Mergers and Spin-Offs Under the UmwG

UmwG mergers and spin offs: what the Transformation Act offers

UmwG mergers and spin offs are the statutory toolkit for restructuring German companies by universal succession. The Transformation Act (Umwandlungsgesetz, UmwG) provides four types of transformation for entities with their seat in Germany: mergers (Verschmelzung), divisions (Spaltung, comprising split-ups, spin-offs and hive-downs), transfers of assets and changes of legal form (Formwechsel) (§ 1(1) UmwG). These forms are exhaustive: other transformations with universal succession are only possible where a statute expressly provides for them (§ 1(2) UmwG). The great advantage of the statutory route is that assets, liabilities and contracts pass as a whole upon entry in the commercial register, without individual transfers and, in principle, without the consent of contractual counterparties.

The price is formality: a notarised agreement or plan, reports, audits in some cases, shareholder resolutions, information for works councils, creditor protection and a register procedure. Each step has its own deadlines, and a defect in one of them can delay registration by weeks or months.

This briefing explains the forms, the documents, employee information, creditor protection and the register procedure, with practical points for group reorganisations and transactions. Cross-border operations are covered in our separate briefing on cross-border conversions, mergers and divisions.

Forms of transformation at a glance

The UmwG contains general rules for each form and special rules for each type of entity involved, such as the GmbH, the AG, partnerships, cooperatives and associations. When planning UmwG mergers and spin offs, the first step is therefore to identify the combination of entities and the applicable special rules.

Documents, reports and resolutions

A merger is based on a merger agreement; a division is based on a division and acquisition agreement or, for a new entity, a division plan. The agreement must contain mandatory information listed in § 5(1) UmwG for mergers and § 126 for divisions, including the exchange ratio, the effective date for accounting purposes (Verschmelzungsstichtag), special rights and the consequences for employees and their representatives. In a division, the agreement must identify precisely the assets and liabilities allocated to each entity, which is the most labour-intensive part of a spin-off.

The management of each entity prepares a report explaining the transformation, and an auditor reviews the agreement where the law requires it or a shareholder asks for it. Reports and audits can be waived by all shareholders in notarised declarations, and they are not required for mergers of a wholly owned subsidiary into its parent. The shareholders of each entity must approve the transformation by a notarised resolution. For a GmbH, the resolution requires a majority of at least three quarters of the votes cast (§ 50(1) UmwG); for an AG, three quarters of the share capital represented.

Where the acquiring AG already holds at least 90% of a transferring corporation, a resolution of the acquiring AG is in principle not required (§ 62(1) UmwG), and a squeeze-out of remaining minority shareholders can be combined with the merger (§ 62(5) UmwG).

Upstream, downstream and sidestream mergers; changes of legal form

In groups, three types of merger are common. In an upstream merger, a subsidiary is merged into its parent; where the parent holds all the shares, no capital increase is permitted, no exchange ratio is needed and reports and audits fall away.

In a downstream merger, the parent is merged into its subsidiary, and the parent's shareholders receive the subsidiary's shares that the parent held; capital maintenance rules must be checked carefully if the parent has debt. In a sidestream merger between sister companies, the law allows the acquiring GmbH to dispense with a capital increase if all shareholders of the transferring entity waive the grant of new shares (§ 54(1) UmwG), which simplifies intra-group mergers considerably.

A change of legal form does not transfer assets at all: the entity continues to exist with a new legal form and the same assets and liabilities (§ 190 UmwG). Typical examples are the conversion of a GmbH into an AG before an IPO or into a GmbH & Co. KG for tax or governance reasons. The conversion requires a notarised resolution taken at a meeting (§ 193 UmwG), usually with a three-quarters majority, and the formation rules of the new legal form apply, including capital cover.

Shareholders who object for the record must be offered appropriate cash compensation for their shares (§ 207 UmwG), and the adequacy of that compensation is reviewed in appraisal proceedings rather than through actions against the resolution. Changes of legal form can also affect co-determination, since a partnership with a corporate general partner is subject to different rules from a GmbH or AG. The co-determination position should therefore be checked before choosing the target legal form.

Whichever form is chosen, UmwG mergers and spin offs should be planned with the group's financing documents in mind: facility agreements often prohibit reorganisations without lender consent or require new guarantors to accede, and security over assets or shares may need to be released and re-granted.

Employees and works councils

The agreement or its draft must be forwarded to the competent works council of each entity at least one month before the shareholders' meeting that resolves on it (§ 5(3) UmwG), and proof of timely forwarding must be filed with the register application (§ 17(1) UmwG). Works councils frequently waive the period in writing, but the forwarding itself remains mandatory. A missing or late forwarding is a common reason for registration delays.

Employment relationships pass by universal succession in mergers. In divisions, they pass in accordance with § 613a BGB, which continues to apply to transformations (§ 35a(2) UmwG). Employees must be informed, and in divisions they can object to the transfer of their employment. Operational changes connected with the transformation can trigger co-determination rights under §§ 111 ff. BetrVG. Board-level co-determination may change if headcounts shift between entities, so the co-determination status of each entity after the transformation should be analysed in advance.

Creditor protection and liability

Creditors of the entities involved can demand security if they register their claim within six months after the registration has been announced and show that the transformation endangers the fulfilment of their claim (§ 22(1) UmwG). In divisions, all entities involved are jointly and severally liable for liabilities that existed before the division took effect, generally for five years and for ten years for occupational pension obligations (§ 133 UmwG). This joint liability is a key point in transactions involving spin-offs: buyers of an entity created by a spin-off need indemnities from the seller for liabilities allocated to other entities.

Capital maintenance rules also apply. A merger or spin-off into a GmbH or AG that involves a capital increase is subject to the rules on contributions in kind, and the register court reviews whether the net assets transferred cover the capital. A spin-off from a GmbH must not reduce its assets below the share capital, and the managing directors must declare to the register that the formation requirements are met after the spin-off.

Register procedure and timing of UmwG mergers and spin offs

The transformation takes effect upon entry in the commercial register of the acquiring entity, or, for divisions, of the transferring entity. The application must include the agreement, the resolutions, reports or waivers, proof of forwarding to the works council and a closing balance sheet of each transferring entity drawn up as of a date no more than eight months before the application (§ 17(2) UmwG). The eight-month rule drives the timetable of most UmwG mergers and spin offs: a reorganisation based on the year-end balance sheet as of 31 December must be filed by 31 August of the following year.

The management must declare that no action has been brought against the resolution within the one-month period (§§ 14(1), 16(2) UmwG). Actions against the transferring entity's resolution cannot be based on an inadequate exchange ratio, which is instead reviewed in appraisal proceedings. Where an action is pending, the company can apply to the court for a release order (Freigabeverfahren) allowing registration despite the action (§ 16(3) UmwG).

Tax and practical issues

UmwG mergers and spin offs are usually designed to be tax-neutral under the Reorganisation Tax Act (Umwandlungssteuergesetz, UmwStG). Book values can be carried forward if certain conditions are met; spin-offs in particular require that a "partial business" (Teilbetrieb) is transferred and impose holding periods on the sale of shares. Real estate transfer tax can arise where real estate is transferred or where shareholding thresholds are crossed, although intra-group relief may apply. The tax analysis should be completed before the documents are finalised. See our briefing on intragroup reorganisations.

Other practical issues include the transfer of public-law permits, which may not pass automatically; change-of-control clauses in contracts, which universal succession does not neutralise; IP registrations and land register entries that must be corrected after the transformation; and data protection, where personal data are transferred. In a carve-out, a statutory hive-down is often combined with a subsequent share sale.

How TRW & Co helps

We plan and implement UmwG mergers and spin offs for German companies and international groups: structuring with tax advisers, drafting merger and division agreements, reports and resolutions, preparing works council information and employee notices, coordinating with the notary and the register court and managing creditor and challenge risks. Our M&A and corporate lawyers work with our employment and tax colleagues on one timetable. Contact us to plan a reorganisation.