News Spanish legislation aims to provide clear guidelines for mergers following structured leveraged buyouts, but the process remains unclear. Jose Fernandez-Ranada explains

Leveraged buyouts (LBOs) followed by a merger between the purchaser and the target company have been very common in recent years, particularly in the private equity field. Traditionally, there have been doubts over their compatibility with the rules prohibiting financial assistance.

The fact is that at a European level, an increasingly flexible approach is being taken in relation to transactions of this type. The Italian corporate law reform in 2003 and Directive 2006/68/EC are good examples of this trend.

The Spanish Bill on structural modifications to commercial companies, inspired in this regard by Article 2501 of the Italian Civil Code, apparently took the same line. However, the Bill's final wording does not clear up certain grey areas.

This type of transaction has traditionally sparked much debate among legal commentators in Spain, as some authors take the view that it contravenes the prohibition on financial assistance. By contrast, another broad section of the legal academic community has argued that the prohibition does not apply to these transactions. The main argument they use is that there are adequate legal safeguards in these processes to sufficiently protect the interests at stake.

The decision ruled by panel number 28 of the Madrid Provincial Appellate Court on 9 January, 2007, in the context of the Endesa tender offer (which the Spanish Civil Code does not recognise as binding case law) shed some light on this debate. In referring to the hypothetical event of a merger taking place subsequent to the tender offer, the panel held that such a merger would not justify the application of the prohibition, "because it is a process that already provides specific safeguards for creditors and minority shareholders".

In a merger between two or more companies, if any of them incurs debt in the immediately preceding three years in order to acquire control (or essential assets) of another company participating in the merger, the following rules would apply (according to article 35 of the Law on Structural Modifications to commercial companies):

• firstly, the merger plan must indicate the funds and the time periods stipulated for the post-merger company in order to satisfy the debt incurred;
• secondly, the directors' report must set forth the reasons that have justified the acquisition of control or of the assets and, if appropriate, justify the merger. The report must also include an economic and financial plan;
• and finally, the experts' report on the merger plan must contain an opinion on the reasonable nature of the matters referred to in the preceding two points, and make a determination on whether any financial assistance exists.

In principle, the initial wording of Article 35 in the Preliminary Bill on Structural Modifications sought to exclude leveraged mergers from the scope of the prohibition on financial assistance, introducing, at the same time, certain requirements that made sense from a transparency perspective to all parties affected by the merger.

However, certain restrictions that could make it difficult to carry out transactions of this type have subsequently been inserted. For example, the experts' report must make a determination on whether any financial assistance exists. The addition of this requirement implies that the objective of the article is not to exclude leveraged mergers from the scope of the rules on financial assistance. Even if the transaction is carried out in compliance with the transparency requirements imposed, following a merger procedure (and thus providing specific safeguards for creditors and minority shareholders), financial assistance may nevertheless exist.

The expert must issue a report on the reasons justifying the transaction and analyse whether there is a link or connection between the financial assistance transaction and the transaction to acquire shares or stock. If we look at the Madrid Provincial Appellate Court's decision previously mentioned, it seems that this would involve ascertaining whether the "determining reason for the transaction" was purely one of assistance (i.e. to have both debt and assets located in the same company).

As a result, the final wording of the Law on Structural Modifications has introduced a notable degree of uncertainty. Respect for transparency requirements, and the mergers procedure and its safeguards, does not exclude the risk of the transaction being viewed as a case of financial assistance. In this regard, the law's final wording seems to depart from the spirit of the Italian corporate law reform, from which we believe it draws its inspiration. Moreover, it does not seem right that an issue that is essentially legal in nature is left to the decision of an independent expert.

In addition, an expert's report will be needed even where there is a unanimous resolution in favour of a merger. The wording is not clear at all on this point. This begs the question as to whether the intention is to remove all possible exceptions to the expert's report requirement (as seems to be the case in Italy). If so, the costs of such a report would be unavoidable, even in the case of mergers benefiting from a simplified procedure, where a report was not required until now.