Implementation of alternative dispute resolution mechanisms in cross border mergers: International legal study

Preliminary Chapter

Introducing the cross-border merger

process from a legal approach

Merger is a complex business combination which almost requires for its completion to comply with several stages. This complexity is considerably increased when the transaction crosses national borders.

The process is structured as follows⁵¹: When introducing the deal, it is first necessary to study its corporate tools. In many aspects, cross-border mergers are not like domestic mergers. There are fundamental differences in the transaction process itself, but also one must take into account the diversity of the rules on how to accomplish it from jurisdiction to jurisdiction. It is equally important, when the participating companies are not familiar with the respective legal and business environment, to study the fundamental requirements to carry out the cross border

process, in order to identify the Law which ought to be applicable to the transaction.

In this chapter we will first discuss the corporate tools needed to bring about the deal section (1) and then the fundamental requirements required in the cross-border merger transaction (section 2).

⁵¹ other legal equally important areas like capital market Law, and anti trust Law to identify open problems in cross-border mergers will not be discussed

Section 1: Cross-border mergers corporate tools

While it is simpler to study the merger process in one step, it is advisable to proceed in two steps bringing-out essentially the negotiation and the integration phases. In this section we will first study the working of the cross-border merger process (parg1) and we will examine the feasibility of the cross-border transaction (parg2)

Pargi: the cross-border merger^,s workin

When a company merges with another company the merger process distinguish between the "Closing- Negotiation phase" (A) and the "Postmerger integration" phase (B).

A- The closing-merger negotiation phase

Although the steps leading up to the conclusion of a merger may vary substantially from case to case, from legal system to legal system, it is first customary to initiate the process by the identification of prospective candidate for a merger. Following the identification of the potential candidate for a merger, the respective boards of directors of the merging companies, through their intermediaries, known as investment banks or lawyers⁵² will then confirm their mutual interest by structuring preliminary agreements.

⁵² The role of "Fusion-conseil" is carried out by department of mergers and acquisitions of Investment banks, Lawyers, or public accountants ..." Routier, R. Les Fusions de Sociétés Commerciales, Prolégomènes pour un nouveau droit des rapprochements, bibliothèque de droit privé, tome 237, 2iéme édition, Paris, 1997

Under company law practice these preliminary documents are called "letters of intent"⁵³ or "memorandums of understanding"⁵⁴.These documents generally outline the key points of the proposed merger (objectives, pricing expectations, various descriptions of negotiation agreements etc...). In practice a letter of intent may set forth little more than a brief draft of the principle points of agreement. However, it can serve useful purposes: firstly, although generally not legally binding, it does represent a moral obligation that is normally taken very seriously by the parties' contract in which they agree "to negotiate the negotiations"⁵⁵. Secondly it memorializes the basic terms of the transaction, which helps to prevent subsequent misunderstanding, both intentional and unintentional.

To illustrate, under the American corporate law practice, the parties to a merger may set forth their understandings of the transaction but do not agree to be bound by those understandings, other than certain limited terms such as confidentiality⁵⁶ , assignment of legal auditors⁵⁷ ,information, and obligation to continue negotiating in good faith to reach a definitive agreement. In other words, the letter of intent outlines the nature of the transaction and it is considered an effective tool to "contractualize the merger negotiations"⁵⁸.

⁵³ A letter of intent customarily employed to reduce to writing a preliminary understanding of the parties, this letter is not a contract and it does not constitute a binding agreement. Rather it is an "expression of tentative intentions of the parties and creates no liability as between the parties. It is in essence "an agreement to agree". Gifis, S. H. "Law Dictionary", 3ed, Barron's Edition , US, 1991

⁵⁴ A letter of intent, sometimes called a memorandum of understanding is a preliminary statement used to outline the general terms of a proposed corporate transaction. Hoehn, M., "Letters of Intent, Confidentiality and Standstill Agreements", Practising Law Institute Corporate Law and Practice Course Handbook Series, Drafting Corporate Agreements 2004-2005 Pillsbury Winthrop LLP, 2004

55 « il s'agit de négocier les negotiations » Mousseron, J.M., Techniques Contractuelles, Paris Editions Francis Levèbre, 2005

⁵⁶ Clause to keep confidential specific business information learned during transaction discussions. See articles 253 and 270 of the Tunisian Commercial Companies Code

⁵⁷ An auditor is a person or firm, an accountant that formally examines an entity financial record... In cross- border mergers he is namely called Commissaries à la fusion in French Law, commissaire aux comptes in Tunisian Law. The Black's law dictionary Op.cit note 1 page 1

⁵⁸ Routier, R. Les Fusions de Sociétés Commerciales, Prolégomènes pour un nouveau droit des rapprochements op.cit note 1 page 14

The Letter Of intent discussion process is considered as a precursor to the negotiations of the final agreement to help the parties reaching a definitive agreement. However, there is good reason not to have a letter of intent. Much energy can be wasted in negotiating an agreement in principle that might be better spent in negotiating the definitive agreement. Accordingly, a letter of intent may not be an essential step in a merger involving domestic and foreign companies and may be often skipped in favor of moving directly to the draft of the definitive contract

(Silence of the Tunisian Company law). In other words the boards/management of the

merging companies should start directly by negotiating the merger agreement.

Since the completing of the preliminary agreement, the drafting of the purchase agreement is under way, the management or boards of directors of the acquiring company's will conduct and perform a careful Due Diligence in order to assess the company's economical and financial health. From the absorbed company point of view , an in-depth analysis effectuated by the management 's absorbing company ,of the absorbed company 's economical position will reveal how it has performed in the past and allow the acquirer to estimate how it is expected to perform in the future. The absorbing company must be careful not to base its evaluation of due diligence issues solely on the value system of its own country. It must approach the evaluation process with sensitivity and respect toward the host country's cultural norms and values.

According to Miller, J., the national director of Ernest & Young's corporate finance practice, based in New York, "due diligence process in cross-border mergers should begin long before a specific target has been identified⁵⁹. The absorbing company's lawyers should work closely with a multi-disciplinary team consisting of the absorbing company's accountants, lawyers specializing in various areas of the Law^6°.

⁵⁹ Miller, J., , Mergers & Acquisitions, back to basic techniques for the 90's , Ernest & Young LLP , Financial Advisory Services , second edition, published by John Wiley & Sons, Inc, 1994

^6° Including environmental, real estate, employee benefits, litigation, tax and intellectual property. Id

Cross border transactions present a supplementary set of due diligence issues which do not occur when both parties are in the same country. If the companies are located in different countries, the legal systems of both countries must be well understood. The absorbing company must have an intimate knowledge of the rules which govern the decisions before considering the essential business issues to be addressed. In the cross-border merger context, the absorbing company^,s Lawyer should coordinates due diligence to be conducted in the various countries involved.

In essence, lawyers should prepare a checklist for the operations' absorbed company in the relevant jurisdiction. For example, in Japan and South Korea, Lawyers are seldom used in due diligence. Instead, Japanese business personnel, many of whom have some form of basic legal

training, are considered well qualified to plan and negotiate the deal⁶¹. the principal purpose of merger due diligence is to assist the absorbing

company in understanding, from a legal perspective, the target^,s business in order to give her the necessary information about the target company to allow her to make an informed investment decision with respect to the proposed merger, identify, understand and to the extent possible, quantify risks and liabilities associated with the target^,s business, identify legal impediments to the completion of the proposed merger including required governmental authorizations and approvals.

Due diligence is regarded differently in civil law and common law practice.

⁶¹ Chung, W., "CROSS-BORDER M&A, Avoiding Surprises Through Due Diligence", Business Law Today Review January 1997, the American Bar Association. West Law data base

Under the Due Diligence common law practice⁶², Lawyers and their clients almost uniformly expect comprehensive due diligence to be conducted before the merger is closed or completed. But such practice often raises two common issues with cross-cultural implications: scope and timing of the due diligence. In-depth investigation of the target and its business affairs is accepted practice for lawyers from common law jurisdictions. In U.S. mergers sphere, for example, the common belief is that "the acquiring company can never do enough due diligence". In the US, management is accustomed to giving and receiving detailed documentary due diligence lists which come out of word processors at large Law firms and at investment banks, and which may include 15 pages of intrusive questions. If the US absorbing company presents such

detailed and searching list to a very possible target company located for example in Europe that may be very much misperceived⁶³. In contrast, due diligence in civil law countries may be somewhat more abbreviated. For example, the matters normally covered by a U.S.-style due diligence, however, requests for legal opinions are not so common-place and the acquiring company's Lawyer should consult with local Lawyers before launching a U.S.-style legal opinion request⁶⁴. In addition, jurisdictionslike in Tunisia- where the due diligence process is more limited, therefore, it should be tailored and abbreviated so that the seller will neither be overwhelmed nor offended⁶⁵.

⁶² "...global due diligence practice may be separated into two schools: the Common law practice, which emanates mainly from American and English Lawyers (or, as sometimes referred to by our European colleagues, the "Anglo-Saxon" practice) and the practice by the rest of the world (represented principally by those who practice some form of Civil law). Chung, Op.cit note 1 page 17 id

⁶³ ./n these countries, it may be preferable to the heads of different functions and then cautiously to ask for documents relating to the matters discussed such as litigation. Accounting firms play an important role in a merger. They check a target company's background and financial health..."Id

⁶⁴ Grusson, "Legal Opinions in International Transactions: Foreign Lawyer^,s Response to U.S. Opinion Requests (3d ed. 1994) presented on Oct. 14, 1994 at the International Bar Association 25th Biennial Conference, Melbourne, Australia, as a report of Subcommittee E1, Legal Opinions, of the Committee on Banking Law of the Section on Business Law of the International Bar Association" 1989 Columbia Business Law Review 197 (1989)

65 _Id

Once the merging companies have thoroughly evaluated the economic worth of each others and are comfortable with the respective local rules, they steps forward to evaluate the financial worth of each company. The evaluation process is generally undertaken by an internal accountant, called "expert comptable" or "commissaire aux comptes" in Tunisian Company law and "commissaire à la fusion" in French Law, "certified public accountant' in the US and "independent expert under European law.⁶⁶ During the evaluation process of the merging companies' financial situation the price of the deal , called "parity exchange" ⁶⁷ is determined based on a balance sheet drawn up for the need of both companies and following the national methods of evaluation of the merging companies.

In common law practice when the deal crosses borders, the absorbing company and its Lawyers must recognize early the generally accepted accounting principles (GAAP) ⁶⁸. The absorbing company's accountants will take the lead on accounting and financial matters. Lawyers, however, must also focus on the differences in GAAP in the relevant jurisdictions that may include different rules and treatment. The range of commonly applied evaluation techniques varies from country to country. In countries with relatively well-developed stock market, including US, Japan, UK and Canada valuations methods typically focus on discounted cash flow⁶⁹ techniques, both of which rely on data derived from comparable public companies.

⁶⁶ A "commissaire aux comptes" according to article 413 of the TCCC amended by Law n°2005-65 of the 27 of July , 2005; a « commissaire a la fusion according to the French company Law , Law 1988 ; an " independent expert" under article 8 of the EU Directive on cross-border mergers

⁶⁷ Pari Exchange or " parité d'échange la parité d'échange traduit le nombre d'actions contre lequel seront échangés les actions de la société absorbante. Elle est la conséquence directe du poids financier relatif qui

résulte du rapport entre les deux sociétés. Le poids relatif entre les deux sociétés détermine directement la composition de l'actionnariat de la nouvelle société et donc le pouvoir en son sein. Apoteker (T) « Concentration bancaire et taille critique », banque magazine n°604, juin 1999 p 63

⁶⁸ The closest standard to global GAAP is the initiative sponsored by the London-based International Accounting Standards Committee (the adoption of which is voluntary by each country^,s accounting standards authority).

See generally "International accounting standards," AICPA Professional Standards «All accountants soon may speak the same language," The Wall Street Journal (Aug. 29, 1995).

⁶⁹ "...The discounted cash flow technique takes into account that a dollar received today is worth more than a dollar received a year from now because today's dollar can be invested to earn a return during the intervening time." Miller, J., Mergers and Acquisitions, back to basic techniques for the 90's, op.cit note1, page 16

In contrast, in countries with limited public equity arenas such as Italy, and Spain market based valuation methods are less common. Instead valuations in these countries are determined through other variety of approaches. Thus, in countries such as Germany and Tunisia where debts has traditionally represented the major source of financing, valuations are often based on the company's balance sheet -adjusted⁷⁰ if necessary for differences between book and market values. During due diligence, internal accountants should actively gain an understanding of the target's business and industry, and corporate structure . They also should make sure that each of these areas is investigated thoroughly before a definitive M&A agreement is reached. Internal accountants therefore must become an integral part of the due diligence process.

Under Tunisian company Law practice, according to the legislation in force, a "specialized expert" , appointed by the special meeting of the merging company' s shareholders will drawn up a financial report to be submitted to the approval of the shareholders' meeting in which he will attest the accuracy of the methods of appraisal chosen, based on which , the price of the transaction was calculated⁷¹.

Once due diligence is satisfactory, the board of directors of each company involved enter into the drafting the final agreement namely called the "merger plan"⁷² or "the merger agreement", the outline for which will be found in the companies statutes which must contain

particulars that may vary from country to country:⁷³

⁷⁰"...Book value adjusted for anticipated purchase price accounting adjustments will help to provide an initial estimate of the goodwill to be recorded in the transaction". (Méthode de l'actif net réévalué), Miller, Op.cit note 1 page 16

⁷¹ Article 1 of Law n° 2005-65 dated July 27th 2005 (Official Gazette of the Tunisian Republic n°61, August 2005) amending the Tunisian Commercial company Code

⁷² "Projet ou traité de fusion", Amamou, N., Manuel permanent du Droit des Affaires Tunisien, édition cabinet, July 1994

⁷³ article 413 TCCC, Article 5 of the EU Directive on cross-border mergers 2005, section 251 b DGCL

The merger agreement/plan is the formal, legal version of the sum of all discussions that business people have had about a merger.

It's the articulation of the often over simplified ideas of the parties as to the terms of the transaction. In its purest form it correctly and explicitly sets forth all the rights and obligations of the parties to the agreement. Under company Law practice, a merger agreement is usually required according to the respective corporate Laws of the merging companies.

In the Daimler-Chrysler case⁷⁴ for example, a merger occurred between a US company-Chrysler Corporation- and a German companyDaimler Benz AG- , two agreements were used : one for the German merger of Daimler Benz AG into DaimlerChrysler AG in which the Daimler Benz AG shareholders accept to exchange their shares for the issuance of new Daimler Chrysler shares and by which the Daimler Benz AG became a subsidiary of DaimlerChrysler AG and disappeared and a second agreement for the American merger in which Chrysler Corporation turned into a wholly-owned subsidiary of DaimlerChrysler AG and changed its name into Daimler-Chrysler Corporation. Agreements of this type are rare under German domestic company Law since corporate Law require separate agreements in accordance with the detailed provisions of the legislation in force. In order to ensure the necessary legal certainty for both companies it was necessary to set forth the whole planning in one agreement, namely the "Business Combination Agreement" in accordance with US practice and subject to the Laws of the states of Delaware and the German Law. The parties have agreed to this overall plan for the business combination of Daimler Benz AG and the Chrysler Corporation into the Daimler Chrysler AG. This agreement provided for two operational headquarters in Germany and in the US. However the German headquarter legally became the seat of the corporation.

⁷⁴ The Daimler -Chrysler case study in Horn, N. Cross Border Mergers and Acquisitions and the Law, Kluwer Law International , 2001 Op.cit note 6 page 6

As for the negotiations in essence, it is important to know that negotiating an agreement for a merger is usually a long and complicated task. At each step along the way the parties involved must cooperate to ensure that even as they preserve their own best interests, they preserve the best interest of their negotiating partners. The downside of a lengthy process can be overcome when varied transfer of management, risks and responsibility provisions are inserted in the agreement to provide for the variable concerns of the parties in terms of time and risk. As it was remarkably quoted by Mousseron, the merger contract needs to be balanced to manage the amalgamation and all the risks that may undermine party's interests"⁷⁵. The proposal is to insert problem solving clauses in the merger contract, that preserve the interests of shareholders of the merging companies and to avoid eventual discrepancies while evaluating the parity exchange.

When the merger agreement is drawn-up and signed, a number of posts -completion steps⁷⁶ may continue to involve both parties. Such formalities designed to perfect the operation may vary from country to country. Under US Company Law practice, the closing stage requires the submission of the merger agreement by the boards of directors⁷⁷ to the shareholders meeting approval of each company⁷⁸. When the general meeting of shareholders of each company approves the draft terms of the transaction, the merger agreement is filed with the state Office managing corporate filings of each company participating in the transaction.

⁷⁵ « Il s'agit d'organiser à priori une gestion juridique du risque juridique...la fusion opération juridique génère des risques. C'est au contrat qui les a fait naître qu'il incombe d'en contenir les effets...le contrat va se préoccuper des déviations que l'opération pourrait connaître par rapport au tracé idéal retenu par ses constructeurs » Mousseron, J.M., Techniques Contractuelles op.cit note 3 page 15

⁷⁶ "Specific guidance is provided where the cross-border nature of the transaction creates particular difficulties and/or makes it unclear which Law should apply, sets out the minimum procedural requirements that the EU Member States will be required to implement within their national legislation". DIRECTIVE on Cross-Border Mergers of limited liability companies, Official Journal of the European Union. See appendices n°1

⁷⁷ Section 251 (b) states "the boards of directors of each corporations which desires to merge or consolidate shall adopt a resolution approving an agreement of merger or consolidation and declaring its advisability."

⁷⁸ Section 251 Delaware General Corporate Law, paragraph (c) "the agreement required by subsection (b) of this section shall be submitted to the stockholders of each constituent corporation at an annual or special meeting for the purpose of acting on the agreement..."

If the merger is between corporations in two different states or Countries, care should be taken in drafting the merger agreement to make sure it complies with the requirements of each State/country Company

La w⁷⁹.

After the agreement is filed in each state/country, the state/country in which the surviving/absorbing company is located will have complete authority over the merged company. Each merging company will then publicize the agreement ⁸⁰ via an entry in the appropriate public register. When the deal crosses borders, common draft terms of the cross border merger should be drawn up in the same terms for each of the companies concerned⁸¹.

Another important step for the completion of the deal need to be stressed that focus mainly on cultural dimension of the transaction.