Merger of joint-stock companies: How we helped a client to find a reorganization option

Backstory 

Recently, we were approached by clients. The request was as follows. There is a parent company, which we'll call “Main Company”. The Main Company, in turn, established two subsidiaries registered as joint-stock companies (we'll call them Subsidiary Company 1 and Subsidiary Company 2). 

Client tasks

1. Merge Subsidiary 2 with Subsidiary 1.
2. Carry out the merger without changing Subsidiary 1's charter, as this legal entity has many bank loans, and any change to the charter must be approved by the bank under the terms of the loan agreement. Otherwise, there is a risk of receiving a demand from the bank for early repayment of the loan.
3. When merging, reduce the tax burden in connection with the transfer of property from Subsidiary 2 to Subsidiary 1. 

Given the sensitivity of the tax issue, we proposed the first option for resolving the client's problems: a merger. However, mergers of joint-stock companies result in an increase in authorized capital. Because authorized capital is a required feature of any charter, changing its size entailed the client's obligation to amend the constituent document. And given the state with banks, we'd like to avoid this. Second, the charter had to be changed twice because joint-stock company law only allows for increases in authorized capital within the limits of declared shares. Furthermore, the client's charter did not include a provision regarding the declared shares. To implement this project, it was necessary to first change the charter in terms of declared shares before beginning the reorganization. 

It is possible to do so without increasing the authorized capital, and thus without changing the charter, in cases where the law allows for the redemption of shares. This is only possible in cases where the law allows it. For example, when AO merges with another AO, it serves as the founder. The client proposed, “What if Subsidiary 1 buys Subsidiary 2's shares from the Main Company and then reorganizes?” The idea isn't bad. However, legal obstacles exist that prevent the formation of a group of companies based on the nesting doll principle. After the share purchase and sale, Subsidiary 2 would be the sole shareholder, with Subsidiary 1 owning 100% of the Main Company's shares. This is a nesting doll structure. The only way out is to pre-sell at least 1% of the Main Company's shares. 

The third option we presented to clients was as follows. What happens if Subsidiary 2 is liquidated? The property is then distributed to its sole shareholder, the Main Company. The Main Company will then contribute this property to Subsidiary 1 as a non-incremental contribution to its authorized capital. This option will save clients money on taxes, as long as all companies are subject to the general taxation system. These savings result from the fact that the founders' contributions are not included in the taxable base when calculating corporate income tax. 

Result

Based on the findings of this consultation, we prepared a legal opinion for the clients, outlining the benefits and drawbacks of each course of action. Timing is also an important consideration when deciding on a course of action. In this regard, we considered the order of actions in each option, as well as the duration of each project.