Companies can divide certain parts of their assets/business units by way of spin-offs. This mechanism is advantageous due to various commercial and business necessities such as separating unprofitable business lines from the rest of a company, diversification of business risks, or facilitating senior supervision by focusing management attention on specific business lines, etc. This mechanism also aims to provide flexibility in many areas for both the parent and the newly established company. For instance, the newly established company could specialize in its core activity and operate its business more entrepreneurially, financially independently, and effectively as a spin-off from the parent company. Accordingly, spinoffs can be led by a dedicated senior management team who can focus their resources and time on the operation and financial performance of the new company.
On the other hand, in mergers and acquisitions, acquirers may wish to exclude some parts of a target company’s assets from the scope of a deal. In such cases, the target company may be subject to a spin-off as well.
Briefly, companies may consider a spin-off for a variety of reasons, including operational simplicity, tax management, risk diversification, improving efficiency and profitability, and regulatory/legal necessities.
A spin-off, which has its normative basis in between Articles 159-179 of the Turkish Commercial Code (“TCC”), can be carried out in two separate ways: full or partial spin-offs. In a full spin-off, all assets and business units of a company are divided and transferred to existing or newly established companies. The parent company is dissolved, its trade name is deleted from trade registry records and its shareholders become shareholders of the transferee companies.
In a partial spin-off, one or more units of a company’s assets are transferred to one or more existing or newly established companies. Unlike a full spin-off, the parent company is not dissolved and continues its business activities with its remaining assets.
Spin-off processes are vulnerable to various compliance risks which should be analyzed in-depth and managed proactively.
1. Identification of Business Purposes
Since one of a spin-off’s purposes is to separate a particular business area from others, it is important to identify business purposes and activities. This will help the parent company to identify the legal requirements (relevant spinoff agreements or plans, licenses, required filings for state institutions and organizations, etc.), legal duties and obligations, etc.
In addition, identifying business purposes will facilitate the compliance process since it limits the areas in which current and potential risks and liabilities will be determined.
2. Identifying Areas of Risk
It is crucial to adopt a risk-based approach to identify potential risks that relevant parties may encounter at the beginning of a spin-off transaction and post-transaction. In this way, the risks, especially caused by being under the influence of the parent company's cultural and institutional elements and thus its commercial, reputational and legal risks, may be largely eliminated. Of course, not all of the risks that may arise in a newly established company can be identified immediately. Therefore, monitoring activities and risk impact assessment should be started in the new company by ethics & compliance teams.
Particularly in spin-off transactions carried out to aid specialization in different business lines, it is important that specific sector compliance laws and regulations, licenses, etc. that are not adhered to in the parent company’s compliance program should be determined correctly. However, it should be noted that the compliance process is not just about such laws and regulations. As described below, legal and compliance due diligence are more secure mechanisms to specify any risks.
3. The Importance of Legal and Compliance Due Diligence
As mentioned above, transferee and transferor companies prefer the spin-off mechanism in practice for the purpose of excluding particular assets from a deal. Therefore, the detailed and meticulous implementation of due diligence to identify and analyze risks is crucial, giving the transferee an opportunity to examine the financial records, legal, employment issues, intellectual property, insurance, licences, litigation, and contractual obligations, shareholding structure and assets of the target company. Also, it can be determined whether the spin-off company has complied with competition, privacy and data protection legislation and whether it has previously undergone an investigation and faced a penalty.
In such an examination, particular attention should be paid to the relevant extra-territorial anti-corruption laws (i.e., The U.S. Foreign Practices Corruption Act, Brazil's Clean Company Act and UK Bribery Act, etc.) and corruption, bribery and money laundering risks in order to determine any suspicious transactions. Additionally, the jurisdiction to which the spin-off is subject should be within the scope of the examination, and government relationships, export controllers and trade sanctions of the jurisdiction should be examined separately.
Additionally, the scope of due diligence should include the importance given by the parties to the environment, workplace health and safety, human rights, and the preventive measures taken against potential violations of these issues.
4. Compliance Mechanisms Stipulated Under the TCC
Some protective mechanisms are envisaged in the TCC for spin-off transactions. According to Article 166/1 of the TCC, if a company transfers parts of its assets to existing companies through a spin-off, the managing bodies of the companies participating must make a spin-off agreement. In addition, according to Article 166/2 of the TCC, if a company transfers parts of its assets, through a spin-off, to newly incorporated companies, the managing bodies of the companies participating in the spin-off transaction must prepare a spin-off plan. A spin-off agreement and spin-off plan will specifically include details of the spin-off transaction such as trade names, headquarters and types of companies participating in the spin-off, the list of assets, units, exchange ratio of shares, assigned rights, the manner of share exchange, list of business affairs to be transferred as a result of the spin-off, special benefits granted to members of managing bodies, managers and other persons entitled to management rights and auditors, etc.
Additionally, according to Article 169 of the TCC, the management body must prepare a spin-off report including the purpose and consequences of the spin-off, its effects on employees, additional liabilities on shareholders and the effects of the spin-off on the company’s creditors, etc.
The spin-off plan, spin-off agreement and spin-off report should be in writing and are subject to approval by the general assemblies of companies. After approval by the general assemblies, the managing bodies request the registration of the spin-off transaction, and it becomes effective upon registration with the relevant trade registry. Following registration, all assets and liabilities in the inventory are transferred to the transferee company.
A spin-off transaction includes fundamental rights for the shareholders, creditors, business partners and employees of the spin-off company. For this reason, the liabilities and undertakings of the participant companies have significant importance with respect to shareholders, creditors, business partners and employees’ rights, which should be protected before initiating the spin-off transaction. In line with this, the TCC regulates the spin-off process in detail including general provisions, provisions regarding the application of the spin-off process, the right to audit and inspect division documents, spin-off resolutions, protection of creditors, responsibilities, and the transfer of business affairs, etc.
These requirements will contribute to the compliance process by determining and preventing possible risks and conflicts and ensuring transactions are conducted in a transparent and appropriate manner.
5. Further Compliance Requirements for Transferee Companies
While transferee companies could operate as independent entities after a spin-off transaction; it should not be forgotten that these companies are inextricably linked to parent companies. Transferee companies do not only transfer their predecessor’s assets, know-how, and labor, but also their intellectual property, corporate culture and compliance programs. It should be noted that a transferee company should not necessarily continue to use its parent company’s compliance program. Compliance processes for legal, financial, technological and other relevant areas should be reassessed and designed following a spin-off transaction. Otherwise, the previous compliance methodology may become incompatible and the transferee company may run the risk of potential compliance violations leading to administrative and criminal penalties, and reputational damage. For this reason, compliance requirements should be tailored to reflect the characteristics of a transferee company, its size, its operations, and the dynamics of the relevant industry.
Spin-off procedures have complex liabilities when considering general compliance responsibilities and regulations as summarized above. Companies should fully comply with tax, legal, employment and relevant sector regulations on a national and/or international basis. For this reason, spin-off transactions should be subject to compliance procedure because unforeseen compliance risks may have negative consequences such as financial and reputational losses, as well as criminal, administrative and legal liabilities. Compliance is also important for companies targeting the development of their business areas and increased profits by way of separating particular assets from a parent company.