section 110 liquidation demerger slides - v1...within a corporate group by way of a section 110...
TRANSCRIPT
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Section110liquidationdemergers
Aguidetolegal,taxandpracticalIssues
Version1.0
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TableofContentsPageNo.
• Acknowledgements 3• ImportantNotice 4• Introduction– whoisthisguidefor? 5• Whatisademerger? 6• Whatisasection110demerger? 7• WhywouldIwanttodemergepartofthegroup’sbusiness? 8• Whatarethemainworkstreamswithinasection110demergerproject? 9• Whatarethepotentialshowstoppers? 10• Howdoesitworkandhowlongdoesittake? 11• WhowillIneedtoinvolve? 12• Ademergercasestudy 13• Overviewoflegalfeasibilityissues 21• AboutLCNLegal 22• FreeLCNLegalResources 23• LCNLegalTestimonials 24
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Acknowledgements
This guide has been prepared by LCN Legal with contributions fromPaul Smith of Blick Rothenberg and Ben Woodthorpe of ReSolve from atax and liquidator’s perspective, respectively.
Blick Rothenberg is a market leading accountancy practice providingaudit, assurance and business advisory services as well as providingadvice on corporate and personal tax matters.
ReSolve is an award winning corporate advisory firm combining bothits own capital and experience in advising and funding financiallydistressed businesses, and providing corporate restructuring expertise.
We would like to thank Paul Smith of Blick Rothenberg and BenWoodthorpe of ReSolve for their time and kind contributions to thecontent of this guide.
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Importantnotice
This guide is provided on an “as is” basis. Readers should take theirown professional advice, and this document should not be relied uponas a substitute for the same. No responsibility is accepted by LCN LegalLimited or any other contributors, or any of their respective directors,partners, employees, agents or representatives for any cost, loss orliability, however caused, incurred by any person by reliance on it.
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Introduction
Whoisthisguidefor?
Thisguideisforanyonewhowantstoknowmoreaboutseparatingbusinesseswithinacorporategroupbywayofasection110liquidationdemerger. Ofcourse,therearemanyotherwaystoseparatethebusinessesandassetsofagroup,whetherbydistributioninspecieoftherelevantassets,acourtapprovedreductionofcapital,aschemeofarrangement,across-bordermergeroranintra-groupbusinesssale.However,thesemethodsareoutsidethescopeofthisguideandarefeaturedinotherLCNLegalresourcesavailableonourwebsite. Herewewillfocusontherationale,thekeyconsiderationsandrisks,andthemainstepsrequiredtoimplementatypicalsection110liquidationdemerger.
Thecontentofthisguideisaimedattax,financeandlegalprofessionals(in-houseandinprivatepractice)whomaybeconsideringorbecomeinvolvedinasection110demerger,orwhojustwanttounderstandmoreabouthowtheyworkandwhytheymightbeconsideredausefulmethodofseparatingbusinesses.
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Whatisademerger?
Asacompanyorcorporategroupmayoperateanumberofdifferentbusinessunits,eachutilisingdifferentassets.Foranumberofreasons,itcanbebeneficialtosegregatetheseunitsorassetsbytransferringcertainbusinessesorassetsintoseparateentities. Thetermdemergerusuallydescribestheseparationofassets,initiallyheldundercommonownership,intoseparatecompaniesorgroupsofcompanies.
Asalreadymentioned,thereareanumberofdifferentmethodstodemergebusinessesorassetswithinagroup.Thisguidefocusesonthelegalstepsrequiredandthecommontaxandliquidationissuestoconsiderwhenimplementingasection110liquidationdemerger.
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WhatisaSection110demerger?
Asection110liquidationdemergerinvolvestheliquidationofaholdingcompanyandthetransferofsharesorassetstotwo(ormore)newlyincorporatedcompanies(forthepurposesoftheguide,called“NewCos”).
Theliquidatorexercisesdiscretionundersection110oftheUK’sInsolvencyAct1986toacceptthesharesintheNewCosasconsiderationforthetransferoftherelevantassetsbytheholdingcompanytotheNewCos.Theliquidatorthendistributesthesesharestotheultimateshareholdersinsatisfactionoftheirrightsintheholdingcompany’sliquidation.
ItisalsopossibletosimplifytheprocessbytheNewCosissuingsharesdirectlytotheultimateshareholders.
TheendresultisthattheNewCosarehelddirectlybytheultimateshareholdersasaretheirrespectivedemergedbusinesses.
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WhywouldIwanttodemergepartofthegroup’sbusiness?
Reasonsforwantingtodemergeabusinessorassetswithinagroupvarywidelyandmightincludeanyofthefollowingreasons:
• Toring-fencecertainassetsfromrisksassociatedwithotherassetsorbusinesseswithinthegroup
• Tosetupanewbusinessdivisionwhichwilloperateindependentlyfromtheremainingbusinessofthegroup
• Topackagepartofthegroup’sbusinessforsaletoathirdparty
• Toseparatebusinessesorassetsfollowingadisputebetweenthegroup’sultimateshareholders
• Toformpartofsuccessionorinheritanceplanning
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Whatarethemainworkstreamswithinasection110demergerproject?
Typicalworkstreamsareasfollows:
• Agreementonthevaluationoftheassetstobedemerged(ifthesharesplitwillnotbeidenticalacrossthedemergedcompanies)
• Legalduediligenceofcontractual/regulatory/thirdpartyconsents
• Taxadviceandtaxclearances
• Shareholders’agreementsforthedemergedcompanies(iftheywillhavemorethanoneshareholder)
• Liaisingwiththeproposedliquidatorsandgettingthemcomfortablewiththeplannedtransactions
• Corporatestructuring,legaldocumentationandimplementation
• Post-completionmattersandcompanyfilings
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Whatarethepotentialshowstoppers?
Examplesofpotentialshowstoppersorsourcesofmajordelay/costoverrunareasfollows(alsoseetheOverviewofLegalFeasibilityIssuesonpage21ofthisguide):
• Disagreementonthevaluationofassets
• HMRCquestionsonclearanceapplicationsorconditionsattachingtoapprovals
• Shareholderobjections
• Changeofcontrolissueswithcommercialcounterparties
• Bankingreleasesandregulatoryconsents
• Liabilityissuesinthecompanytobeliquidated(ifthisisnotanewholdingcompany– seeStep1below)
• Changestotheproposedstructureduringimplementationoftheproject,etc.
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Howdoesitworkandhowlongwillittake?
Thetimeneededtocompleteademergerwilldependonanumberoffactors,including:
• whetherthecompaniesorassetsinvolvedinthedemergeraresubjecttomortgagesorotherthirdpartycharges;
• whetherallrequiredadvisorshavebeeninstructedfromtheoutset(includingthelegal,taxaccountingandliquidatorroles);and
• thetypeofassetsandthecomplexityandhistoryofthebusinessbeingtransferred.Forexample,arethirdpartyconsentsrequiredtotransfertheassetsorthebusiness?Willemployeeconsultationberequired?
Inourexperience,thesetypesofprojectsusuallycompletewithin2-6months,however,ifproperduediligenceisnotcarriedoutfromtheoutset,theycantakeinexcessof12monthstocomplete.
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WhowillIneedtoinvolve?
Typicallytheoutlinestructureofthedemergerwillbeputtogetherbythestakeholdersinthebusiness,legaladvisersandtaxadvisers.Amemberoftheprojectteamwillneedtobeappointedtonegotiateanyre-financingarrangementsorthirdpartyconsentsrequiredtocompletethedemerger.
Aliquidatorwillneedtobeappointedandshouldbeconsultedearlyonthestructureandthedetailoftheproposedliquidationdemergersteps. Leavingthistotheendmaydelaytheprojectsignificantly.
WhataretherisksIshouldbeawareof?
Inthedemergercasestudysetoutonpages13to20,wehaveincludedcommentaryonthekeyrisksandissuestobeconsideredbyyourprojectteam,includingfromatax,legalandaliquidatorsperspective.
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ADemergerCaseStudy
BeforeandAfter
Thefollowingpagesillustratethetypicalstepstakeninasection110liquidationdemerger.Thecorporatestructuresoppositeshowthepresentstructureandtheproposedfuturestructurefollowingcompletionofthedemerger.
Inthiscasestudy,themaindriverforthedemergeristoseparateandring-fencetwobusinessescurrentlyoperatedwithinanexistingcompany(TradeCo1),withaviewtoincentivisingthemanagementofeachbusinessseparatelythroughtheintroductionofshareparticipationschemesfollowingcompletionofthedemerger.Thismaybetoincentivisemanagementtogrowtherespectivebusinessesforproposedfuturesale.
AllthecompaniesinvolvedareUKcompanies.
Anythirdpartyconsentsrequiredfortransferringcustomer,supplierorotherthirdpartycontracts,togetherwithsecuredcreditors’consentsorregulatoryapprovalswillneedtobesoughtinadvanceofthedemerger.
TradeCo1
Before After
NewCo1
TradeCo1
NewCo2
TradeCo2
100% 100%
Shareholders Shareholders Shareholders
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ADemergerCaseStudy
Step1– LegalSteps
AnewUKholdingcompany(“NewHoldCo”)isinsertedontopofTradeCo1.Thereasonforthisistohavea‘clean’companyinthestructureinordertoallowtheliquidatortoimplementthedemergerimmediatelyuponcommencementofthemembers’voluntaryliquidationinstep5.Liquidatingtradingcompaniescanprovemorecomplex,timeconsumingandcostly,asaresultofpotentiallackofcorporatememory,hiddenindemnities,warrantiesorotherexposure,andunknownpersonalinjuryclaims,forexample.
ThisstepiscarriedoutbywayofashareforshareexchangeinwhichallcurrentshareholdersofTradeCo1transfertheirsharesinTradeCo1toNewHoldCoinexchangefornewshares(withequivalentrights)inthenewholdingcompany.
NewHoldCoshouldhaveanamenotassociatedwiththatofTradeCo1. Eventhoughtheliquidationisasolvent(i.e.,a‘good’)liquidation,byassociationitmaybringunwelcomeattentionwhenadvertisingtheliquidationifthenamesaretoosimilar.
Taxissues:Technically,theshareholdersdisposeoftheirsharesinTradeCo1and,asconsiderationforthesale,theyreceivesharesinNewHoldCo. UndergeneraltaxprinciplessuchadisposalcouldresultintheshareholdershavingaliabilitytotaxonanycapitalgainthatmightariseonthedisposalwhencalculatedbyreferencetothemarketvalueofTradeCo1,atthetimeofthetransaction. However,inalmostallcases,noactualtaxliabilitywillarise,providedthetransactionisbeingundertakenforbonafidecommercialreasons. AtaxclearanceapplicationistypicallysubmittedtoHMRCinadvanceofthetransactioninordertoobtainHMRC’sconfirmationonthismatter. Thisensuresthatthereisnounexpectedtaxliabilityarisingontheshareholders,asaconsequenceoftheirtransferoftheTradeCo1sharestoNewHoldCo. Inpracticea“combined”clearanceapplicationwillbemadetoaddressthismatterandsimilarissuesarisinginthesubsequentsteps. The“combined”clearancewillincludeaclearanceundersection138TCGA1992andsection701ITA2007toconfirmthatnotaxliabilityarisesontheshareholders,asaconsequenceofStep1.
NewHoldCo
TradeCo1
NewHoldCoisincorporatedandinsertedaboveTradeCo1
100%
Shareholders
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ADemergerCaseStudy
Step2– LegalSteps
AnewUKsubsidiarycompany(“TradeCo2”) isincorporatedasa100%subsidiaryofNewHoldCoandsistercompanytoTradeCo1.Anexistingsubsidiarycouldequallybeusedforthispurposebutmayrequireadditionalrestructuringstepstoreflectthecorporatestructureshownopposite.
ThebusinessorassetstobedemergedarethentransferredtoTradeCo2.IftheassetsaresoldbyTradeCo1toTradeCo2thismaybeatbookvalueifTradeCo1hassufficientdistributablereserves(netrealisedprofits).TheconsiderationforthetransfermightbeleftoutstandingasadebtpayablebyTradeCo2.
Taxissues: ThetransferofthebusinessorassetstobedemergedwillbeadisposalfromTradeCo1toTradeCo2fortaxpurposesandtaxliabilitiescouldpotentiallyarise. However,totheextentthattheassetstransferredarecapitalassets(i.e.,capitalgainsassetsorintangiblefixedassets)thenthe“combined”clearanceapplicationtoHMRC(referredtoatStep1above)willseekconfirmationfromHMRCthatthetransactionisbeingundertakenforbonafidecommercialreasons. IfHMRCagreesthatthisisthecasethenthecapitalassetsaretransferredfortaxpurposesattheirtaxbasecosts(i.e.,nocorporationtaxliabilitywillariseasaconsequenceofthisstep). Unfortunately,therearenoprovisionsthatenablestockintradetobetransferredwithouttriggeringanimmediateliabilitytoUKcorporationtax. However,asthenatureofstockintradeisthatitistobesoldintheshortterm,theninmostcasesthisrepresentsonlyamodestcashflowdisadvantage. Ifland/buildingsareincludedintheassetsbeingtransferredthenstampdutylandtaxcantypicallybeavoidedbyelectingforgrouprelieftoapplytothetransaction. Taxadviceshouldbesoughttoavoidinadvertentlytriggeringataxliability. The“combined”clearancewillincludeaclearanceundersection139TCGA1992toconfirmthatnotaxliabilityarisesontheshareholdersasaconsequenceofStep2.
NewHoldCo
TradeCo1
NewHoldCoasformedinstep1
TradeCo2isincorporatedasa100%subsidiaryofNewHoldco
TradeCo2
100% 100%
Shareholders
TradeCo1sellstherelevantbusiness/assetstoTradeCo2
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ADemergerCaseStudy
Step3– LegalSteps
ThenextstageofthedemergerprocessisusuallytoestablishtwonewcompanieswhichareincorporatedonbehalfofeachoftheshareholdersandareheldbytheshareholdersinthesameproportionsastheoriginalholdingsinTradeCo1.Inourexample,theseareNewCo1andNewCo2. Atthisstage,onlysubscribersharesareissuedbytheNewCostotheshareholdersbecausetheremainingsharesareusedasconsiderationforthetransferoftheTradeCo1andTradeCo2sharesinstep5below.
NewHoldCo
TradeCo2
100%
NewCo1 NewCo2
NewCos1and2areincorporated
TradeCo1
Shareholders
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ADemergerCaseStudy
Step4– LegalSteps
Theshareholderspassaspecialresolutiontocommencethemembers’voluntaryliquidation(“MVL”)ofNewHoldCoandaliquidatorisappointed.
IftheMVLiscommenced,theliquidatoreffectivelyholdstwoassets– i.e.,thetwowhollyownedsubsidiariesofNewHoldCo,beingTradeCo1andTradeCo2.
TheplacingintoliquidationofNewHoldCoandtheappointmentofaliquidatordoesnotinitselftriggeranytaxcharge.
NewHoldCo
TradeCo2
100%
NewCo1 NewCo2
TradeCo1
Shareholders
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ADemergerCaseStudy
Step5– LegalSteps
A demergeragreementisenteredintobetweentheliquidator,theshareholders,NewCo1andNewCo2.ThisagreementprovidesfortheliquidatortodistributethesharesofTradeCo1toNewCo1andthesharesofTradeCo2toNewCo2.Inconsideration,NewCo1andNewCo2issuenewsharestotheshareholders.
Taxissues: Providedthetransactionisbeingundertakenforbonafidecommercialreasons,thennocorporationtaxliabilityshouldbetriggeredinNewHoldCo,whenitssharesinTradeCo1andTradeCo2aredistributedbytheliquidatortoNewCo1andNewco2,respectively.ThosesharesaretreatedfortaxpurposesasiftheyhadbeendisposedofbyNewHoldCo,andasacquiredbyNewCo1andNewCo2,respectively,attheirtaxbasecosts. The“combined”clearancewillincludeaclearanceundersection139TCGA1992toconfirmthatnotaxliabilityarisesonNewHoldCo,asaconsequenceofitsdisposalofsharesinTradeCo1andTradeCo2bytheliquidator.
NewHoldCo
TradeCo2
100%
NewCo1 NewCo2
TradeCo1
NewHoldCo/LiquidatortransfersthesharesinTradeCo1toNewCo1
Shareholders
NewHoldCo/LiquidatortransfersthesharesinTradeCo2toNewCo2
NewCo1issuesnewsharestotherelevantShareholders
NewCo2issuesnewsharestotherelevantShareholders
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Step5– Taxissues(continued):
Thereshouldalsobenotaxliabilityfortheshareholders,asreconstructionreliefshouldbeavailable.Theshareholders’taxbasecostsintheirsharesofNewCo1andNewCo2shouldbeequaltotheirtaxbasecostinNewHoldCo(whichwasequaltotheirtaxbasecostinthesharesofTradeCo1beforethereorganisation).ThisputstheshareholdersinthesametaxpositionastheywerebeforethereorganisationwiththeirtaxbasecostnowsplitbetweenthetwoNewCos. The“combined”clearancewillincludeaclearanceundersection136TCGA1992toconfirmthatnotaxliabilityarisesontheshareholdersasaconsequenceofthisstep.
AlthoughTradeCo2leavesthegroupwithinsixyearsofanintra-grouptransferofassetstoit,nocapitalgainsde-groupingchargearisesbecausethateventisasaconsequenceofamemberofthegroupceasingtoexist(section179(1)TCGA1992andsection788(1)CTA2009).Aclawbackofgroupreliefforstampdutylandtaxshouldalsonotbetriggeredbecausethede-groupingisaconsequenceofa“windingupofthevendororanothercompanythatisabovethevendorinthegroupstructure”(Para4(4)Schedule7FA2003).
ThetransactionisalsolikelytoqualifyforreconstructionrelieffromstampdutyforthetransferofthesharesofTradeCo1andTradeCo2providedthereorganisationisnotpartofanarrangementtotransfertheultimateownershiptooneormoreidentifiedthirdparties(Sections77&77AFA1986)
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ADemergerCaseStudy
Post-LiquidationStructure
Asaresultoftheconclusionofstep5,TradeCos1and2willhavebeensplitintotwosegregatedbusinessesbothofwhichcanfunctionindependentlyandeachofwhichareheldbydifferentshareholders.Forthepurposesofourcasestudy,eachofTradeCo1andTradeCo2cansubsequentlyissueemployeeparticipationsharestotheirrespectivemanagementteamsasameansofincentivisingtheteamstogrowtherespectivebusinesswithaviewtoapotentialfuturesaleofoneorbothofthedemergedbusiness.
TheliquidatorwillthenproceedtofinalisetheliquidationofNewHoldCo.Asthereisnotradinghistoryattachingtothiscompany,taxclearancewillnotlikelyberequiredandtheliquidatorwillseektoholdafinalmeetingoftheshareholderspriortomovingittodissolutionasquicklyaspossible.
RelationshipbetweenTradeCo1andTradeCo2
Ifrequired,aservicesagreementmaybeputinplacebetweenTradeCo1andTradeCo2togoverntheprovisionofservices(ifany)fromonetotheother.
Taxissues: Theshareholdersareinthesamepositionastheywerepriortothedemerger. Inparticular,theyarestilltaxedondividendsandgainsinexactlythesamewayastheywerebeforethereorganisationexceptthattheynowhavetwoinvestmentsinsteadofone.
NewCo1
TradeCo1
NewCo2
TradeCo2
ShareholdersShareholders
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Overviewoflegalfeasibilityissues
1.DissentingshareholdersAlthoughitispossibletoimplementademergerwithdissentingshareholdersinthecurrentholdingcompany,itisgenerallymorecomplicatedandcostly. Additionalproceduresmaybeneeded,suchasacourt-approvedschemeofarrangement.
2.DistributablereservesinthecurrentholdingcompanyAswehaveseen,atypicalsection110demergerinvolvesinsertinganewcompanyontopoftheexistingholdingcompany,bymeansofashare-for-shareexchange.Theexistingholdingcompanywouldthenhiveupassetsorsharestothenewholdingcompanybywayofadistributioninkind. Theexistingholdingcompanymusthavesufficientdistributablereservestodothis. Itwouldalsoneedtohaveauthorityinitsarticlesofassociationtomakeadistributioninkind.Eachofthesepointsshouldbecheckedwellinadvanceofimplementationofthedemerger.
3.IndemnitiesinfavourofliquidatorsUsually,thedemergerhappenssoonaftertheliquidationofthenewholdingcompanyiscommenced.Thismeansthattheliquidatorwillnothavecompletedtheusualprocessofadvertisingforcreditors.Theliquidatorswillthereforetypicallyrequireindemnitiesfromtheultimateshareholdersagainstclaimsmadebyanycreditors.Inpractice,thisisnotusuallyanissuebecause,bydefinition,newholdingcompanyhasnotpreviouslytraded.Sometimestheindemnitymightincludethirdpartiesandagreementonthetermsofallindemnitieswouldbesoughtpriortotheliquidator’sacceptanceoftheappointment.
4.ConsentsfromthirdpartiesTheconsentofbanksorotherthirdpartylendersmayberequiredinordertoimplementthedemergerandshouldbeconsideredwellinadvance.Ifatradeorassetistobetransferredaspartoftheproject,thenthirdpartyconsentsmayalsoberequired.Foranoverviewoftypicalconsents,seethefollowingarticleontheLCNLegalwebsite:Legalfeasibilitychecklist:IntragrouptransferofUKtradeandassets
5.ChangeofcontrolissuesonatransferofsharesWheresharesarebeingtransferredaspartoftheproject,theremaybechangeofcontrolissuestoconsider,eveniftheultimateownershipofthecompaniesconcernedisnotchanging. Forexample,asubsidiarycompanymaybeapartytoajointventure.Thesharesinthatsubsidiarymaybetransferredbytheexistingholdingcompanytoanewholdingcompanyaspartofthedemerger.Thatchangeinshareholdingmaytriggerchangeofcontrolprovisionsinthejointventuredocumentation.
6.LargenumbersofshareholdersIfthereisalargenumberofshareholdersintheexistingholdingcompany,considerwhetherthedemergerwillinvolvean“offerofsecuritiestothepublic”forthepurposesoftheFinancialServicesandMarketsAct2000.Typically,theviewistakenthatitshouldnot,butthatwilldependonthespecificcircumstancesinvolved.Inpractice,ifalargenumberofshareholdersisinvolved,thenitalsobecomesimportanttoanticipatethepossibilityofshareholderdissentandtoputinplacecontingencyplans.
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One of our co-founders, Paul Sutton, was previously a corporatepartner in the London office of Pinsent Masons, and before that aDirector in KPMG’s law firm in London. Our other co-founder, XiaofangSutton, studied law in Beijing and Edinburgh. She then helped theLondon Chamber of Commerce and Industry to establish its ChineseBusiness Association. During that time, Xiaofang worked with manyChinese state-owned and family-owned businesses.
OurseniorlawyershavetrainedandworkedatinternationallawfirmssuchasLinklatersandBaker&McKenzie.Collectively,ourteamhasover50years’experienceofthelegalimplementationofgroupreorganisationsandinternationalcorporateinvestmentstructures.
We have acted on the legal implementation of groupreorganisations for household name clients in a range of sectorsincluding telecoms, electronics, retail, financial services, IT,consulting and outsourcing. This has involved projects includingcorporate migrations, cross-border mergers, share and asset salesand acquisitions, business sales, corporate streamlining, transferpricing compliance, eurobond listings, removing of dividend blocksand the unwinding of tax planning which is no longer appropriate.
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