When shareholders, partners, or senior management of a company begin to assess the benefits and challenges of carrying out a spin-off of a company, a variety of questions often arise. Among them, whether the spin-off will meet the objectives set in terms of greater efficiency in the management and investment of resources, in the optimization of the company’s operations, the adaptation and success of the newly created companies in current markets, etc.
A spin-off, beyond being a mere division or separation of assets, constitutes a strategic decision for the partners and directors of the company seeking to spin off, because it can change the risk perception of banks and credit institutions—possibly leading to breaches of existing contracts if not carefully planned—and even affect operational cash flow.
To this end, by considering and evaluating whether the benefits pursued outweigh the challenges, decision-makers will conclude whether or not to proceed with the spin-off.
One of those challenges is to comply with legal requirements. As it is a matter of relevance to the future of the company that wishes to carry out a spin-off, only the qualified majority of shareholders or partners assembled in meetings can take this decision.
In addition, the contributions that the partners or shareholders are obliged to make, either at the setting-up of the company or at a later time, must be fully paid.
These two prerequisites already pose a challenge in planning the spin-off. Because only the majorities that reach a percentage determined by the law can decide whether or not to approve it. Of course, those members or shareholders who voted against will have the right to separate themselves from the company.
In addition, the shareholders must not have any unpaid or pending capital contributions.
However, in addition to the aforementioned and other requirements laid down by law, a central issue that companies seeking to carry out a spin-off should consider is the right of opposition granted by law to certain persons. That is, the right to object to the split.
The resolution approving the split must be registered with the Public Commercial Registry and published in the Ministry of Economy’s electronic system for corporate notices. This is done with the aim that the partner(s) who do not agree with the spin-off and who represent at least twenty percent of the share capital, as well as any creditor who has a legal interest, can object to it.
From the date of such publication and registration, the aforementioned members and/or creditors will have a period of 45 calendar days to file an opposition to the spin-off.
What implications does opposition to the split-off have?
The objective of making the spin-off agreement public is to enable interested parties to challenge the resolution before the courts.
While it is true that a spin-off can bring multiple benefits to the company, as well as to its partners or shareholders, it could also have adverse effects for its creditors or for the partners who had not attended the meeting or who had voted against it.
The corporate assets of a company, among other matters, represent a guarantee and promise of payment to its creditors. As such assets (assets, liabilities, and share capital) are divided, either in whole or in part, to be contributed in blocks to another or other newly established companies, the chances of successful recovery by creditors could be compromised.
In other words, the conditions under which the creditors of the company contracted with it would change as a result of the spin-off. To such an extent that it would be another newly created person who would assume the payment obligation to the creditor(s).
Moreover, the newly created companies will remain jointly liable for three years from the publication of the spin-off agreement for the payment obligations of the newly established company bound to it.
Of course, this does not mean that creditors will be completely helpless in the face of a spin-off.
Otherwise, the law would not authorize the realization of spin-offs, nor would it require companies to register and publish the spin-off agreement.
A poorly planned spin-off can increase the likelihood that an objection filed by creditors or shareholders may jeopardize the performance of key contracts, compromise agreements or covenants, create uncertainty with banks, suppliers, and customers, and so on.
In this scenario, a judicial challenge by creditors or shareholders will not be as costly to the company as the legal and financial uncertainty generated and the loss of time.
How can the partners of the company and its creditors demonstrate their legitimacy to oppose the spin-off?
To demonstrate the status of the partners so that they can object to the separation, it would be sufficient for them to be registered in the corresponding registry books. And in the case of shareholders, they must show their stock share or provisional certificates.
The updated corporate books will reflect the percentage of the share capital of the partners who wish to object.
But in the case of creditors, how could they prove they are indeed creditors? More importantly, how would they verify that they have a legal interest according to the law?
Two main positions exist to address these questions. The first is that any person who demonstrates that he or she has a right to demand the fulfillment of an obligation on the part of the spun-off company proves the legal interest.
This is regardless of the type of debt the company has in favour of the creditor and the amount of the debt.
The second position is that, in order to prove the creditor’s legal interest, there must be a—firm—judgment condemning the company that splits to comply with a certain obligation in favour of the creditors.
Our federal courts have supported the first position. They have argued that it is not necessary for the law to include:
“a detailed description of what type of creditors have such interest, as these may be of different nature and contained in different arrangements, because the purpose of the rule is only to protect creditors, regardless of the type of legal interest they have and even less the quantification of the credit on which they are made dependent, but only of their status in relation to the original company being spun off…”
Final Comments
A precise analysis of the various legal challenges that a company seeking to split-off could face is essential. This will not only avoid inconvenience for the company’s partners but will also make it easier for the goals pursued by the division to be achieved more quickly and efficiently.
One practical measure that will help mitigate the risks of potential opposition from both partners and creditors is that, where the relationship permits, there are approaches to explain the process. If possible, it is recommended to document the prior consent of the creditors to the spin-off.
At best, a judicial opposition can delay the effects of the spin-off at the desired time. In the worst-case scenario, it can prevent the spin-off from taking place without a payment agreement being reached with the creditor first.
Corporate governance helps identify and anticipate various risks before convening the general meeting of partners or shareholders at which a spin-off is to be approved.
Planning should be carried out that considers the correct legal deadlines, ensures that corporate books and share certificates contain up-to-date information, identifies creditors whose claims may hinder the spin-off, evaluates ongoing litigation and contracts, and assesses asset transfers and their consequences.
If you have any questions please contact us at: acervantes@ceglegal.com
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[1] [TA]; 10th Epoch; T.C.C.; Gaceta S.J.F.; Book 59, October 2018; Volume III; Page 2158. Digital Registration 2018107.
