Letter of Intent

The starting point for a merger & acquisition transaction in Switzerland is quite often the signing of a letter of intent (LOI). The potential buyer intends to conduct due diligence (dd) on the targeted entity. The seller needs protection against the transfer of business secrets. Generally the LOI contains secrecy clauses that protect the seller and allow the potential buyer to begin dd. Furthermore, the parties often stipulate in the LOI the extent of the dd to be conducted, the timetable for the transaction and the procedural issues involved with the dd procedure. LOIs may also contain exclusivity clauses, since the dd procedure involves substantial costs, and since the potential buyer incurs those costs only if he has assurance of being the only bidder. Other clauses contained in an LOI include the initial proposed purchase price and other issues essential to the proposed purchase agreement. It is not unusual that a disagreement on material issues is identified at a very early stage when the parties execute an LOI, saving time and costly dd procedure.

Due Diligence

The purpose of dd is for the buyer to obtain information from the seller that is not already available through public information. Contractual representations and warranties usually only cover the existence of certain assets and the absence of particular liabilities. A seller is usually not willing to guarantee certain financial and relevant price factors such as EBITA or future net profits since those factors are in the hands of a buyer, post-closing. DD should also enable the board and the management of the buyer to meet its own fiduciary responsibilities.

DD should help the buyer to overcome information gaps. From a practitioner’s standpoint, it is advisable that dd take place after signing the LOI and before signing the purchase agreement (Presigning dd). Postsigning dds also take place in Switzerland. In fact, presigning or postclosing dd may prompt purchase price adjustments.

It is not uncommon for the seller to have legal or contractual secrecy obligations. Those confidentiality concerns are usually addressed by respective secrecy agreements, though they are difficult to enforce as a practical matter. If secrecy obligations cover third party interests, the solution to the problem is very often that the confidential data is made anonymous. Another solution is that an accounting firm hired by the seller can provide a dd report covering the third parties’ secrecy concerns.

Considering the extensive costs, the scope of dd must be discussed before the dd procedure commences. The size of the transaction is one decisive factor. In depth dds are also very time consuming. The relevant issues to both parties of the potential transaction should be defined, if possible, in advance. If a high-tech company is the target, intellectual property issues are emphasized. Industrial targets demand a closer look at the environmental risks.

In general, legal dd usually covers the target’s corporate and contractual law issues. DD should also identify material pending or threatened litigation and employment related legal issues. Real estate, anti-monopoly and insurance issues are additional decisive factors. Pension funds should be reviewed but are often not looked at closely in dd. This is because pension funds are highly regulated in Switzerland, and as long as so-called "collective foundations" managed by Swiss banks or Swiss insurance companies are involved, pension fund risks are rather limited. DD should also identify all governmental permits which are required to conduct the target’s business activities. Tax and financial dds are separate fields which are often covered by accounting firms and should be distinguished from the legal dd discussed herein. Increasingly popular in Switzerland are so-called "management audits" (human resource audits) whereby certain weaknesses in the management can be identified at an early stage.

Stock Purchase Agreements

Stock purchase agreements for Swiss companies are similar to and can be compared in all relevant aspects to stock purchase agreements entered into elsewhere in the world. The two issues of representations and closing are addressed herein.

A seller must only warrant for deficiencies that the buyer did not know or should not have known when signing the stock purchase agreement. Through an extensive dd procedure, the buyer usually uncovers and obtains knowledge about certain deficiencies which are then as a practical matter intensively discussed during the purchase negotiations. A problematic area involves documents that were disclosed during the dd procedure but their specific financial and legal exposures or ramifications were not referred to or discussed by the parties. For instance, if both intercompany agreements and the related managing accounts were disclosed, the seller may argue that the seller has sufficiently disclosed a deficiency and a diligent buyer and his tax advisers should have thoroughly reviewed the agreements against the accounts, comparing the differing amounts and could have easily identified that the intercompany transactions were not at arm’s length. In order to avoid such problems, it is advisable that disclosed information be clearly identified and provided in accompanying attachments. Second, deficiencies that are merely disclosed but not reviewed in detail should be excluded from the buyer’s warranty.

At the closing, the following documents are usually executed or exchanged by the parties:

(1) stock certificates, in case of registered shares with the appropriate blank endorsements;

(2) board resolutions including those approving the buyer as new shareholder; very often, a target’s articles of association require board approval for the shareholder’s entry into the stock ledger; such board approval can be denied for reasons set forth in the articles of association, for instance, if the acquirer is a competitor, if the buyer does not hold the necessary professional qualities, or if certain share voting percentages are exceeded;

(3) transfer of the stock ledger setting forth the buyer as a new shareholder;

(4) resignation letters of the board members appointed by the selling shareholder;

(5) bank checks or other documents evidencing the payment of the purchase price;

(6) and bank guarantees for the representation and warranties.

Shareholder’s Rights at Various Investment Levels

Generally, minority shareholders do not have the right to representation on the target’s board, unless the articles of association so provide. In addition to the disclosure requirements to which an acquirer is entitled when acquiring shares of a publicly listed company, an acquirer is also entitled to the following when reaching certain investment levels.

(1) A shareholder whose combined holdings represent at least 10 percent of the share capital may demand that a shareholders’ meeting be called.

(2) A shareholder whose combined holdings represent an aggregate par value of at least CHF 1 mio. may demand that a matter be included in the agenda of the shareholders’ meeting.

(3) A shareholder whose combined holdings represent at least 10 percent of the share capital or an aggregate par value of at least CHF 2 mio. may demand a court appointed special auditor to review specific facts of a proposal if a shareholders’ meeting previously declined such proposal.

The above described shareholder’s rights are those provided by law. Professional diligence requires the careful study of the target’s articles of association where lower barriers for minority shareholder’s rights may apply or where additional shareholder’s rights may exist.

Public Offerings

Until January 1, 1998, any buyer of publicly traded shares was only subject to the Swiss Takeover Code which was a self-regulatory set of rules established by the stock exchanges in Zürich, Geneva and Basel. Today, Swiss stock exchange laws provide for additional disclosure requirements, and if certain voting thresholds are met, a buyer is required to make a public tender. Disclosure and public tender rules apply only to companies registered in Switzerland that have their stocks or other investment papers, such as participation or benefit certificates (bonds are excluded), listed on the Swiss Stock Exchange (Cf. London City Code on Takeovers).

Due to the nature of the Swiss stock exchange laws, there are a number of foreign companies listed on the Swiss Stock Exchange which are subject to Swiss stock exchange laws only by virtue of so-called "listing agreements". These, however, do not bind the companies’ shareholders. Furthermore, stock corporations registered in Switzerland which have their shares listed exclusively on a foreign stock exchange are not subject to Swiss stock exchange laws.

If more than one third of the voting rights of a company are to be acquired, a buyer must make a public offer (so-called "mandatory public offer"). Such public offer is not required, if the target’s articles of association contain so-called "opting-up" or "opting-out "clauses. Opting-up means that a public offer must only be made if more than 49 percent of the voting rights are acquired. Opting-out frees a buyer from making any public tender. There are other public tender exemptions that the Swiss Takeover Board may grant such as transfer of voting powers within a corporate group, or in the case of reorganizations, for example.

In cases of mandatory offers, the offer price must be at least as high as the current stock exchange price and may not be lower than 25 percent of the highest price paid by the offeror in the preceding twelve months. In the case of a voluntary public offer, the offeror is free to determine the offer price with the only proviso that shareholders must be treated equally to the extent they belong to the same share class.

When a public offer is being tendered, there are extensive and very detailed requirements to fulfil the steps required in order to tender a public offer, in particular if competing offers are launched. The requirements insure that the shareholders have as much knowledge as possible and as much impartiality in choosing which offer they deem more appropriate and choose to accept. Where competing offers are launched, shareholders may withdraw their acceptances for the first offer if a second public offer is made. The initial offer may then be extended and can be amended by the first offeror and the shareholders may then choose between the competing offers.

An offeror must publish his offer in a prospectus containing true and complete information, in particular: a description of the offeror, current ownership of shares, the number of shares and options rights acquired over the last twelve months, the detailed terms of the public offer and the proposed financing. The prospectus must also set forth in detail the intentions the offeror has with regards to the target and any agreements with shareholders and management.

The prospectus must be audited by a qualified accounting firm in Switzerland. The target’s board is required to submit a report to the shareholders recommending or not-recommending the offer.

Any transactions materially affecting the target’s financial situation, in particular the sale of key assets and the establishment of golden parachutes, are prohibited during the whole offer period. However, as long as no public offer is launched, Swiss stock corporations are still able to introduce traditional Swiss defensive strategies, for instance limited voting rights of three or five percent which often occurs with large publicly traded companies in Switzerland, or by introducing voting shares with inequitable voting rights.

After successful completion of the takeover, Swiss stock exchange laws allow for certain squeeze outs whereby minority shareholders owning less than two percent interest in the company can be cancelled, provided those shareholders receive the same offer price as the other shareholders.

Acquisitions of more than 5, 10, 20, 33.3, 50 and 66.66 percent of shareholders’ voting rights must be disclosed to the Swiss Stock Exchange. As of December 31, 2000, a three year transitional period has elapsed, and any acquisitions made on or before December 31, 1997, must be now also be disclosed.

Beginning in 1998, new disclosure requirements have substantially increased the public information available on ownership of shares in public Swiss stock corporations. Prior to 1998, public Swiss stock corporations (but not their shareholders) were only required to disclose and publish the names of shareholders holding more than five percent interest in the company in the notes of their annual financial statements.

Acquisition of derivative financial instruments are also subject to the above disclosure requirements as long as performance in addition to a cash settlement is provided. The probability that the option will be exercised and any monetary value realized is irrelevant.

A disclosure notification must be made within four working days both to the Swiss Stock Exchange and the listed company. Following an additional two working days, the company is required to make a publication in the electronic media (such as Reuters, Bloomberg etc.) and the official Swiss Commercial Gazette. Before making their disclosures, companies may also file for an advance ruling whereby the Swiss Stock Exchange decides on any further duties the company may have to make additional disclosures. An advance ruling may be reviewed by the Swiss Banking Commission.

Competition Aspects

Notification requirements before the Swiss Competition Commission (SCC) exist if (first test) the entity concerned reported joint global sales of at least CHF 2 billion or joint sales in Switzerland of at least CHF 500 mio; and (second test) at least two of the entities concerned reported individual sales in Switzerland of at least CHF 100 mio. From a practical standpoint, it is usually advisable in mid-sized transactions to start gathering data for the second test as early as possible when negotiations begin or the LOI is signed. The above thresholds do not apply if the SCC has ruled in a formal decision that a particular entity has a market-controlling position.

For the computation of so-called "Swiss sales", a market impact approach is used, i.e., one should not look schematically at the sales figure for a particular entity involved, but rather should review whether these sales have an impact on the Swiss market. For instance, if a distribution company has sales of CHF 600 mio., one should review the sales that are made to clients residing in Switzerland.

In the banking sector, the above sales thresholds are replaced by 10 percent of the balance sheet totals (in compliance with the old EU-threshold system for banks and other financial institutions; now revised). The balance sheet totals for Switzerland are computed based on the claims the banking entity has towards clients (including other banks) residing in Switzerland, over the claims a banking entity has towards all other clients. This ratio is then multiplied by the balance sheet total. In the media sector, special thresholds apply, i.e., actual sales are multiplied by 20. Insurance businesses are judged on their gross premium volumes instead of sales.

The SCC must be notified of a transaction before the actual closing takes place. The notification is mandatory, if the thresholds are met. Contrary to EC-competition law, there is no fixed deadline for notification after the signing of a transaction has taken place. The only restriction is that the participating entities must refrain from closing a transaction for one month following notification to the SCC. However, on special request, the SCC may authorize an earlier closing if the SCC finds there are important reasons to allow the exception. Within one month following the notification, the SCC must decide whether it opens a full investigation. As a general rule, such full investigation must be completed within a four month period, and again, the closing cannot take place in that four month time period without the SCC’s explicit approval of the earlier closing.

The parties usually have an interest in notifying the SCC well in advance. Practitioners consider the signing of the stock purchase agreement as an ideal moment for notification though it is possible to provide notice even at an earlier stage, for instance when the letter of intent is signed. However, the entities involved are taking the risk that following the signing of the letter of intent, the stock purchase agreement may change the structure of a deal such that the SCC may require a revised notification and require a review procedure.

In its investigations, the SCC decides whether the entities involved gain or reinforce a controlling market position which reduces or eliminates efficient competition which cannot be justified for reasons of economic efficiency. Following its review, the SCC may prohibit a planned merger completely or it may approve it with certain restrictions.

If a planned merger has an impact on markets outside of Switzerland, any signing or closing may be subject to the approval of other anti-competition authorities such as the EU-Commission or the U.S. Federal Trade Commission.

Taxes

If a private individual taxpayer in Switzerland sells his shares in a company, there is no tax on any capital gain. However, one proviso should be made regarding the so-called "professional investor" who uses leverage, options or other derivative financial instruments. According to various Swiss Federal Supreme Court decisions, the following actions or characteristics may result in the qualification of a private individual taxpayer as a "professional investor": short holding periods between trades, particular professional knowledge, a certain level of trading frequency, or a strategical investment approach. If an individual taxpayer is deemed to be a "professional investor", he will be subject to capital gains tax on his transactions.

The other proviso applies in connection with the so-called "partial liquidation issue". Any dividends from a Swiss stock corporation are taxed at a federal withholding tax of 35 percent, i.e., the stock corporation is required to pay out only 65 percent of the dividends. Under certain circumstances (in particular in the case of an individual taxpayer in Switzerland) this withholding tax can be recovered through a set-off with the income tax the individual taxpayer must pay on the dividend income.

If a target has substantial non-operating and distributable assets, it makes good business sense, from a tax standpoint, to make a dividend payment since the acquirer is not interested in paying for non-operating assets. Conversely, the private shareholder is interested in realizing a complete private and tax-free capital gain and hence is generally opposed to such a dividend payment. As a practical matter, the target is usually sold along with the non-operating assets and the purchaser later on tries to repay the purchase price via dividend distributions or similar transactions. The Swiss tax authorities may consider such schemes as a partial liquidation with the following tax consequences: (i) on the corporate level, the target is levied with a 53 percent withholding tax (35 percent gross-up); (ii) on the former shareholder level, the individual taxpayer must pay income tax.

It is advisable to address the partial liquidation issue early in the negotiation process. Through appropriate contractual clauses, the acquirer’s subsequent transactions in connection with the target can be defined and the seller can be protected. Sometimes, it is also possible to receive a tax ruling under the so-called "rich buyer’s approach", whereby it is explained to the tax authorities that the acquirer has sufficient liquidity and that any dividend payments will not be used in order to repay the purchase price.

As a general rule, corporate taxpayers realize a fully taxable gain when selling shares. Substantial tax reductions exist only for investments of more than 20 percent held for more than one year which were acquired after January 1, 1997. However, those tax breaks only exist on the federal level with its uniform tax rate of 8.5 percent. As of January 1, 2001, the state taxing authorities are allowed but not required to introduce similar tax reductions.

Since state corporate tax rates are usually much higher than the federal tax rate of 8.5 percent - between 12 percent and 25 percent for instance in the cantons of Schwyz, Zug and Zürich and up to 30 percent in other cantons (depending on the municipality tax multiplier), it is advisable to review the income tax consequences for a selling stock corporation very closely and well in advance. None or substantially reduced state income taxes are levied on the state level in cases where a "holding company" or a so-called "auxiliary stock company" sells.

Stock transfers of a Swiss stock corporation are subject to a .15 percent transfer tax if either the buyer or the seller is a Swiss security dealer. Swiss security dealers are not only banks and other professional brokers in Switzerland, but also companies which own securities with a fair market value of more than CHF 10 mio. Swiss VAT is not levied in cases of stock transfers.

Last but not least, any acquirer should also review whether to buy the Swiss target via a Swiss acquisition company. By a subsequent merger between the target and an acquisition company, it is under certain circumstances possible to set off the repayments of the purchase price and other financing costs against operating income from the target.

Environmental Aspects

When acquiring targets with industrial activities, in particular chemical enterprises, it is advisable to conduct a separate environmental risk assessment. The costs of such environmental dd procedures are usually high. One should therefore review carefully whether environmental exposures can be adequately covered by respective representations and warranties. Particular prudence is required if material reconstruction of certain industrial sites is planned since it may result in environmental exposures which would otherwise be tolerable if untouched.

It is not possible to avoid any existing or material environmental liabilities by way of an asset deal, since both federal and state environmental laws target the so-called "business operator" regardless of actual ownership.

The main areas of environmental protection by federal and state laws cover air, noise, water and soil.

The various air and noise regulations both on the federal and state levels provide for detailed protection standards for existing and new business facilities. Pollution of surface and ground water is only allowed if such pollution will affect minimal pollution standards. Water discharge into local sewage treatment facilities requires special discharge permits insuring that there is minimum pollution in order to protect the health of human beings and animals and the environment in general.

When conducting a business in Switzerland, the operator is required to establish extensive disaster protection programs in case the business involves material risks for human beings and the environment. The operators are further required to make immediate disclosures to environmental protection agencies both on the federal and state levels in emergency cases (so-called "extraordinary events"). For hazardous substances, detailed inventory and secure storage and transportation are required along with extensive disclosure obligations.

Employment Law Considerations

Swiss Employment laws require notification and consultation both of employees and governmental labor agencies where an asset purchase deal is contemplated. It is also advisable to develop an information and public relation strategy towards employees and the general public at the time the LOI is signed

In cases of so-called "mass dismissals", the employer is required to conduct notification and consultation procedures. A mass dismissal exists if, as a rule of thumb, 10 percent or more of the employees are to be dismissed. The mass dismissal requires that: all employees be informed about the reasons for the restructuring, the number of employees to be dismissed, and the time period during which the employees should be expected to be terminated. All employees must be informed so that employees or employee committees can make proposals as to how termination notices should be given and how the consequences of the mass dismissal might be avoided or mitigated. Foreign investors should not fear the above notification and consultation procedure since no material time delay is involved if the mass dismissal is professionally organized. The most recent trend in Switzerland employs professional public relations consultants to assist companies with the nuances of mass dismissals.

Though there is no legal requirement, mass dismissals should be accompanied by a so-called "social plan" which grants various benefits to the employees who will be affected by the mass dismissal. The benefits will vary depending on the employee’s age and years of services. Sometimes, it is also possible to provide funding for the social plan from so-called "patronal pensions funds".

In addition to the employer’s duties that are required by law in the case of mass dismissals, other duties may arise from "collective labor agreements" that were previously entered into by an employer or an employer organization with its employees or unions. These collective labor agreements should be disclosed during dd and discussed between the parties.

Pension Fund Aspects

Pension funds in Switzerland are managed as separate legal entities which are independent from the employer (usually foundations). Considering this, many problems discussed in foreign mergers & acquisition transactions do not exist in Switzerland. To the extent there are any issues, they are to what extent should pension fund liabilities be consolidated or is an employer entitled to report certain pension fund reserves as assets under a consolidated viewpoint.

If a target is acquired, it is usually not advisable to liquidate its separate pension fund scheme in order to avoid the taxable realization of hidden reserves. However, if certain or all employees are transferred from their pension fund scheme to another pensions fund (e.g. the acquirer’s pension fund scheme; very often the case), the question must be answered as to how the so-called "free reserves" are divided up between active (contributing) employees and retired (receiving) employees. The Swiss merger & acquisition practice calls this procedure a partial liquidation. In such a case, it is necessary to draw up a special liquidation plan which must be approved by the supervising authorities. Unless such liquidation plan does not exist, the target runs the risk of substantial transfer payments.

A potential acquirer should also carefully review whether it is possible to reduce the purchase price (economically) via so-called "contribution holidays". In the case where free reserves exist, the pension fund board may decide that free reserves are used up by contribution holidays equally shared between employer and employees.

Banking Specifics

An acquirer or seller of more than 10 percent of the share capital or more than 10 percent of the voting share rights in a Swiss bank must notify the Swiss Banking Commission (SBC) of such acquisition or disposition. The same notification requirements exist for thresholds of 20, 33 and 50 percent of the share capital or the share voting power. The acquirer must also establish for the SBC that it can secure the Swiss bank’s ongoing solid business conduct. The ability of solid business conduct is evaluated based on the financial situation of the acquirer, its business activities and group structure. Conversely, the Swiss bank itself is required to notify the SBC of any shareholder changes within the above thresholds.

Special notification and permit requirements exist if a foreign acquirer intends to buy or sell shares in a Swiss bank. The SBC approves a foreign acquisition only if the foreign country where the acquirer is registered grants reciprocal treatment. The SBC makes available a list of countries which grant reciprocal treatment. The reciprocal treatment list has lost most of its importance due to the WTO/GATS Treaty on Financial Services. If a foreign financial group is the acquirer, the SBC regularly reviews as well whether there is sufficient consolidated supervision.

Investment Restrictions

Since October 1997, barriers for foreign investments in Swiss real estate have been substantially lowered. Before, investments by non-residents in Swiss corporations holding substantial real estate assets of more than one third (fair market value) required a permit. Such a permit was granted if the real estate served as a permanent business establishment and if the foreign owner was willing to exert business control usually as a member of the board. Particular problems existed with regard to real estate serving housing purposes.

Today, there are no longer investment barriers as long as commercial real estate located in Switzerland is involved. The so-called "land reserves" (unused commercial property) should not constitute more than 50 percent of the total owned commercial real estate. A lawyer’s close review is still necessary if there is substantial non-commercial real estate, for instance, if an insurance enterprise or a pension fund owns private houses or apartments. Investments in commercial real estate by non-resident individuals is also no longer a problem. However, foreigners residing in Switzerland under a one-year work permit (so-called "B-Permit") still encounter restrictions, when they invest in private real estate (for instance, they are not allowed to invest in more than 3'000 square meters), which is sometimes a solvable problem when high net-worth individuals intend to establish a permanent residence in Switzerland.

Aside from the above described investment restrictions in ownership of Swiss real estate and Swiss banks, which are from a practitioner's standpoint the most commonly reviewed issues brought by foreign clients, there are further barriers in terms of the insurance, airline, television and radio industries.

There are no restrictions on the repatriation of profits and capital gains from Switzerland. From a tax perspective, one exception may exist. The taxing authorities, both on the federal and state levels, usually require the existence of a minimum debt-equity ratio of 70/30 which may result in requalifications of interest payments into dividend payments. In case of requalification, the target is, as previously mentioned, confronted with a 53 percent witholding tax (35 percent gross-up) on the requalified interest payments.

Another exception exists in the corporate law requirement for building up mandatory reserves (so-called "general reserves"). Five percent of annual net income must be allocated to the general reserves until such general reserve attains 20 percent of the paid-in share capital. After that, 10 percent of dividends which are paid in excess of a dividend of five percent and any proceeds received in excess of the par value in case of further share issuance must also be allocated to general reserves. To the extent that general reserves do not exceed 50 percent of the share capital, general reserves can only be used to cover losses or to prevent or mitigate unemployment or other such measures. Special provisions on the establishment of general reserves apply to holding companies and licensed transportation and insurance businesses.

'The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.'