U.S. businesses wishing to make an acquisition in the United Kingdom obviously need to know how mergers and acquisitions work in the UK. This article highlights some of the similarities and differences between the approaches taken in the U.S. and the UK.
Despite the term "Mergers and Acquisitions" being as commonly used in the UK as it is in the U.S., in the UK there is no legal concept of merging two companies into one. Accordingly, transactions generally need to be structured as stock acquisitions or asset acquisitions.
As in the U.S., precise legal structure is primarily a function of risk, value and efficiency. On the risk side of the analysis, as in the U.S., in UK stock acquisitions all assets and liabilities of the target remain with the target, whatever they are and whether or not they are disclosed. Detailed representations and warranties, indemnity protections, deferred consideration arrangements and retention or escrow accounts, all of which are customary in the UK, may ameliorate the risk of unknown liabilities but will not eradicate it. Unlike the U.S., however, in the UK an asset purchase can effectively insulate the acquirer from liabilities it does not expressly assume (save in respect of employees. as discussed below). This is a significant difference from the U.S. where concepts of successor liability and statutory liabilities for such areas as environmental and employee benefits could impose unintended risk on an acquirer. Stock acquisitions tend to be more common in the UK, due, in part, to the relative logistical efficiency of the structure. In instances where the target is a separately organized, stand alone enterprise, a stock acquisition avoids the need to convey each and every asset. As in the U.S., the assets are bundled in the enterprise and the delivery of duly endorsed stock certificates legally transfers the entire bundle. Stock acquisitions also tend to be easier from the perspective of obtaining third party consents. In a stock acquisition, generally only restrictions on changes in ownership and preemptive rights tend to create issues requiring consents to be obtained.
In the UK, unlike in some U.S. jurisdictions, there is no legal requirement in an assets purchase to notify reditors of the target (unless existing loan agreements require otherwise). Where, however, the target is owned by multiple equity holders, an asset acquisition can be the more efficient (or, sometimes, the only) way to consummate the transaction. In a UK corporation, directors may usually authorize an asset sale without the consent of stockholders.
The value analysis also involves considerations of risks and of the various tax implications of each structure. The existence of tax losses in the target could also heavily influence the decisions on structure. If the acquiring entity is a tax resident in the UK or has a UK presence with taxable profits, a stock purchase creates the possibility of using tax losses in the target. However, this is limited to losses from the post-acquisition period; losses carried forward by the target cannot be used by the acquiring company.
Where the U.S. acquiror has no existing UK presence, establishing a new vehicle in the UK to acquire the target can be a way of deducting the costs of the financing against the profits of the target. Indeed it may be possible to obtain relief in both the U.S. and the UK for interest payments - a so-called "double dip" - if the U.S. entity obtains financing and in turn lends these amounts to its UK acquisition vehicle and, as noted below, such UK acquisition vehicle is treated as a "disregarded" entity under a "check-the-box" election for U.S. tax purposes. For UK tax purposes, the UK vehicle could surrender to the target its losses from the interest payments to set against the target's profits. For U.S. tax purposes, the UK vehicle could be treated as transparent under the "check the box" procedure, so the interest payments from it to the U.S. parent would be ignored for tax purposes. The availability of tax deductions would be subject to anti-avoidance legislation in both jurisdictions, which would need to be considered in each case.
Establishing a UK acquisition vehicle to acquire the target in a stock purchase has the further advantage that, on a subsequent sale of the target, any gain on the disposal of the target may be exempt from tax by virtue of the substantial shareholding exemption. This is likely to be more generous than the U.S. tax treatment if the U.S. entity were disposing of the target directly, unless the UK acquisition vehicle is a "controlled foreign corporation" in the hands of its U.S. shareholder, in which case such gain would be currently taxable to such shareholder as ordinary income (whether or not distributed under Subpart F of the U.S. Internal Revenue Code).
Transfer duties are also payable in the UK. In a stock acquisition, the buyer is liable for stamp duty at the rate of 0.5%. In an asset acquisition, the buyer is liable for a transfer duty of 4% on real estate exceeding £500.000 in value. No duty applies to personal property.
The UK is, of course, a common law jurisdiction like the United States. Accordingly. U.S. in-house counsel usually find that English laws and principles are more familiar to them than those in Continental Europe. This remains the case notwithstanding the harmonizing of laws in the European Union.
In the field of anti-trust, or "competition" as it is known in the United Kingdom, the European Community Merger Regulation ("ECMR"), will apply where the proposed transaction exceeds specified revenue tests (relating to the parties' world-wide and EU-wide revenues). Where the revenue tests are satisfied, the transaction will need to be approved by the European Commission in Brussels. Transactions raising no substantive concerns will be cleared within the Phase I investigation. lasting 25 working days, whereas those that do raise concerns and which require a Phase II investigation will only be concluded after an additional 90 working day period. Transactions not satisfying the revenue tests in the ECMR may be caught by national merger control regimes in the EU. For example, the UK's Office of Fair Trading ("OFT") has jurisdiction to investigate a merger where the revenue in the UK of the target enterprise exceeds 70 million pounds and/or if the merged group will supply or consume 25% or more of goods or services of a particular description in the UK or a substantial part of it.
Where the target company operates in a sensitive industry (such as media and communications, utilities or banking) additional regulatory approvals may need to be obtained and counsel should be consulted early in the process.
Also, in the UK there are no foreign investment controls nor laws prohibiting the repatriation of value to the U.S.
Broadly speaking, employees in the UK are entitled to greater protection than those in the U.S. Legislative protections include the right to be informed and, in some circumstances, consulted on an asset purchase, the right to a statutory redundancy payment (or severance) and protection against unfair dismissal. These rights are in addition to any union arrangements or collective bargaining agreements and, accordingly, detailed advice should be sought as to the prospective costs of proposals to restructure the target business after acquiring it. On the acquisition of a business as a going concern, the employment contracts of employees working in the business immediately prior to the acquisition will transfer automatically to, and be binding on, the acquiring firm.
Public UK Targets
In the UK there is no equivalent to the restriction in the U.S. on the transfer of securities which are not registered. If, however, the acquisition is of shares of a UK public company (such as where the shares are listed on the London Stock Exchange or on the Alternative Investment Market ("AIM") or are otherwise publicly held), the acquisition will not be governed by a share purchase agreement but will instead be governed by an entirely separate set of procedures set out in The City Code on Takeovers and Mergers. These are very specific, but are akin to U.S. tender offer rules.
For all other transactions, as with U.S. mergers and acquisitions, heads of terms (like letters of intent) are often used, which protect the seller while the due diligence process is underway and before the full purchase agreement is entered into. These are generally non-binding (but should so state), except for standstill and confidentiality provisions. As in the U.S., the purchase agreement is usually prepared by the lawyers acting for the buyer.
Purchase agreements usually contain extensive warranties where the target is in the UK as, unlike in the civil law jurisdictions in Continental Europe, there are no implied standards (which often can be open to interpretation) imposed on the seller as to the target. In the UK, purchase agreements do not always contain detailed indemnification provisions and damages for breach are often left to be settled by common law. Accordingly, a U.S. purchaser should highlight the need for indemnity protection at an early stage to avoid arguments later (arguing perhaps that as a matter of risk allocation indemnities are more appropriate).
It is common in UK transactions to take broad-based exceptions to warranties for such items as publicly available information (e.g., at public registers, such as the Companies Register, where accounts and annual returns and other information have to be filed by UK companies). The principle of more limited disclosure exceptions should. therefore, be addressed early in the negotiation process.
Unlike U.S. companies, UK companies are not permitted to give financial assistance, pledges, guaranties, etc. in connection with the purchase of their own shares. This rule does not apply on asset acquisitions. The issue most frequently arises where the financing for the acquisition is to be secured over the assets of the target. There are, however, exemptions to the financial assistance legislation.
Opinions And Officers' Certificates
In UK mergers and acquisitions legal opinions are generally not given and if an opinion is given, a party's own lawyers are usually expected to issue it. Cross-opinions, where counsel provides a legal opinion to the other side, may involve an inherent conflict of interest and goes against the general legal culture in the City of London. It is also less common in the UK for certificates to be given by officers bringing down representations and warranties at closing.
In general, the similarities between the approach used for private mergers and acquisitions in the U.S. with the UK are greater than the differences. However, there are differences in the law between the U.S. and the UK and often there are differences in the expectations of the parties (e.g., in terms of the level of indemnity protections, risk allocation and legal opinions). Accordingly, expectations should be clearly identified and a strategy laid out to best address legal and cultural differences.
On January 1, 2005, the U.S. law firm Kirkpatrick & Lockhart LLP and the English firm Nicholson Graham & Jones combined their resources as Kirkpatrick & Lockhart Nicholson Graham LLP. Stuart Borrie is a Partner in the firm's London office where he advises on corporate and corporate finance transactions. He can be reached at +44.20.7648.9000. John D. Vaughan is a Partner in the firm's New York office where he advises on a variety of corporate and financial transactions. He can be reached at (212) 536-3900.