Value Creation Through Mergers and Acquisitions

The word 'efficiency' may not mean much for those of you who were absent during economics class in school. It is a term around which the whole concept of economic studies in based. Investopedia[i] defines 'efficiency' as the allocation of resources in an optimal manner to serve a company or an individual in the best method by reducing waste. It is the concept of getting work done with the least amount of resources. But that comes at a cost. Many a time, companies try to reduce their costs and maximize profits by employing cheaper materials and inefficient human resources. Companies also try to maintain or increase the level or standard of their output by pooling their resources. While the former is one of the least preferred methods to obtain efficiency, the latter has gained popularity due to the enhancement of corporate structures and growing consumer demands. But efficiency is a million-dollar word.

A similar story lies behind one of the largest mergers in history between Henry J. Heinz Company and Kraft Foods Group, Incorporation. This merger created one of the major players in the food and beverages industry. Ergo, companies should review every aspect, factor and underlying right(s) of all the parties before initiating a merger or restructuring a corporate structure. The structure and type of merger may primarily depend upon the industry and the size of the companies. For example, when the investor limits the transaction to the assets of another company; such an acquisition is an asset purchase. However, when the investors are interested in buying the shares of the other company, the structure of the merger should be remolded to that of a share acquisition. Hence, it is evident that the structure and type of merger or acquisition are decided upon after considering and understanding the factors involved, the extent of assets and liabilities of the companies and the jurisdiction of the parties. Therefore, the benefit of opting for a particular structure or type of merger may be detrimental to the other party. Therefore, this article seeks to draw a line between an asset sale and share purchase and explain about the advantages and disadvantages of both these structures from the purview of private companies in the United Arab Emirates (UAE).

Status quo in the UAE

The principles of contracts govern the mergers and acquisitions in the UAE. The primary piece of legislation that has laid down the provisions regarding the matter is Federal Law Number (2) of 2015 on Commercial Companies (the Companies Law). Article 22 of the Companies Law has stated that a UAE national should hold at least fifty-one (51%) shares of an onshore company in the UAE should be and branch offices of foreign entities in the UAE may appoint a local agent to conduct trade in the UAE. Therefore, transfer of shares in companies established in the UAE should adhere to this restriction on foreign ownership.

Transaction structures for private companies

As mentioned earlier, investors have the option of either acquiring the shares of the company (a share acquisition) or the assets of that company (an asset acquisition). The investors should conduct due diligence and agree on one of the two (2) structures depending on the factors discussed below:

Share Sale

In the case of a share sale, once an investor has purchased all the shares of a particular company, all the assets and liabilities of that company (known or otherwise) will be transferred to the acquirer. Therefore, the status of the target company is not affected by a share sale; however, with a new owner and the seller of the shares will lose his nexus with the entity. It is pertinent for the buyers to conduct extensive due diligence process by employing a law firm that provides bespoke legal advice before purchasing the shares of a company since the investors will assume all the obligations of the business entity. Therefore, the buyer should also negotiate the indemnity, insurance, and warranty of the exact liabilities to mitigate any issues that may arise. However, these solutions are not comprehensive since they may face problems in enforcement since their value depends on the creditworthiness of the seller. Further, an indemnity clause may also be restricted from full enforcement since it is likely to constitute unjust enrichment - prohibited by Sharia Law. Therefore, the injured party can only enforce indemnity to the extent of loss that they have suffered. Minority shareholders will be left when a buyer cannot acquire hundred percent (100%) shares in a company.

The buyer and seller have to comply with all the restrictions on pre-emptive rights provisions in the company's constitution or the shareholders' agreement.

However, share sale also has substantial advantages since the investors do not have to purchase every asset of the company individually. The objective of purchasing the assets is indirectly covered in the transfer of shares. This means that the investor acquires all the contracts and other third-party obligations also. However, the buyers should review change-of-control and termination clauses and may also have to obtain the approval or consent of the third parties before those contracts can be executed. Therefore, the investors should ensure that the seller provides all requisite approvals from all third-parties including regulatory approvals before the completion of the transaction. Specifically, the investors should make sure that the DED (Department of Economic Development) of the respective Emirate approves the transfer of shares and issues an amended license with the new ownership status. The target company may not be permitted to conduct its activities in the UAE without a valid license.

Asset sale

On the other hand, the investor will only acquire the specific assets and liabilities that are identified. This provides investors with a higher degree of certainty since the investors and handpicks the exact assets and liabilities that they want to acquire. However, buying some assets may also mean acquiring certain liabilities. For example, the investor may be liable for any environmental problem in the real estate property. When the property purchased by the investors are a part of another contract, then the buyer will also be liable for the provisions under those contracts from the date of transfer. However, unidentified assets and liabilities are not transferred to the investors.

This method is considerably more ambiguous and complicated than share sale since every asset has to be transferred individually by delivery (for a moveable property) or by transfer of title (for real estate). Therefore, the investor should acquire every property and machinery owned by the target company. The ownership of the seller (i.e. the shares in the company) does not change at the completion of an asset sale. These shareholders will continue to be the legal owners of the company since they hold the shares. Further, if an investor who wishes to obtain the benefit of a license or contract; they will need that particular right to be transferred separately. It is pertinent for investors to note that commercial contracts generally contain a clause that restricts the right of the parties to assign the contract to any third-party. Therefore, the investor should explicitly make sure that the seller obtains all approvals required when there is a provision that restricts the novation or assignment of a particular document without the approval of the other party. Federal Law Number 18 of 1993 issuing the Commercial Transactions Law has mentioned the procedures and conditions that the parties should adhere to while transferring a company's property. Article 42 of this law has stated that any action that may deal with the transfer of ownership of a company's property should be attested and authenticated by the Notary Public and should also be registered in the Commercial Registry. Further, Article 45 (1) has also stated that the investor must publish a summary of the contract of sale in two (2) daily Arabic newspapers (between an interval of one week) with the view of providing creditors of the target company to put forward any objections or claims against such sale.

Miscellaneous

Transfer tax is not applicable on transfer of the share of companies in the UAE. However, a transfer fee of four percent (4%) shall apply to the transfer of shares of a company established in the UAE. Further, a transfer tax ranging from 1% to 4% is charged on the assignment of real estate right by the Policy Sale Services at the Dubai Land Department. The rate may vary with the nature of the property interest and the particular Emirate.

On the other hand, in share sales, the employees of the target company will continue to work under the business, and the change in ownership will not change the employment relationship between the employees and the company itself. Although, this general rule does not apply to foreign employees. Federal Law Number 8 of 1980, as amended and Ministerial Order Number 13 of 1991 (collectively, the Labour Law), a foreign employee’s sponsorship cannot be transferred to a new employer. However, the buyer may draft new employment contracts for foreign employees of the target company, in the prescribed forms of the Ministry of Immigration and Labor. In an asset sale, the employees of a company cannot be transferred automatically. Although, the investors have the option of revoking the present employment contracts and registering new employment contracts under the new entity. Ergo, companies have to make sure that their transactional structures are most suitable after considering all the factors to safeguard the rights of the parties.