Why a demerger?
Demergers involve part of a business breaking away from a larger Firm (Divesting Firm) to form a new Firm (Demerged Firm), usually by way of a transfer of business, assets and people. Often, Divesting Firms see demergers as an opportunity to strategically re-align their focus on their core business competencies and strengths and to streamline expenditure and operations. For the Demerged Firm, financial and management independence and the ability to potentially unlock untapped value for partners and employees in that part of the business can be a compelling driver to break away from the Divesting Firm.
The implications of a demerger: the break-up
There are many issues for Professional Services Firms to consider in a demerger. As a starting point Firms will need to factor into the timetable and commercial terms of the deal any constitutional provisions which are relevant to the demerger, including the requisite partner approval for the transaction and notice requirements, payment of outstanding capital and current account balances, restrictive covenants and other provisions affecting those partners who are transferring to the Demerged Firm.
Many Firms’ constitutional agreements will set out the specific voting thresholds and procedures to approve a divestiture of part of the business. The threshold required may be more than a simple majority and, depending on the specific agreement, could require as much as 90%, or unanimous partner, approval. It is, therefore, vital for the Firm to engage in advanced planning and consultation with the affected partners and wider partner body to ensure that the requisite buy-in can be obtained. Even once partner approval is secured, it may be that not all the partners who form part of the proposed Demerged Firm are on board with the demerger for professional or personal reasons. In these circumstances, the Divesting Firm will need to consider how to treat these partners going forward; if the demerger went ahead without the dissenting partners, the partners who are left behind may need to be re-deployed to other parts of the business or, if that is not possible, the Divesting Firm may need to agree exit terms with those partners.
Pre-completion, both the Divesting Firm and the Demerged Firm will want to ensure that a fair and balanced approach is taken to determining and valuing the assets and liabilities transferred, such as the work in progress and book debts of the transferred business and agreeing how these are dealt with going forward. This can be complicated for Professional Services Firms, especially in relation to valuing work in progress, book debts and apportioning liability/responsibility for recovery and credit control.
Carving up client engagements for transfer to the Demerged Firm needs to be dealt with carefully to ensure that professional duties to the clients are met and they feel well looked after. Both Firms will need to agree a managed approach to notifying affected clients and obtaining consent to transfer their files and confidential information and novate (or renegotiate) any terms of engagement.
Additionally, the Divesting Firm will be keen to ensure that professional indemnity and successor practice liabilities (if they are a law firm) are transferred to the Demerged Firm.
We expect to see more Firms choosing to demerge in order to streamline their operations in the coming months and it will be important that they ensure the right advice and steps are taken so that the process is smooth and the demerger is ultimately successful for both parties.
If your Firm is considering a demerger or if you have any questions on the issues covered above, please contact Partner Zulon Begum or Associates Wonu Sanda and Wendy Chung, all of whom advise partnerships and LLPs in all sectors (including law firms) on a range of legal matters, including partnership structures, profit sharing arrangements, partnership mergers and de-mergers, partner disputes and legal risk management.