Corporate restructuring: how to choose between demerger, conversion or merger

That law establishes the general regime of insolvency proceedings intended to reorganize or liquidate the liabilities and assets of a Debtor Company (Empresa Deudora) (Article 1). A Debtor Company is any private-law legal entity, and any natural person who has been a First Category taxpayer within the twenty-four months before the start of the procedure (Article 2 No. 13); the law does not require it to be unable to pay in order to request its reorganization. The Insolvency Reorganization Procedure is the one regulated in Chapter III (Article 2 No. 29); it applies only to the Debtor Company and starts with a petition by that company before the court of its domicile (Article 54). It is a judicial procedure in which creditors vote on an agreement, a matter this firm does not practise. Corporate restructuring is, by contrast, the voluntary reordering of solvent companies by their owners, under Law 18.046 and the Commercial Code.

A demerger (división) distributes the estate of a corporation between itself and one or more corporations incorporated for that purpose, and the shareholders of the demerged company receive in the capital of each new company the same proportion they held in the one being demerged (Article 94 of Law 18.046). The extraordinary shareholders meeting must approve the capital reduction and the distribution of the estate, and the bylaws of the new companies, which may differ from those of the demerged company in the matters indicated in the notice of the meeting; that approval incorporates by operation of law all shareholders of the demerged company into the new ones (Article 95).

A conversion (transformación) is the change of the kind or type of a company, carried out by amending its bylaws, with its legal personality surviving (Article 96). Converting another type of company into a corporation requires only the formalities of Article 5 of the law; converting a corporation into another type requires the formalities of both types (Article 97). The conversion has one limit: when a general partnership (sociedad colectiva) or a limited partnership (sociedad en comandita) is converted into a corporation, its general or managing partners remain liable for the company debts incurred before the conversion, except towards creditors who have expressly consented to it (Article 98).

A merger (fusión) consists of the combination of two or more companies into a single one that succeeds them in all their rights and obligations, and into which the entire estate and all shareholders of the merged entities are incorporated. There is a merger by creation when the assets and liabilities of two or more companies that dissolve are contributed to a new company that is incorporated, and a merger by absorption when one or more companies that dissolve are absorbed by an existing company, which acquires all their assets and liabilities. In both cases the merged or absorbed companies are not liquidated. Once the audited balance sheets and the expert reports that apply, and the bylaws of the created or absorbing company, have been approved at the meeting, the board of the resulting company distributes the new shares directly among the shareholders of the merged companies, in the corresponding proportion (Article 99).

These rules are written for the corporation, but they reach the SpA: where the bylaws and its own rules are silent, the SpA is governed supplementarily by the rules applicable to closely held corporations, insofar as they do not conflict with its nature (Article 424 of the Commercial Code). Its bylaws are amended by resolution of a shareholders meeting, with minutes notarized or converted into a public deed, or without a meeting, by a public deed or a notarized private instrument signed by all shareholders, and an extract is registered and published (Article 427). Whatever the route, no shareholder may lose that status by reason of a share exchange, merger, absorption, conversion or demerger, unless they consent to it (Article 100 of Law 18.046).

• Demerge when the problem is concentration: real estate and the operating business in the same company, a line whose future risks should be separated from the rest, or a business that will be sold and must reach the negotiating table in order. The owners keep the same proportions in each of the companies (Article 94), so the demerger reorders assets without reordering ownership. The demerger does not erase what has already happened: if the demerged company is criminally convicted, all the companies that result from it are jointly and severally liable for the fine (Article 18 No. 2 of Law 20.393). See is criminal liability inherited?.
• Convert when the entity type no longer serves the owners: a limited liability company that will receive an investor usually needs the share mechanics of the SpA. There is also one case in which the conversion is not chosen: an SpA that for twelve consecutive months meets the conditions that oblige a closely held corporation to register its shares in the Securities Registry is converted into a corporation by operation of law (Article 430 of the Commercial Code). The company remains the same person, with its RUT (tax ID), its contracts and its history. The comparison of entity types is in SpA or Limitada?.
• Merge when the group drags along companies that only add cost: subsidiaries with the same line of business, an entity that stayed alive after serving its purpose, or a recently acquired company whose contracts and assets should end up in the buyer. The resulting company succeeds the merged ones in all their rights and obligations (Article 99), which is why a merger leaves no liabilities behind.

Once the route is chosen, two limits condition the plan. A minority that dissents from a conversion or a merger has the right to exit at book value in a closely held corporation (Article 69), so the price of that exit goes into the plan before the meeting is called. And the reassessment exclusion of Article 64 of the Tax Code has different requirements depending on the route. In a merger and a demerger, it requires keeping the tax basis of the assets and that no actual cash flows arise for the contributor (ninth and eleventh paragraphs). The exclusion does not apply if the assets pass to entities in the territories of Article 41 H of the Income Tax Law or to entities exempt from keeping accounts (thirteenth paragraph). The contribution of assets and the other restructurings also require a legitimate business reason (tenth paragraph), which the law describes in operational terms: business conditions, financing, costs or risks, capacity, market presence, management, and in every case a purpose other than a merely tax-driven one (fourteenth paragraph). No route falls outside the general anti-avoidance rule (Articles 4 bis to 4 quinquies of the Tax Code), so the business purpose should always be documented.

That reassessment exclusion does not mean the transaction pays no taxes. The contribution of tangible movable or immovable property may be subject to VAT (Article 8 letter b) of the Sales and Services Tax Law). The merger that follows the purchase of all the shares has its own rules on the difference between the price paid and the equity of the absorbed company (Articles 15 and 31 No. 9 of the Income Tax Law). Those effects are reviewed before choosing the route, not after.

• Objective and design. Which assets, liabilities, contracts and people remain in which company, and why. At this stage the business purpose of the transaction is documented: in the contribution of assets it is a requirement of Article 64 of the Tax Code, and in every route it is the defence against the general anti-avoidance rule.
• Valuation and balance sheets. A merger requires audited balance sheets and the expert reports that apply (Article 99 of Law 18.046); a demerger requires the meeting to approve the capital reduction and the distribution of the estate (Article 95). The assets must pass at their tax basis, and that basis must be recorded in the accounts and in the supporting documents, if the reassessment exclusion of Article 64 is sought.
• Approvals. An extraordinary shareholders meeting with two thirds of the issued voting shares in the corporation (Article 67 No. 1), held before a notary, who certifies that the minutes are a faithful record of what took place and was agreed (Article 57 of Law 18.046). In the SpA the bylaws govern, at a meeting or by an instrument signed by all shareholders (Article 427 of the Commercial Code), and if the bylaws are silent, the same two thirds of Law 18.046 by reference under Article 424. Where the law grants withdrawal, the payment of the dissenters’ shares is provisioned: those who opposed at the meeting and those who, without attending, express their dissent in writing within the deadline (Article 69).
• Deeds and registrations. In the corporation the minutes are converted into a public deed (Article 3 of Law 18.046) and its extract is registered and published within 60 days (Article 5, to which Article 97 refers for the conversion); in the SpA the minutes are notarized or converted into a public deed, and the extract is registered and published (Article 427 of the Commercial Code). The merger or contribution deed states that the company that is created or survives assumes all taxes of the dissolved company when the group wants to avoid the termination-of-business notice (Article 69 of the Tax Code).
• Tax authority and third parties. Mergers, demergers and conversions are reported through the electronic tax file within two months; the omission is penalized under Article 97 No. 1. In addition, the statute of limitations for the unreported changes is extended or renewed by twelve months, with a maximum of six years. That extension applies only when the breach seeks to avoid paying a tax, conceal the taxpayer or avoid the application of a special or general anti-avoidance rule (Article 68 of the Tax Code). The companies that dissolve prepare their termination-of-business balance sheet and those that are created or survive pay the corresponding taxes (Article 69); the ruling request of Article 26 bis exists when the application of Article 64 raises doubts. Banks, counterparties with change-of-control clauses and the authorities that granted permits are notified or asked for authorization according to each contract and each permit.
• Employees. In a demerger and a merger, the contracts of those who pass to another company continue with it by law (Article 4, second paragraph, of the Labor Code); the practical work is the annex recording which company now employs each person and the continuity of their seniority and benefits. In a conversion the employer does not change.

A restructuring usually comes before or after a transaction. Before a sale, a demerger can prepare the perimeter being sold; whether the buyer accepts it depends on the liabilities, contingencies, guarantees and consents the inventory reveals. After a purchase, a merger integrates what was bought. The structures of the purchase itself are compared in merger, share purchase or asset purchase, and our work in the transaction is described in mergers and acquisitions. The tax filings a restructuring requires are part of tax compliance.