewed to check if intra-group transfers are permitted and there may be specific requirements or conditions that need to be met in relation to the financial strength of the proposed transferee. Whilst relief is usually available when transferring property assets between group companies, consideration needs to be given to any potential stamp duty land tax liability that may arise as a result of transferring any property assets.
• Lenders (particularly those holding security over affected companies or assets) may need to be consulted in advance and their approval sought under the terms of finance or security documents. Lenders will need to be satisfied that their risk exposure or security position is not adversely impacted by a proposed reorganization.
• Internal flow of services and licences within the group will need to be reviewed, and the changes that may arise as a result of a reorganization.
• Data protection and recent privacy developments will need to be considered to ensure changes in the flows of personal data resulting from the reorganization are in accordance with the law and market practice.
• The accounting treatment will need to be reviewed in the context of the precise steps to be carried out as part of the reorganization.
• It may be necessary to licence back intellectual property or information technology contributed by a company to another or to grant new licences to allow the continued use of such shared assets.
• Documenting the terms of shared licences and services should be considered and constructed with care, particularly with regard to transfer pricing arrangements. In circumstances where a pre-sale reorganization is undertaken, it will be important to determine the level of intra-group licences and services required by the target company to operate.
• It may be necessary to consider the appointment of appropriate valuation advisers to conduct and deliver appropriate market valuations of the proposed transfer of assets as part of the reorganization.
• Specific tax advice must be obtained in advance during the planning phase of the reorganization, and the documents implementing a reorganization should be reviewed from a tax perspective to ensure the desired tax treatment is achieved.
• The involvement of local counsel and/or related advisers for parts of the group based in overseas jurisdictions should be undertaken at an early stage to ensure compliance with local laws in a timely manner.

In order to plan with all the above in mind, a preparatory due diligence or information gathering exercise is helpful in ensuring the reorganization is structured and implemented efficiently.

Preliminary Legal issues

The preliminary legal issues that need to be considered at the outset include the following:

• Insolvency: There are risks/potential clawbacks arising under the UK insolvency legislation from the transfer of assets at an undervalue and/or a preference. Furthermore, under normal circumstances, directors may incur personal liabilities if they allow a company to continue to trade past the point where the directors should have concluded that there was no reasonable possibility of saving the company. New measures introduced by the UK government in response to the coronavirus pandemic allow directors to trade even if there are reasonable grounds to suspect the company will become insolvent, without incurring personal liability. There is also a temporary moratorium to prevent creditors from seeking to wind up companies that are seeking a rescue or restructuring. It is important to note however, that insolvency can raise breach of director duties, unfitness and director disqualification issues. These issues must be considered as part of the reorganization.
• Directors' duties: There are a variety of directors' duties that must be considered in the context of a group reorganization. Reorganizations will typically involve the boards of multiple companies considering and making decisions. Each board (even if comprising the same individuals) will need to independently consider the transactions relevant to that company and its corporate benefit. This is due to the statutory duty each board director owes to such company, even if that company forms part of a larger group. It is important from the corporate governance perspective to document all decisions and demonstrate that all decisions made by the board are reasonable in the circumstances. It is important for directors to be aware that they should not transfer key assets out of the company, where there is no commercial justification for doing so. Furthermore, directors must be aware of the duty to avoid conflicts of interest which may affect their objectivity. Directors need to be aware of circumstances where affiliates decide to allocate funds across a group. The careful attention of directors is required where cash is being transferred intra-group and the need to address conflicts where some directors sit on the boards of multiple companies within the group. The assessment of the value of assets may be difficult in the current environment and determining the solvency of the entities involved in the reorganization may be challenging. Directors must obtain appropriate third-party advice in these circumstances.
• Financial assistance: English law provides, subject to some exceptions, that a UK public company is prohibited from giving financial assistance for the purpose of the acquisition of its shares or those of a parent company, and a UK private company from giving financial assistance for the purpose of the acquisition of shares of a public parent company. A private company may give financial assistance for the purchase of shares in itself or another private company The term 'financial assistance' is broadly defined and can include (without limitation) cash payments, gifts, loans, transfers above or below fair market value, asset transfers, incurring liabilities, releasing debts and providing security. The consequences of breaching any of the rules relating to financial assistance are potentially severe and may include the transactions being set aside and/or the directors incurring personal liability and committing a criminal offence.
• Capital contributions: Capital contributions are usually contributions made to the capital of a company without the issuance of shares. There is no statutory framework (the Companies Act 2006 makes no reference to capital contributions) and there are conflicting views regarding their treatment from tax and accounting authorities, and in case law. As a result of the uncertainty concerning capital contributions, tax, accounting and legal advice should be obtained where capital contributions are proposed. The terms on which a capital contribution is provided and received should be documented including inter alia, the capital contribution is not repayable and no asset, right or consideration is given in return for the capital contribution.
• Employment issues: The impact of a reorganization on employees depends on how it is structured. If a reorganization is affected through the transfer of shares and employees remain with their existing employer, there is a limited impact on those employees, and their terms and conditions of employment will be unaffected. However, if a reorganization will result in employees being transferred between group companies, this is likely to constitute an employee transfer under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). TUPE requires a prescribed informational process (and, in certain circumstances, a consultation process) to be conducted with employee representatives prior to the transfer, and generally limits changes to employee terms and conditions, and redundancies in connection with the transfer. Apart from any TUPE transfer, another outcome of a reorganization may be employee redundancies. If this is the case, a pre-redundancy consultation process will need to be carried out, or on behalf of, the relevant employees and redundancy payments may be payable (either on a statutory minimum or company-specific enhanced basis). If the Coronavirus Job Scheme is being used by a company, then the impact of the reorganization on the employees will also need to be considered.
• Pensions and benefits: The key issue to consider is whether the group operates, has operated, or is a participant in a defined benefit plan (DB Plan), and whether the reorganization is being carried out in connection with an M&A transaction. In any case, the impact of the reorganization on the DB Plan must be reviewed and, where necessary, attended to. The UK Pensions Regulator and the pension plan trustees are likely to play a key role in this process. Appropriate legal, financial and actuarial advice may need to be obtained by the group before implementing a reorganization, particularly where a DB Plan is involved. In relation to other employee benefits (including defined contribution pension arrangements), the impact of the reorganization is unlikely to have a significant impact from a legal perspective, although it may still need to be addressed.

Follow-up

The above details provide a brief overview of preliminary and legal issues to consider when planning a corporate reorganization. You will need to be aware that certain issues will have an impact on the timing of the implementation of the reorganization.