With softening market conditions and Solvency II getting closer, insurers are under pressure to reassess how efficiently they are using their capital. Multiple carriers in different jurisdictions expose groups to a splintered capital base, as well as an inconsistent regulatory approach to capital setting, meaning greater uncertainty and consequent compliance costs. Bob Haken in our London office considers the potential benefits of the new cross-border merger directive.
The Merger Directive (Directive 2005/56/EC) aims to facilitate the carrying-out of cross-border mergers with a view to the completion and functioning of the single market. The Merger Directive was the first measure to be presented under the Commission’s Action Plan on company law and corporate governance in the European Union, published in May 2003. It requires Member States to make available procedures allowing for cross-border mergers to the extent that mergers are permissible under its domestic law. It was due for implementation by 15 December 2007 and to date has been implemented in about half of the Member States.
It is somewhat surprising that the introduction of a quick, simple procedure for mergers and amalgamations of companies has attracted so little attention.
Application to insurance
The provisions of the Merger Directive apply to the majority of companies in all sectors, but within the insurance industry the full scale of their effectiveness has not yet been appreciated. One oft-quoted criticism of the portfolio transfer process (at least in Continental Europe) is that there is no automatic transfer of any associated reinsurance protection, meaning that laborious discussions with reinsurers are needed if indeed it is possible to identify all relevant companies. Even in the UK and Ireland (where the courts have the power to transfer reinsurance contracts), questions over the enforceability of portfolio transfer court orders outside Europe have led to significant costs, applications for relief from the US bankruptcy courts and, in extreme cases, perfectly legitimate commercial aims being defeated or shelved.
In a true merger, however, all assets and liabilities of the merging companies are transferred to a single surviving company. Accordingly, absent any special terms in the relevant contracts, the surviving company will assume the benefit of the reinsurance protection.
Further, since a merger as a corporate process is more widely available throughout the world than a portfolio transfer, it is expected that many more jurisdictions will give effect to mergers, particularly as the transferring company will have ceased to exist. The surviving company will be entitled to enforce any contract entered into by the transferring company prior to the merger, and the anticipation is that overseas courts (notably in the US) will recognise that ability.
The merger process
The Merger Directive allows for:
- one or more companies to transfer all their assets and liabilities to another company on being dissolved without liquidation
- two or more companies on being dissolved without liquidation to transfer all their assets and liabilities to a new company incorporated for that purpose
- a company to transfer all its assets and liabilities to its parent company on being dissolved without liquidation.
There must be a genuine “cross-border” element to the merger ie, the merger must involve at least two companies governed by the laws of different Member States (although many jurisdictions also allow mergers within their own borders).
The basic process is that each merging company must obtain a certificate in its own jurisdiction conclusively attesting to proper compliance with all pre-merger formalities in that jurisdiction. The company that is to survive the merger then applies to the competent authority in its jurisdiction to confirm the merger. There are also detailed provisions requiring the surviving company to implement employee participation procedures in certain circumstances.
Since the effect of a cross-border merger, in the case of an insurer, is to transfer the transferring company’s book of business (and associated assets and liabilities) to the surviving company, we would expect most regulators to regard the transaction as a portfolio transfer. Where the use of the portfolio transfer mechanism is mandatory, the effect of this will be that parallel processes are required. This has a strange consequence, in that portfolio transfers are generally subject to the jurisdiction of the transferor, whereas mergers are subject to the jurisdiction of the surviving company.
It is not expected however that this will cause many practical difficulties in the majority of cases.
The position in the UK
The Merger Directive was implemented by the UK on 15 December 2007 through the Companies (Cross-Border Mergers) Regulations 2007, allowing a genuine merger of companies for the first time under English law. The process described above has been transposed without significant alteration into English and Scots law, save that (i) the High Court (or the Court of Session in Scotland) has been designated the competent authority for the purposes of issuing a pre-merger certificate and for sanctioning a merger and (ii) to ensure consistency with the existing procedure in Part XIII of the Companies Act 1985 (to be replaced by Parts 26 and 27 of the Companies Act 2006), it may be necessary for the merger to be approved by a court-convened meeting of its creditors.
On the face of it, the possibility of having to convene creditors’ meetings might be expected to represent a significant impediment for English companies, as the approval thresholds (a majority in number representing 75 per cent by value of each class of creditors) will be difficult to reach in the absence of any incentive for creditors to vote in favour. As market practice develops, however, it is expected that the court will exercise its discretion not to convene meetings where sufficient steps have been taken to protect creditors’ interests.
Given that the FSA will treat any merger of insurers as a portfolio transfer anyway, we anticipate that the Court will take comfort from an independent expert’s report, the statutory notification of policyholders and reinsurers and the rights of any creditor to make representations to the court and so, absent specific issues, will feel it unnecessary to convene creditors’ meetings.
As most European jurisdictions merely require a public notary to certify that the required steps have been taken in order to give effect to a merger, it is anticipated that the courts in the UK will not wish to operate a more onerous procedure than that in other jurisdictions for companies wishing to merge. At the time of writing, only three English companies, none of which were insurers or reinsurers, have registered documents for a cross-border merger with Companies House. As pressure on capital management grows, however, it cannot be long before the industry realises the benefits of mergers and the trickle turns into a flood.