Downstream merger - when a subsidiary acquires its parent company

In restructuring practice, we most often encounter a model in which the parent company acquires its subsidiary (known as an upstream merger). A less frequently analyzed, but fully acceptable solution is the reverse model—a downstream merger, involving the acquisition of the parent company by its subsidiary.

The Commercial Companies Code ("CCC") does not contain a provision explicitly regulating this type of merger. It is based on the general provisions on mergers by acquisition (Article 492 § 1(1) of the CCC in conjunction with Articles 498-516 of the CCC). This means that a downstream merger is not a special construct from a legal point of view, but it is special from a functional and structural point of view.

1. The essence of a downstream merger

In a downstream merger, the subsidiary acts as the acquiring company, while the parent company acts as the acquired company. Upon entry of the merger in the register, the parent company is deleted and its assets are transferred to the subsidiary by way of universal succession.

The existing shareholders of the parent company become shareholders of the acquiring company. In practice, this often means a “flattening” of the holding structure—the holding level disappears and the owners obtain a direct position in the operating company (the acquiring company, in this case the subsidiary).

2. The problem of treasury shares

The most characteristic issue in a downstream merger is the question of treasury shares.

If the parent company held shares in the subsidiary, as a result of universal succession, the subsidiary will acquire its own shares. This is a technical effect, but one that has significant legal consequences.

Treasury shares cannot remain in the company's assets permanently. They must be sold or redeemed in accordance with the provisions on treasury shares.

In the case of a downstream merger, i.e. when a subsidiary (the acquiring company) merges with its parent company (the acquired company), the merger plan should clearly and precisely regulate the rules for granting own shares to the shareholder of the acquired company, taking into account the specific nature of this type of restructuring. In particular, the legal basis for the acquiring company's acquisition of its own shares (most often as a result of universal succession) should be indicated, the number and nominal value (or percentage share in the share capital) of own shares to be issued to a shareholder of the acquired company, and clearly describe the mechanism for their allocation – whether it takes place by operation of law on the date of the merger or requires an additional corporate action. The merger plan should also indicate the share exchange ratio, the date from which the own shares participate in the profit, and any restrictions resulting from the provisions on the acquisition of own shares. Such wording ensures the transparency of the process and minimizes the risk of objections as to the correctness of the acquisition of shares by the existing shareholder of the acquired company.

It is this structure that distinguishes a downstream merger from a classic acquisition of a wholly-owned subsidiary and explains why the simplifications provided for vertical mergers in Article 516 of the Commercial Companies Code do not apply here.

3. No procedural simplifications

Unlike the acquisition of a wholly-owned subsidiary (Article 516 of the Commercial Companies Code) or sidestream mergers (Article 515¹ of the Commercial Companies Code), a downstream merger requires the full merger procedure to be followed.

It is necessary to draw up a merger plan, prepare management reports, have the plan reviewed by an expert (as a rule), and adopt merger resolutions by the shareholders' meetings of both companies. There are no grounds for waiving the allocation of shares or limiting the protective mechanisms provided for shareholders and creditors.

This is because a downstream merger involves a real change in the ownership structure, which justifies the full application of the classic protective regime.

4. Economic sense and practical applications

Despite its greater formalism, a downstream merger can be a useful restructuring tool. It is sometimes used to:

simplify multi-level holding structures,
eliminate a holding entity that does not conduct operational activities,
prepare an operating company for sale or investor entry,
increase management transparency and reduce administrative costs.

This operation allows the burden of the corporate structure to be shifted to the operational level and eliminates unnecessary links in the ownership chain.

5. Risks and aspects requiring special attention

A downstream merger requires careful planning due to several key elements.

First, it is necessary to correctly determine the share exchange ratio to ensure equal treatment of shareholders. Second, the rights of minority shareholders and potential claims for compensation must be taken into account. Third, the tax implications, which can be significant in holding structures, cannot be overlooked.

Unlike in a sidestream merger, it cannot be argued here that the economic position of the shareholders remains unchanged. The change is real and structural, which requires full transparency and corporate rigor.

Summary

A downstream merger is a structure that is fully permissible under the CCC, although it does not benefit from any specific statutory simplifications. It is a more demanding operation than a classic acquisition of a subsidiary or a sister merger, primarily due to the issue of treasury shares and a real change in the ownership structure.

However, a properly planned downstream merger can be an effective tool for reorganizing a capital group and simplifying its structure. It does, however, require greater legal and capital precision than other models of merging companies within a single group.