Contribution of business unit to a limited liability company by means of a share capital increase

The resolution of the Directorate General for Registrars and Notaries (Dirección General de los Registros y del Notariado) (“DGRN”) solves certain problems raised  since the approval of article 71 of Law 3/2009, on structural modifications (“LSM”) and accepts the possibility of contributing a business unit to a limited liability company through a share capital increase with contributions in kind. Accordingly, there is no need to follow the rules on company reorganizations and, particularly, spin-off of business units, contained in the LSM.

This resolution addresses the registration note issued by the Commercial Registrar of Jaen in relation to a deed of a capital increase through contribution of a business unit in a limited liability company. The term business unit has been defined as a company’s group of assets that constitute an independent economic unit necessary for financial growth.

The Registrar argued that the contribution of business unit should be governed by article 71 on spin-offs rather than through mere contributions in kind. In both scenarios, a company contributes a business unit to another company and, in exchange, the contributing company receives shares in the transferee. However, choosing between one option or the other brings significant differences in terms of procedure and impact:

• A spin-off is considered as a particular type of company reorganization, with all that such corporate transactions involve (directors and third party reports, publicity, requirements for qualified majorities, creditors’ rights to object the reorganization, etc.). This type of company reorganizations are governed by the principle of “universal succession” (i.e, the totality of the assets and liabilities are en-bloc conveyed to the recipient and in the same act, and do not need to comply with the legal formalities required for the transfer of each individual asset or liability).
• As share capital increase in a private limited liability company requires the approval of the transaction by the general shareholders’ meeting of the qualified legal majority. Additionally, the contributing company shall approve the assets disposal by resolution of its directors, unless the asset is considered essential under article 160(f) of the Companies Act, in which case the approval shall be given by its general shareholders’ meeting. As regards the legal effects, each contributed asset and liability must comply with its specific transfer requirements (e.g., in case of transfer of liabilities, the consent from the corresponding creditor must be sought; in case of transfer of real estate, a public deed is required; etc)

Traditionally in Spain, the contribution of business units was exclusively contemplated by tax regulations and was subject to the general rules governing capital increases through contributions in kind. Nevertheless, scholars discussed about the possibility of applying the rules on divisions to a contribution of business unit. Prior to the approval of the LSM, some resolutions issued by the DGRN considered that the contribution of business unit should not be subject to the divisions’ regulations and should be therefore governed by the regulations on in-kind share capital increases. After the approval of article 71 of LME on spin-off of business units, the possibility of applying the rules on spin-offs or in-kind capital increases was debated again.

By means of this resolution, the DGRN finally addressed this issue and resolved that, in the absence of an express prohibition, shareholders and companies are free to choose between contributing a business unit through a company reorganization (universally transferring all assets and liabilities to the contributed company) or an in-kind share capital increase (in which case, each asset and liability contributed shall meet its particular requirements for the transfer of ownership).

The DGRN bases its resolution in the following legal reasoning:

• Although there is a functional identity in both cases (the parties obtain the same economic outcome) there is no conceptual identity since their requirements and effects are different.

• The transaction cannot be qualified as fraudulent, which is what the Registrar of Jaen argued, because said qualification is out of the Registrar’s authority and, in any event, should be determined by a Court of competent jurisdiction. Besides, even if the transfer was qualified as fraudulent by a Court, it does not mean that the company reorganization rules should apply in any case. The Court would simply remedy the fraud (by, for example, declaring the joint and several liability of the transferee for debts of the contributing company).

•  If the lawmaker had wished to impose the reorganization procedure to all transactions involving the contribution of a business unit, he would have expressly set it out in the LSM, as it was done in the case of article 53, where it expressly ruled that global transfer of assets and liabilities in favour of a sole shareholder should be governed by the merger rules.

• The registration of a contribution a business unit through an in-kind share capital increase cannot be rejected based on an alleged protection of the stakeholders of both the contributing and contributed companies (which was one of the Registrar’s arguments), because the rules governing in-kind share capital increases already protect their interest through, for example, the requirement for directors and experts reports on the value of the contribution or the necessary approval of the creditors of the contributed liabilities under article 1,205 of the Civil Code.

In conclusion, the DGRN finally clarifies that a contribution of a business unit can be carried out either through a capital increase or through a particular type of company reorganization (spin-off), provided that the requirements and formalities applicable to each alternative are followed.