Carve-outs: top 7 legal issues impacting value creation

Not surprisingly, the economic success of complex carve-out deals fundamentally depend on good and early preparation and planning that also adequately covers the main legal issues, which may have a significant impact on time and costs and thus on value creation.

Below, we briefly set out our top 7 legal issues in carve-out deals that could have a material adverse impact on value creation:

1. Splitting shared contracts
   Sometimes, contracts are of relevance for both the carve-out unit and the remaining company (shared contracts). In principle, it is possible to split these contracts. However, the split can generally only be carried out with the consent of the other contracting party. It is not uncommon, however, for the contractual partner to make the granting of consent dependent on further commercial concessions.
2. Material agreements with change-of-control clauses
   The same applies if the carve-out unit also includes material agreements with change-of-control clauses. Typically, such clauses allow a contractual partner to terminate an agreement if the parent company of the other contractual partner changes during the term of the agreement. The carve-out of such agreements can only be implemented if the contractual partner waives its termination right for which, again, it may request further commercial concessions.
3. Transfer of material governmental permits, licenses and authorisations
   In not a few cases, the operation of a business unit depends on the holding of governmental permits, licenses and authorisations. Typically, these permits, licenses and authorisations cannot simply be transferred, but need to be reapplied for from the competent authority. The necessity of a new application is often overlooked and the duration of the reapplication is often underestimated. Both can lead to a critical situation for the carve-out unit.
4. Termination of profit and loss transfer agreements for legally independent business units
   Often, group companies to be carved out are intertwined with the rest of the group through intra-group agreements, such as profit and loss transfer agreements. The termination of such agreements can be very tricky and usually requires careful planning. In some cases, this intra-group relationship may only be terminated by entering into a termination agreement with effect as of the end of the business year of the controlled company. Sometimes, this may require creating a one-off short business year, which may further require the consent of the tax authorities and which becomes only effective upon its registration in the commercial register before the end of the newly created short business year. Thus, the parties are, to some extent, at the mercy of the tax authorities and the staff of the relevant commercial register in this context.
5. Transfer of pension liabilities
   Typically, the carve-out of business units includes the transfer of pension liabilities. Unless the parties do arrange otherwise, the pension liabilities may also include commitments owed to former employees of the company. These liabilities are therefore regularly of considerable economic relevance. In negotiations, this point therefore often takes a central part in the overall transaction.
6. Reconciliation of interests and social plan
   If, in addition, the carve-out would lead to a split of an existing business in the company, the company is obliged to negotiate with the works council on a reconciliation of interests (i.e. on the "whether" and "how" of this change of business) and conclude a social plan (i.e. provisions on compensation and mitigation of the consequences of the change of business for the affected employees). The carve-out may not be completed until the negotiations on a reconciliation of interests have been concluded. The negotiations can take several months, in extreme cases up to a year.
7. Transitional Service Agreements
   Typically, in integrated groups, a number of functions (IT, personnel administration, and accounting) are provided centrally for all group companies or business units. They are regularly not the subject of the carve-out transaction. Often, however, acquirers are not able to provide these central functions to the carve-out unit immediately after the acquisition day. These functions will then continue to be provided by the selling company for a certain transitional period (6 to 18 months; rarely even longer) under so-called transitional service agreements. This usually also induces the acquirer to pay a higher purchase price. The flip side, however, is that the company remains involved in the carve-out unit after the closing date and may not be able to focus fully on the new business strategy.