What if the value or appraisal of assets changes during the course of a corporate reorganisation?
An appraisal of assets in the course of corporate reorganisations is a required element for determining their value when transferred from one company to another as a result of a merger or demerger. But the procedure for reorganising companies is often lengthy, and during the course of the procedure components of the transferred assets or liabilities may change due to ordinary or extraordinary circumstances. Or the appraisal itself may change. This raises a fundamental question of the extent to which the reorganisation documentation must be modified, including the draft terms of merger or demerger, and how these changes can be reflected in the accounting records without having to redo the entire reorganisation procedure.
This issue arose in the case of a demerger of a Polish company, accompanied by transfer of certain assets to a newly formed company. Originally, in the draft terms of demerger, the company adopted the balance sheet valuation of the transferred assets. Then, a market valuation was subsequently commissioned, which showed a significant difference in the value of the transferred assets. Was it permissible—and if so, under what conditions—to update the documentation to reflect the current data, while increasing the agio accompanying the acquirer’s capital increase?
The argument for this possibility was simple: in the course of several months of reorganisation, normal business activity is carried out, as a result of which the value of the transferred assets may change. But the counterargument is that a change in the valuation methodology is not equivalent to a change in the composition or value of the assets, and the valuation provided in the reorganisation documentation is intended to set a value that is then carried over into the financial data of the acquirer and the rights of shareholders participating in the demerger, who rely on this data to take certain decisions in accordance with the procedure set out in the regulations.
Rules for determining the value of transferred assets
At this point, it is worth tracing the statutory regulations in Poland pertaining to the respective types of corporate reorganisations.
In the case of a merger of companies, the draft terms of merger must be accompanied by a determination of the value of the assets of the company being acquired or of the companies merging by forming a new company, as of a specified date in the month preceding the filing of the application for announcement of the draft terms of merger, and a statement with information on the accounting status of the company prepared for purposes of the merger as of the same date, using the same methods and in the same layout as the last annual balance sheet (Art. 499 §§2–4 of the Commercial Companies Code). In the statement, it is not necessary to present a new inventory, and the values shown in the last balance sheet should be amended only if necessary to reflect changes in the accounting records.
Among other things, in a cross-border merger of companies, the draft terms of merger should include information on the valuation of assets and liabilities transferred to the acquiring or newly formed company as of a specified date in the month preceding the filing of the application for announcement of the draft terms of merger (Commercial Companies Code Art. 5163 §1(13)). Also, the draft terms of a cross-border merger should indicate the date of closing the accounting books of the merging companies used to set the terms of the merger under the Accounting Act (in particular, Art. 12(2) and following).
The demerger procedure requires the draft terms of demerger to include, among other things, a detailed description and allocation of property (assets and liabilities) and permits, concessions or exemptions attributable to the acquiring companies or newly formed companies (Commercial Companies Code Art. 534 §1(7)). Among other things, the draft terms of the demerger must be accompanied by a determination of the value of the demerged company’s assets as of a specified date in the month preceding the filing of the application for announcement of the draft terms of demerger, and a statement with information on the accounting status of the company, prepared for purposes of the demerger, as of the same date (Art. 534 §§ 2–(4)) (subject to certain exceptions, for example an accounting statement is not required with consent of all shareholders of each of the companies participating in the demerger). As in the case of mergers of companies, the statement does not need to present a new inventory, and the values shown in the last balance sheet should be amended only if necessary to reflect changes in the accounting entries.
In a cross-border demerger, the draft terms of demerger should include, among other things, a detailed description of the property (assets and liabilities) and permits, concessions or exemptions of the demerged company, and a statement on their allocation to the newly formed company or companies, or the method of their retention by the demerged company in the case of a demerger by split-up or a demerger by spin-off, including the provisions on the classification of assets or liabilities not allocated in the draft terms of cross-border demerger, such as assets or liabilities unknown at the time the draft terms were prepared, as well as information on the valuation of assets and liabilities attributable to each company participating in the cross-border demerger (Art. 5506 §1(14)–(15)). Also, the terms of the cross-border demerger should indicate the date of closing of the accounting books of the company being demerged used to set the terms of the cross-border demerger under the Accounting Act (in particular Art. 12 (2), (3a) and following).
In the case of conversion, i.e. a change in the company’s legal form, the draft plan of conversion should include, among other things, a determination of the balance sheet value of the company being converted as of a specified date in the month preceding submission of the draft terms of conversion to the shareholders (Art. 558 §1(1)). The draft terms of conversion must be accompanied by financial statements prepared for the purpose of conversion as of the same date, using the same methods and in the same layout as the last annual financial statements. In the case of conversion into a joint-stock company (S.A.), the draft terms of conversion must still be accompanied by a valuation of the assets and liabilities of the company being converted.
By contrast, in a cross-border conversion, the provisions require that the draft terms of merger include the repurchase price of the shares of a shareholder or partner who does not agree to the conversion, and the report of the management board of the company being converted should also include the method or methods used to set this price (Art. 5804 §1(9) and 5805 §3(1)).
The cited examples (the most typical ones) illustrate that depending on the type of reorganisation, the valuation duties are formulated somewhat differently, to adapt the requirements in this regard to the particular procedure and its effects on the entities involved. Apart from some cases, such as a conversion, where the balance sheet valuation is sufficient (with the exception of conversion to a joint-stock company), generally the regulations do not contain precise rules on the valuation methodology applied to determine the value of the transferred assets, and in particular whether it is possible to rely solely on the balance sheet value, or whether a market valuation or fair value under the Accounting Act should be applied. According to the general definition in Art. 28(6) of the Accounting Act, fair value is the amount for which a given asset could be exchanged or a liability settled in an arm’s-length transaction between interested, well-informed, but unrelated parties.
In the section on mergers, the Accounting Act contains a number of regulations on determining the fair value of individual assets acquired, which, however, refer directly to the merger date, defined in the act as the date on which the merger is entered in the register for the head office of the acquiring or newly formed company. But determining the value of assets for the purpose of preparing the draft terms of reorganisation is done much earlier.
So it should be emphasised that entry and recognition of the transferred assets as of the date of registration of the merger or demerger in the accounting books of the acquiring or newly formed company is a separate matter, and should be conducted in accordance with the Accounting Act (for example, in the case of mergers, using the acquisition method or the pooling of interests method).
Also, in the legal literature, there is no uniformity as to which asset valuation methods should be applied for preparation of documentation required for corporate reorganisations. In practice, the method of valuing assets is generally chosen within the discretion of the management board. If there are no significant discrepancies in the valuation of assets depending on the adopted methodology or points of issue over valuation between shareholders, companies often adopt the carrying value derived from the accounting books, unless the regulations explicitly prohibit it, because it cannot be considered unlawful to determine the value of the company’s assets on the basis of the balance sheet value. However, the same valuation method should be used for all companies participating in the reorganisation, to provide a uniform basis for determining the share exchange ratio (if such an exchange takes place).
Change in the valuation of assets during reorganisation
In answering the question of whether, in the course of reorganisation, in the documentation, it is possible to change the method of valuation of assets, transferred assets or liabilities as a result of a change in the valuation methodology, first of all we must examine the statutory regulations. The provisions clearly indicate that the value of assets should be determined as of a certain date in the month preceding the filing of the application for announcement of the draft terms of merger or demerger, and in the case of conversion, as of a certain date in the month preceding submission of the draft terms of conversion to the shareholders. Therefore, it should be assumed that the components of such assets as of the valuation date are known and the valuation itself should be prepared as of the date specified in the provisions.
Then, the prepared valuation constitutes the basis for determining, in particular, the exchange ratio or issue price of the shares taken up in the acquiring company (excluding situations where, for example, the merger is carried out without granting such shares on the basis of the amended provisions of the Commercial Companies Code) and the basis for making appropriate future entries in the acquirer’s accounting books, particularly the amount of equity. In other words, since the valuation is required as of a certain date in the preceding month, it is not permissible to change the methodology of this valuation at a different date and use an amended valuation in the course of the ongoing reorganisation. And if the valuation materially affects the financial figures adopted in the draft terms of reorganisation, the procedure must be repeated. However, the foregoing refers to the corporate data and documentation required to carry out the reorganisation, which does not exclude updating the accounting records as of the date of the merger or demerger in accordance with the Accounting Act. Thus, it may happen that the corporate documents (including the draft terms of reorganisation and resolutions) will not change despite the new valuation, while the accounting data will be adjusted as of the record date based on the current valuation (with the proviso that the share issue price assumed in the corporate documents will not then be modified).
Change in the composition or value of the transferred assets
The case is different when there is a change in the composition or value of the transferred assets as a result of business conducted by the company after preparation of the draft terms of the company’s reorganisation. Such a change might result for example from the sale of goods, inventory, purchase of semi-finished goods, or repayment of obligations, but also extraordinary events significantly affecting the value of the transferred assets.
We should note that determination of the asset value for the purposes of the draft terms of merger or demerger is prepared as of a certain date in the month preceding the filing of the application for announcement of the draft terms. This means that the value presented in the draft terms of reorganisation will generally be a historical value that may already be outdated on the day it is signed, let alone on the date of registration of the merger/demerger. Therefore, such changes do not result from the valuation methodology applied, but from specific events taking place after preparation of the draft terms of reorganisation. In such cases, it is necessary to assess to what extent these changes can be accommodated by appropriate updates to the documentation (for example, by exchanging one asset for another), by reducing or increasing the amount of the agio in the case of a planned share capital increase (i.e. adjusting the issue price), or by appropriate accounting entries reflecting goodwill (positive or negative), and to what extent they affect the exchange ratio in such a significant way that, in the absence of shareholder approval, it is necessary to change all the documentation required for the reorganisation.
For this reason, the management boards of the companies involved in the reorganisation are required to inform each other of all material changes in assets and liabilities occurring between the date of the draft terms of merger or demerger and the date of adoption of the resolution on merger or demerger, so that they can then inform the shareholders of these changes. This is because such changes might not only affect the exchange ratio, but also for example lead to an excess or shortfall in the contributed assets relative to the issue value of the shares obtained in exchange. Then such differences can be reflected for example by adjusting the issue value, or in practice most often the amount of the agio, to reflect the changes in the value of assets contributed to the acquiring company.
However, the duty of the management board to notify such changes can be waived with the consent of all the shareholders of each company participating in the reorganisation. Similarly, the provisions governing corporate reorganisations require, in principle, that the draft terms of reorganisation be examined by an auditor, while also allowing waiver of this obligation in most cases, with the consent of all shareholders (waiver is not allowed, for example, in the case of conversion to a joint-stock company).
Other doubts involving asset valuation in connection with reorganisations
Other concerns have arisen surrounding the regulations on valuing assets transferred in the course of corporate reorganisations. For example, in the case of a merger of companies, determination of the value of assets applies exclusively to the company or companies being acquired, or the companies merging by formation of a new company. Therefore, in theory, it covers the entities that will lose their legal existence as a result of the merger, whose rights and obligations will be taken over via universal succession by the acquiring or newly formed company.
But the Supreme Court of Poland has recognised that the literal wording of these regulations is generally inconsistent with the transactional practice in corporate mergers, because as a rule, to correctly determine the exchange ratio, it is necessary to determine the relationship between the values of the merging companies, i.e. to value the acquiring company as well (judgment of 7 December 2012, case no. II CSK 77/12, OSP 2013/10 item 96). In this ruling, the court employed a functional interpretation, holding that the valuation attached to the draft terms of merger serves to verify the correctness of the exchange ratio established in the merger plan, and therefore, “the valuations of assets of all merging companies, including the acquiring company, should be attached to the draft terms of the merger.”
The court also correctly pointed out that the valuation of a company is not the same as the valuation of its assets, as the valuation of a company should also take into account the off-balance sheet elements affecting the company’s market value (brand, goodwill, clientele, market position, knowhow, human capital, growth prospects, and capacity for market expansion). Thus the companies’ transactional value for purposes of merger reorganisations should be determined by valuation of the companies involved in the procedure, and not just valuation of their assets.
By contrast, in the judgment of 31 May 2011 (case no. I ACa 328/11, Lex no. 1135394), the Łódź Court of Appeals held that even if a valuation of the assets of the acquiring company would be desirable under the economic conditions of the merger, no obligation to enclose such a valuation with the draft terms of demerger can be derived from the current wording of Art. 499 §2(3) of the Commercial Companies Code. In other words, even assuming an obligation to include a valuation of the assets of the acquiring company with the draft terms of merger, the mere violation of this obligation cannot constitute sufficient grounds for declaring the merger resolution invalid or setting it aside.
Tax aspects of valuation
The discussion above regarding the valuation of assets transferred in reorganisations have focused mainly on corporate aspects. But it is also worth looking at these issues from the tax perspective.
To determine the tax consequences of a reorganisation for certain entities (e.g. a shareholder of a merged or demerged company), the Corporate Income Tax Act uses the concept of “issue value.” This term has a different meaning than that adopted in the Commercial Companies Code, and means the price at which shares are acquired, as specified in the company’s articles of association or equivalent document. Importantly, the issue value in this sense cannot be lower than the market value of the shares.
The “price” at which shares are acquired is determined in a corporate document, which is often created months in advance of restructuring. In turn, the moment when the tax liability arises, for which the issue value is relevant, is tied to the date of reorganisation (the merger date or demerger date). In this context, a question arises whether and how the tax consequences of the reorganisation are affected by the difference between the value derived from the corporate documents and the market value that arose between these dates.
The individual interpretations issued by the National Revenue Information Centre take the view that in the event of a merger, the assets of the company being acquired are converted into shares of the acquiring company. As a result, the price of taking up shares is the equivalent of the assets of the acquired company transferred to the acquiring company. This leads to the conclusion (as stated for example in the individual interpretation of 25 May 2023, no. 0114-KDIP2-2.4010.127.2023.2.SP) that “the issue value of the shares is considered to be ‘the price at which the shares are taken up,’ but ‘not lower than the market value of the shares.’ Therefore, if the value adopted for the purpose of the draft terms of merger is lower than the market value, in this case the issue value of the shares will be the market value of the assets of the company being acquired.” A similar position was confirmed in the interpretation dated 18 May 2023 (no. 0111-KDIB1-3.4010.90.2023.3.PC).
These interpretations show a rational approach to defining the issue value and taking into account the natural changes in the value of corporate assets during the restructuring process, but some practical aspects of the process remain unresolved. In particular, it is not clear whether determination of the issue value requires preparation of a separate market valuation as of the day before the merger/demerger.
On the one hand, there are no regulations directly imposing such an obligation. Also, it would be unreasonable to expect a valuation to be prepared for the purpose of determining revenue which, in principle, is not taxable (restructuring activities are generally tax-neutral for income tax purposes).
On the other hand, the legislative technique adopted by the Polish parliament may raise doubts in this regard. For example, the market value of the assets received by the acquiring or newly established company, determined on the date of the merger/demerger, in the part exceeding the issue value of the shares granted to shareholders of the merged or demerged company, is deemed to be revenue of the shareholder of the merged or demerged company. Following the foregoing reasoning, these values (market and issue values) should be the same, especially in a situation where control of the merged/demerged companies is retained by a single shareholder. It seems unreasonable to expect a separate determination of the market value in such a situation, also because the rule in reorganisations is to carry forward the tax value of assets adopted by the entity being demerged or acquired. Nevertheless, the regulations do not provide a clear answer to this question.
Conclusion
As may be seen, the legal issues related to the valuation of assets transferred in the course of corporate reorganisations in Poland are not interpreted uniformly. But on the practical side, close cooperation between the companies and their accountants, tax advisers and legal advisers is essential throughout the procedure to prepare the documentation and valuation methods that best reflect the companies’ financial situation. If, on the other hand, a need arises either to change the valuation methodology or to adjust the value of the transferred assets, then further steps should be taken in such a way as to minimise the risk of failure of the entire procedure. The timetable for registering organisational changes is often planned far in advance, and properly prepared documentation definitely streamlines the entire process at the stage of entering changes in the National Court Register.
Dr Kinga Ziemnicka, attorney-at-law, M&A and Corporate practice, Wardyński & Partners
Jakub Macek, attorney-at-law, tax adviser, Tax practice, Wardyński & Partners
