Demerger

Demerger: Definition and Legal Overview

Definition and Distinction of the Term Demerger

A demerger (German: Ausgliederung or Abspaltung) refers in business law to the legal separation of a company into two or more independent entities. The aim of a demerger is to transfer business segments previously grouped within a company into separate units. The term is particularly common in an international context but is increasingly being adopted in German-speaking legal and business practice.

Legal Basis of a Demerger

Basic Structures

A demerger can be implemented in different legal forms. Under German company law, implementation usually takes place based on the Transformation Act (UmwG), specifically through a spin-off (§§ 123 et seq. UmwG) or demerger (§ 123(3) UmwG). In other jurisdictions, such as in Anglo-American law, company law provides specific regulations for the demerger process.

Forms of Demerger under German Law

The Transformation Act distinguishes between various types of restructuring that can be grouped under the umbrella term ‘demerger’:

• Spin-off to form a new company: Parts of a company are spun off and contributed to a newly established company.
• Spin-off to absorption: The spun-off company shares are transferred to an already existing company.
• Demerger to form a new company: Companies carve out part of their assets to establish a new company, with the transferred part going to the new company.

Demerger in International Comparative Law

International comparisons show different legal concepts and terminologies. In the United Kingdom, ‘demerger’ and ‘spin-off’ are common terms, whereas in US law ‘spin-off’, ‘split-off’, or ‘split-up’ are frequently used. The legal requirements, particularly regarding creditor protection, allocation of shares, and co-determination rights, vary significantly according to national company law.

Procedure and Legal Requirements of a Demerger

Preparation Phase

Preparing a demerger generally involves the following steps:

1. Due diligence review: Examination of the business units to be spun off with regard to assets, liabilities, contracts, and employment relations.
2. Drafting of a demerger or spin-off plan: Definition of the assets and company shares to be spun off and the modalities of the transfer.

Decision-making and passing of resolutions

• Resolution by the highest corporate body: The implementation of a demerger usually requires a qualified majority resolution of the shareholders’ meeting or – in the case of stock corporations – the general meeting, often with a majority of at least three-quarters of the represented capital (§ 13 UmwG).
• Signing of the demerger or spin-off agreement: Notarial certification is required (§ 15 UmwG).

Registration and Effectiveness

• Registration with the commercial register: The resolved demerger must be registered with the commercial register; the entry constitutes the legal validity of the demerger (§§ 17, 19 UmwG).
• Creditor protection: Creditors of the relevant companies are entitled to security and may object to the demerger in accordance with §§ 121 et seq. UmwG.

Company Law and Tax Implications of the Demerger

Corporate Law Consequences

A demerger has a direct impact on the involved companies’ structures. The separated shares, assets, and contractual relationships are transferred by operation of law through universal succession to the new company. Employees and their existing employment contracts may also transfer to the demerged company (by analogy with § 613a BGB).

Co-determination and Participation Rights

Employee co-determination rights as well as existing equity participations must be observed in the context of the demerger in accordance with the relevant statutory provisions. In particular, the rules of the Works Constitution Act (BetrVG) regarding employee participation and the shareholders’ rights in stock corporations remain unaffected by the split.

Tax Treatment

The tax consequences of a demerger are varied. Generally, the following types of taxes apply:

• Corporate income tax: The transferability of assets for tax purposes is regulated by the Transformation Tax Act (UmwStG). The aim is usually to achieve tax neutrality of the demerger under certain conditions.
• Real estate transfer tax: Transfers of real estate within the framework of a demerger may be subject to real estate transfer tax under certain conditions.
• Value-added tax (VAT): Intra-group services carried out in connection with the demerger may be privileged or burdened for VAT purposes.

Creditor Protection and Liability in the Demerger

Creditor Protection Instruments

The Transformation Act provides extensive protection mechanisms for creditors of the companies involved. For example, creditors may, within the creditor call procedure, demand securities within a certain period if they consider the fulfilment of their claims to be endangered by the demerger (§ 22 UmwG).

Liability of the Companies Involved

In addition to general provisions, both the dividing and the receiving companies are jointly and severally liable for obligations established prior to the demerger, limited to the value of the transferred assets (§ 133 UmwG). This applies to both civil law liabilities and public law obligations.

Particularities of Demergers in the International Context

Cross-border demergers are subject to European transformation law, in particular the EU Directive on Transformations. Regulations regarding equal treatment of shareholders, creditor protection, co-determination, and compliance with information and disclosure obligations must be observed.

Distinction from Related Transactions

A demerger must be distinguished from related restructuring measures such as:

• Merger (Verschmelzung): The merger of at least two legally independent companies with dissolution without liquidation.
• Spin-off: Sometimes used synonymously, especially in US law, this often refers to the carve-out of a business segment into a separate entity with subsequent distribution of shares to the previous shareholders.
• Carve-out: Separation of a business division in preparation for an independent IPO or sale.

Literature and Web Links

• Transformation Act (UmwG)
• Transformation Tax Act (UmwStG)
• Works Constitution Act (BetrVG)
• European Directive (EU) 2019/2121 on cross-border transformations, mergers, and demergers

Note: The demerger is a complex instrument for corporate restructuring with far-reaching legal, tax, and corporate implications. The specific implementation should always comply with current legal and tax requirements.

Frequently Asked Questions

What legal requirements must be met for a demerger in Germany?

A demerger – often referred to in German law as Ausgliederung or Abspaltung – is subject to a number of legal requirements governed by §§ 123 et seq. of the Transformation Act (UmwG). A formal transformation resolution by the shareholders’ meeting of the company concerned is an absolute prerequisite. This resolution must be notarized. The law also requires the drafting of a demerger agreement or demerger plan, which details the allocation of assets and the assumption of existing legal relationships. It is also important to observe the so-called creditor protection procedure according to §§ 125, 133 et seq. UmwG, which entitles the company’s creditors under certain conditions to request securities. In the case of listed companies, additional capital market requirements may apply, for example, publication and information obligations under WpHG and MAR. Finally, co-determination rights (e.g., under MitbestG, DrittelbG, SEBG) may need to be considered, especially if the restructuring results in changes to employee representation structures. Careful legal review of compliance with all required formalities is essential, as formal errors can render the restructuring measure void.

What co-determination rights do employees have in a demerger?

In the context of a demerger, employee co-determination rights under German law play a central role. According to § 13 UmwG, the works council must be informed and consulted at an early stage about planned restructuring measures. The Works Constitution Act (BetrVG) also provides for rights to information and participation, especially under §§ 111 et seq. BetrVG – for example in the case of planned changes to business operations, such as a split. Works agreements and social plans may also be necessary. If a company is subject to the Co-determination Act (MitbestG) or the One-Third Participation Act (DrittelbG), it needs to be checked how the composition of the supervisory board will be structured after the demerger, and whether rights and obligations are transferred to the new companies. Special regulations apply to cross-border spin-offs covered by the SE Participation Act (SEBG), particularly regarding employee participation at the European level. Violation of these regulations can render the demerger ineffective or give rise to employment law claims.

What creditor protection must be ensured in a spin-off?

The Transformation Act grants creditors comprehensive rights of protection in the course of demergers. According to §§ 125, 133 et seq. UmwG, affected creditors must be informed of the spin-off when the demerger is announced in the (electronic) registers. Within six months after registration, they may demand security if they can plausibly demonstrate that they will be disadvantaged by the demerger. The liability provisions of § 133 UmwG also provide for joint and several liability of the companies involved for all liabilities transferred in the demerger agreement. This means that both the transferring and receiving companies are liable for the relevant old debts either proportionally or, in some cases, wholly. An effective implementation of creditor protection requires that all existing and potential liabilities are carefully identified and evaluated in order to prevent challenges or additional claims.

Do merger control regulations need to be considered in a demerger?

Demergers are subject under certain conditions to merger control pursuant to the Act Against Restraints of Competition (GWB) and the European Merger Regulation (ECMR). A notification requirement arises particularly when the spin-off and acquisition of part of a company by an independent entity would result in or strengthen a dominant market position, or when certain turnover thresholds are exceeded. It should also be taken into account that intragroup restructurings may be notifiable if they have competition-relevant effects on the market structure. Violations of the notification requirement are subject to severe penalties and, in some circumstances, the restructuring may need to be reversed, so early antitrust advice is recommended.

What are the tax consequences of a demerger from a legal perspective?

From a legal perspective, numerous tax aspects must be observed in a demerger in order to achieve tax-neutral restructurings in accordance with the provisions of the Transformation Tax Act (UmwStG). Decisive in law is compliance with the formal and substantive requirements of the UmwStG, especially regarding book value transfers (§§ 15, 16 UmwStG) and the continuation of tax loss carry-forwards. If these requirements are ignored or incompletely met, hidden reserves may be recognized and significant tax burdens may arise. A tax clearance certificate, previously required, is no longer mandatory, but may still provide legal certainty in individual cases. Cross-border demergers may also trigger further tax notification obligations and issues of international double taxation.

How is a demerger registered in the commercial register?

The registration of a demerger in the commercial register is subject to numerous procedural steps. All required documents – such as the minutes of the shareholders’ resolutions, the demerger agreement or plan, the demerger report, and, if necessary, audit reports and declarations regarding creditor notification – must be submitted to the competent registry court. The notarial registration pursuant to § 130 UmwG must be signed by all authorized representatives. In the case of corporations, notarized authentication is regularly required. After a positive review by the registry court, the registration effectuates the corporate implementation of the restructuring measure, i.e., rights and obligations are transferred as of this time. The registration must be publicly announced according to § 14 HGB and provides legal certainty vis-à-vis third parties. Procedural errors or incomplete documentation may result in rejection of the registration application.