The exchange ratio constitutes one of the most important terms of a merger. Through it, the extent of the participation of shareholders or partners in the company resulting from the transformation is determined. Its importance is such that the legislator provides for specific protection where the exchange ratio does not prove to be fair and reasonable. The relevant defect does not lead to annulment of the merger. The law does, however, establish a specific right to compensation for the shareholder or partner adversely affected. For management, experts and advisers, the proper substantiation of the exchange ratio constitutes a critical point of responsibility.<\/p>\n
The legislator\u2019s choice not to treat an exchange ratio that is not fair and reasonable as a ground for annulment is connected with the need for legal certainty. It is also connected with the stability of corporate transformations.<\/p>\n
The valuation of the participating businesses and the determination of the exchange ratio often allow for different approaches. For this reason, even where the exchange ratio is not fair and reasonable, the validity of the merger is not affected.<\/p>\n
The protection of the shareholders or partners adversely affected is ensured through a claim for compensation against the absorbing company. In this way, reversal of the transformation is avoided, without leaving the financially disadvantaged partner or shareholder without protection.<\/p>\n
A finding that an exchange ratio is not fair and reasonable does not arise merely from disagreement with it. It requires examination of the financial data and parameters, the valuation method, the assumptions adopted and the effect on the position of the partners\/shareholders following the merger.<\/p>\n
The valuation of the corporate participations is based on their economic value before and after the merger. It is necessary to ensure that, following the merger, each partner\/shareholder retains a participation of economic value corresponding to that which they held before it.<\/p>\n
For the secure completion of the merger and the completeness of the relevant file, clear documentation and a clear connection between the figures, assumptions and final exchange ratio are critical.<\/p>\n
An exchange ratio that is not fair and reasonable may arise from an unjustifiably low or high\u2014and ultimately unequal\u2014valuation of the corporate participations.<\/p>\n
The first case will often prejudice the partners\/shareholders of the undervalued company. The second may dilute the position of the others through the increased\u2014excessive\u2014participation of others.<\/p>\n
This assessment is not limited to formal valuations. It requires an overall assessment of the actual economic value of the participations.<\/p>\n
Where goodwill arises, it is, in principle, allocated in proportion to the intrinsic value of the participations of the partners\/shareholders. It must, however, be demonstrated not only how that goodwill was determined, but also why it does not transfer an unjustified benefit to a particular group.<\/p>\n
Furthermore, in determining the exchange ratio, specific characteristics of the participating companies may be taken into account.<\/p>\n
These include the structure of the proprietary rights of partners\/shareholders, provisions of the articles of association, privileges, transfer restrictions or special voting rights.<\/p>\n
These particularities may affect the valuation of the participations and, logically, the determination of an exchange ratio that is fair and reasonable.<\/p>\n
Determination of the exchange ratio does not constitute an exact mathematical process. Valuation presupposes financial assumptions and assessments that leave the parties a reasonable margin of judgement.<\/p>\n
For this reason, there is not always one single correct exchange ratio. Different valuation methods or different assumptions may lead to different, equally reasonable results.<\/p>\n
This margin, however, cannot cover arbitrary, insufficiently substantiated or manifestly unbalanced choices.<\/p>\n
The correctness of the exchange ratio is assessed on the basis of the information that was known or could reasonably have been taken into account at the time the merger was completed.<\/p>\n
Subsequent developments do not, in principle, affect its assessment. Thus, the fact that an activity subsequently proved to be more or less profitable is not sufficient to challenge the exchange ratio.<\/p>\n
Subsequent events form part of the business risk assumed by the partners\/shareholders of the company resulting from the merger.<\/p>\n
The position is different where information already existed but was concealed, ignored or inadequately assessed.<\/p>\n
Where the exchange ratio is not fair and reasonable, the shareholder\/partner who has suffered loss is entitled to claim monetary compensation from the absorbing company.<\/p>\n
This claim constitutes the principal means of protection precisely because an exchange ratio that is not fair and reasonable does not affect the validity of the merger.<\/p>\n
A claim against the absorbing company does not exclude, where the relevant conditions are satisfied, parallel liability on the part of management members or experts.<\/p>\n
Of particular interest is the fact that bringing a claim for compensation does not always presuppose that the partner\/shareholder opposed the transformation.<\/p>\n
Their participation in the adoption of the relevant decision, or even their vote in favour of it, does not, in principle, preclude a subsequent reliance on an exchange ratio that is not fair and reasonable.<\/p>\n
The opposite view has nevertheless also been supported, although not particularly convincingly. According to that view, the claim should be recognised only in favour of those who opposed the merger or expressed reservations regarding it.<\/p>\n
The claim for compensation is brought against the absorbing company and is subject to a twelve-month limitation period from completion of the transformation.<\/p>\n
The claim may be pursued judicially. Extrajudicial settlement, arbitration or mediation are also not excluded, where the relevant conditions are satisfied.<\/p>\n
The short limitation period self-evidently requires timely financial and legal assessment by those adversely affected.<\/p>\n
The exercise of the claim by one shareholder or partner does not bind the others. Corresponding claims may be brought by different persons and decisions with differing content may be issued.<\/p>\n
The claimant must prove that the exchange ratio is not fair and reasonable, the loss suffered and the causal link between them.<\/p>\n
For this reason, the valuation, the expert report and the relevant corporate decisions acquire central evidentiary importance.<\/p>\n
Determination of the amount of compensation is connected with the margin of judgement recognised in determining the exchange ratio.<\/p>\n
Given that there is no single correct exchange ratio, compensation does not seek to identify one hypothetically exact figure. It focuses on whether the exchange ratio selected exceeded the limits of reasonableness.<\/p>\n
The purpose of compensation is to restore the loss caused by an exchange ratio falling outside the permissible limits.<\/p>\n
It seeks to restore the partner\/shareholder to the financial position in which they would have been had the exchange ratio been determined within those limits.<\/p>\n
Compensation does not operate as a new valuation from scratch, but as a correction of the financial loss.<\/p>\n
It is important, of course, to note that determining the specific financial loss will constitute a significant difficulty both for the person who suffered it and for the judge who will issue the relevant decision.<\/p>\n
Within the above framework, the protection afforded by the law is primarily proprietary in nature.<\/p>\n
The law does not restore the participation of the person adversely affected, nor does it reverse the merger. Instead, it protects the economic value of the injured party\u2019s participation through monetary compensation.<\/p>\n
In this way, the need to protect partners\/shareholders is balanced against the need to preserve transactional security.<\/p>\n
An exchange ratio that is not fair and reasonable in the context of a merger does not constitute a merely formal issue of numerical\/mathematical calculation.<\/p>\n
It constitutes a point of responsibility for management, experts and advisers.<\/p>\n
Documentation proves particularly important: the valuation method, individual assumptions, special rights, corporate particularities and the time of assessment.<\/p>\n
Departure from the permissible limits does not reverse the merger, but it may give rise to significant compensation liability.<\/p>\n
Those adversely affected must react promptly, prove their loss and substantiate\u2014usually with particular difficulty\u2014the amount of that loss.<\/p>\n
In the next article of this series, we will examine a merger by formation of a new company.<\/p>\n
<\/p>\n