Major Mistakes in Corporate Reorganisation

Mainstream

Corporate reorganization is not an accounting operation, nor is it a way to “optimize taxes” with one solution. This is a complex structural process, errors in which appear not immediately, but years later - in the form of tax extra charges, claims of creditors, corporate deadlocks or loss of assets.

The question is not whether a reorganization can be carried out. The question is whether the business will remain legally sustainable once it is completed.

A successful reorganization begins with three checks:

1. What is the real business objective and how justified is it?
2. How will the interests of creditors, employees and partners be protected?
3. What are the tax, corporate and transaction risks that are being laid and how will they manifest themselves in 3-5 years?

If these three issues are not resolved before filing the first application with the registering authority, the company risks not continuing the business, but a cascade of litigation and fiscal problems.

When a corporate reorganization is required

Corporate reorganization in Russia and the CIS may be required if:

• The structure of business ownership changes and asset allocation is required;
• merger or acquisition of companies;
• It is necessary to separate non-core assets and operating business;
• a holding structure is introduced and management centers are created;
• the group moves to a single share (for JSC);
• business transfer between jurisdictions within the CIS;
• Redomiciliation of a foreign company to Russian jurisdiction is required;
• It is necessary to protect key assets from the risks of the underlying operating activities;
• pre-sale restructuring is carried out before selling to the investor;
• business is emerging from the deadlock of corporate conflict;
• consolidation of losses or redistribution of debt load is required;
• Bankruptcy or pre-bankruptcy proceedings have been initiated.

The mistake that most of the initiators of the reorganization make

Many companies start with the question:

In what form should the reorganization be carried out: Merger, accession or separation?

That's the wrong first question.

The right question is:

What is the structural objective to be achieved and how to minimize the risks of challenge so that the business can continue to operate without disruption?

Sometimes the best solution is to abandon the reorganization altogether in favor of transferring shares/shares or simply contributing to the property. Sometimes - the allocation with a deferred performance of obligations to creditors. Sometimes – cross-border merger, taking into account the legislation of the two CIS countries. Sometimes – refusal of quick registration and preliminary settlement of relations with creditors and tax authorities.

The reorganization does not require filling out forms P12001 and P12003, but rather strategic legal design.

Step 1. Check and justify the business purpose

The first thing that the court and the tax authority will check years later is not a set of documents, but the presence of a reasonable business purpose.

The key is:

• the economic logic of reorganization;
• No signs of artificial division of business;
• Reorganization with real efficiency improvement;
• the absence of the main goal in the form of tax savings;
• synchronization with investment agreements and corporate agreements;
• reflection of the business purpose in internal memorandums and protocols;
• compliance with the structure of the stated business logic of the group.

If the business purpose is not documented and substantiated, virtually any subsequent tax charge or creditor claim receives an additional argument in favor of the “scheme.”

Step 2. Choose the right form of reorganization

To continue your business, it is critical to choose a form that is appropriate to the task, rather than a tax board from a month ago.

You have to keep in mind:

• merger, accession, division, separation, transformation;
• the features of succession in each form;
• influence on licenses and permits;
• Transfer or termination of corporate contracts;
• the fate of shareholder agreements;
• consequences for previously issued bank guarantees and guarantees;
• The possibility of separation with the preservation of joint and several liability.

An error in the choice of form leads to the fact that the business does not get the legal effect that it expected: The license is terminated, the debt goes to the wrong person, the liability remains wider than expected.

Step 3. Complete due diligence before launch

Reorganizing without a comprehensive review is one of the most expensive mistakes.

Before submitting documents, it is necessary to collect and analyze:

• Corporate history and all minutes of general meetings;
• Shareholder registers/lists of participants;
• rights of third parties to shares and shares;
• existing credit agreements and covenants;
• guarantees, pledges, independent guarantees;
• Employment contracts and collective agreements;
• Licensing and franchising contracts;
• lease agreements with restrictions on changing control;
• intellectual property and the chain of title;
• incomplete trials;
• unfulfilled orders of the supervisory authorities;
• Tax history and the state of calculations with the budget.

Especially dangerous are hidden obligations that will appear after the reorganization of the successor, including unaccounted tax risks and unfinished inspections.

Step 4. Consider the interests of creditors and not provoke early claims

Creditors are the main uninvited participants in any reorganization in Russia and the CIS.

Mistakes at this stage include:

• Ignoring the obligation to notify creditors;
• pass the period for publication in the State Registration Bulletin;
• failure to provide security to creditors who demanded early performance;
• incorrect calculation of the transferred amount of obligations;
• leaving of “dormant” debts with the company, which after reorganization will become technical;
• omitting covenants prohibiting reorganization without the consent of the bank.

The creditor, whose rights have been violated, may demand not only early execution, but also a challenge to the reorganization itself, and in some cases, to bring controlling persons to subsidiary liability.

Step 5. Assessing tax risks beyond tax neutrality

A common myth is that the default reorganization is tax neutral.

In practice, tax risks include:

• VAT refund on transferred property;
• additional income tax in case of unequal distribution of assets;
• loss of the right to a special regime (USN, patent) during reorganization;
• consolidation of losses with restrictions and refusal of offset;
• requalification of allocation to the hidden sale of assets;
• transfer pricing claims after the structure change;
• artificial business splitting to preserve special regimes;
• Unreported tax obligations for the periods prior to reorganization.

Tax audit in respect of the legal predecessor may be completed by additional charges to the successor three years after the reorganization, when the business has already been rebuilt, and reserves have not been created.

Step 6. Comply with labor guarantees and avoid mass disputes

Reorganization is not a reason for terminating employment contracts, but employees are often the last to learn about the changes.

Key mistakes:

• dismissal on the grounds of reorganization without offering vacancies with the successor;
• violation of the notification procedure of employees;
• incorrect translation;
• loss of personnel documentation during transfer;
• Ignoring the opinion of the trade union where it is necessary;
• Changes in essential working conditions without following the procedure.

Labour disputes after reorganization create reputational risks, distract management and can lead to the recovery of workers with payment of absenteeism, especially if the reorganization is recognized as illegal.

Step 7. Documents without procedural defects

Procedural irregularities are the most frequent grounds for challenging reorganization.

It is necessary to ensure:

• carrying out inventory of assets and liabilities;
• preparation of a legally correct transfer act;
• compliance of the transfer deed with accounting data;
• Approval of the reorganization by the appropriate management body;
• compliance with quorums and voting procedures;
• accounting of minority shareholders’ rights, including the right to demand the redemption of shares / shares;
• correct notification of the registering authority;
• compliance with the timing and sequence of all stages;
• Notification of the antimonopoly authority, if required.

The transfer deed, drawn up formally, without detailing the rights and obligations, is one of the main causes of future corporate and tax conflicts.

Step 8. Manage succession, not just register changes

Succession is not the moment of making an entry in the USRLE, but a long transition period.

Practical problems of succession:

• the inability to re-issue the license without a new licensing procedure;
• Refusal of contractors to recognize a new debtor under continuing contracts;
• loss of rights to a trademark or domain name due to untimely re-registration;
• inability to transfer bank accounts and credit lines without the consent of the bank;
• blocking of transactions on accounts until the completion of the tax reconciliation;
• - termination of contracts containing restriction on change of control;
• Problems with the recognition of succession in foreign jurisdictions (including CIS countries).

The mistake here is that lawyers complete the project at the time of state registration, while the main work of seamless business transition is just beginning.

Step 9. Addressing the cross-border element within the CIS

When reorganization involving companies from different CIS countries, additional risks are added:

• Disparity between national reorganization rules;
• different regulation of succession with respect to obligations;
• tax implications in two jurisdictions;
• Currency controls and capital controls;
• the need to recognize the reorganization abroad;
• the risk of double taxation in the transfer of assets;
• Problems with cross-border transfer of personnel;
• Sanctions restrictions applicable to legal entities from certain jurisdictions.

Without a simultaneous analysis of Russian law and the law of the relevant CIS country, it is possible to create a structure that will legally exist in one country and not be recognized in another.

Step 10. Establish post-reorganization protection mechanisms

Completion of registration procedures does not mean that the risks are behind.

The post-reorganization strategy includes:

• monitoring of claims and claims against legal predecessors;
• Control of on-site tax audits for the periods before reorganization;
• audit of the transfer act execution;
• Closing of unused accounts and “technical” legal entities;
• notification of counterparties and re-issuance of contracts;
• consolidation of personnel and accounting documentation;
• Evaluation of the need for post-closing adjustments between participants;
• Resolving the remaining disputes with minority shareholders and creditors.

The absence of a post-reorganization plan often leads to minor procedural defects accumulating and escalating into a systemic crisis.

Merger or separation: risk-taking

The choice of form depends not on the overall reputation of a particular method, but on the business purpose, composition of assets, debt load and plan for continuing the business.

How to strengthen your position before the reorganization

The best protection against errors is laid in the preparation stage.

Prior to the start of the reorganization, it is necessary to:

• develop and approve a roadmap with legal, tax and accounting blocks;
• prepare a written justification for the business purpose;
• conduct due diligence of all participating companies;
• to draw up a detailed transfer deed;
• to agree on terms with major creditors and banks;
• inform key counterparties and receive confirmations;
• Check corporate contracts for restrictions;
• receive preliminary clarifications from the tax authority (if necessary);
• assess the need for antimonopoly approval;
• prepare a communication plan with employees;
• define the post-reorganization management structure;
• Provide legal support throughout the transition period, not just before registration.

The reorganization should not be designed for the moment of filing documents, but for the most tense scenario - a tax audit in three years or a creditor's claim for early repayment.

Common mistakes in corporate reorganization

1. Start without a written business purpose. In the absence of justification, any action becomes vulnerable to reclassification.
2. Choose a form for tax benefit, not business logic. Short-term savings often lead to long-term losses.
3. Ignore creditors and not notify them. This gives them the right to demand early execution or to challenge the reorganization.
4. To make a formal inventory. The transfer act without detailing the obligations creates a zone of uncertainty.
5. Forget about licenses and permits. Termination of the license in a reorganization may stop the core business.
6. Violate workers' rights. Mass layoffs or mistranslation lead to lawsuits and GIT checks.
7. Do not check the tax risks before reorganisation. The successor is liable for the debts of the predecessor, including future additional charges.
8. Miss deadlines and break the procedure. Procedural defects are the basis for recognizing the reorganization as invalid.
9. Not to mention minority rights. Requiring share repurchases/shares can create an unexpected financial burden.
10. Consider the project completed after registration. The main risks are realized in the first three years after the reorganization.

Checklist before the start of the reorganization

Before the reorganization begins, 15 questions must be answered:

1. Is the business objective defined and documented?
2. What form of reorganization is appropriate for this purpose?
3. Are there any legal and tax due diligence?
4. Are there restrictions on reorganisation in loan agreements and corporate agreements?
5. Who are the creditors and how will they be notified?
6. Is there a detailed transfer report?
7. What are the tax implications for each of the companies involved?
8. Will the licenses, permits and permits be retained?
9. How will the staff transfer be arranged?
10. Is the consent of the antimonopoly authority required?
11. Are minority rights and the right to demand ransom protected?
12. What assets are in dispute or under encumbrance?
13. Is there a cross-border element and is such a reorganization recognized in another CIS jurisdiction?
14. Who will provide post-reorganization support?
15. What is the worst case scenario and what reserves are created for it?

What a strong reorganization strategy looks like

A strong strategy usually includes five levels:

1. Corporate & Commercial Justification Justification - Justification of business purpose, choice of form, corporate procedures, protection of participants' rights.

2. Creditor & Stakeholder Strategy Mapping of creditors, notifications, negotiations, restructuring of claims, collateral.

3. Tax & Fiscal Planning Modeling of tax consequences, reservation, tax runways, assessment of requalification risks.

4. Regulatory & Procedural Execution Preparation of documents, compliance with deadlines, registration, antimonopoly approvals, licensing.

5. Post-Reorganization Integration & Protection Business transition, succession management, risk monitoring, closure of technical companies, settlement of residual disputes.

Without the fifth level, the first four give only an entry in the register, not a continuation of a sustainable business.

FAQ

Can the reorganization that has already been completed be cancelled?

Yes, in court, if significant violations of the law are committed, the rights of creditors or participants are violated, or the reorganization is carried out with signs of abuse of the right. In some cases, it is possible to restore a previously existing legal entity.

What's more dangerous: Tax audit or creditor claims?

Both risks are realized simultaneously. Creditors may require early execution within 30 days of notice. Tax increases may come years later when reserves are no longer available. No block can be ignored.

Can a reorganization be carried out without the consent of the creditor bank?

Technically yes, unless otherwise provided by the loan agreement. But in practice this provokes a default on the covenants and early recovery of the entire loan amount. Reorganizing without a dialogue with the bank is a risky move.

What if the minority shareholder demands the redemption of its share and blocks the process?

It is necessary to assess the financial ability of the company to fulfill the redemption claim and to pledge funds to the project budget before the reorganization begins. Trying to ignore this requirement will lead to a corporate dispute and challenge the reorganization.

Is the reorganisation always tax-neutral?

Nope. The tax code establishes cases when reorganization does not entail tax obligations, but these rules have exceptions. Incorrect structuring, subsequent sale of assets or unequal distribution can lead to additional accruals.

Can employees be fired during the reorganization?

You cannot be fired on the initiative of the employer only because of reorganization. In case of change of owner or reorganization, the employment relationship with the consent of the employee shall continue. The employee’s refusal to continue work is issued on special grounds.

How to protect yourself from claims on debts that were not reflected in the transfer deed?

In the case of separation and division, the law establishes joint and several liability for obligations not transferred or transferred in violation. The risk cannot be completely excluded, but it can be minimized by careful due diligence and a detailed transfer deed.

More importantly: speed of registration or full preparation?

For business, sustainability is more important. Hasty registration without settling relationships with creditors, employees, and tax authorities almost always leads to high costs in the future.

What is the difference between reorganization in the CIS and reorganization in the Russian Federation?

Cross-border reorganization requires simultaneous compliance with the laws of the two countries, recognition of succession abroad, and resolution of issues of tax residency and currency control. Mistakes at the jurisdictions junction are particularly difficult to correct.

Related services

• Corporate Reorganization, M&A and Cross-Border Restructuring in Russia & CIS
• Commercial Contracts and Corporate Governance
• Tax Planning, Disputes and White-Collar Defence
• Employment, Immigration and Mobility
• Regulatory Compliance, Licensing and Permits
• Cross-Border Investments and Joint Ventures

Related material

• How to choose the form of reorganization: step-by-step analysis
• Transfer Deed in Reorganization: How to Avoid Dispute
• Protection of creditors’ rights in the reorganization of a legal entity
• Tax Risks in Mergers and Separation of Business
• Employment relations during reorganization: jurisprudence
• How to Set Up a Business Purpose That Will Suppress Tax Audit
• Reorganization with a foreign element: Russia and CIS countries
• Due diligence before M&A and corporate restructuring
• Rights of minority shareholders in reorganization
• Post-reorganization integration: checklist

Conclusion

The main mistakes in corporate reorganization in Russia and the CIS are not due to ignorance of the law, but because of the attitude to reorganization as a technical measure.

Reliable continuation of business requires not a rapid change of entry in the register, and a strategic project, which is equally important business purpose, protection of creditors, tax security, compliance with labor guarantees and detailed planning of succession.

The winner in corporate reorganization is not the one who files the P12001 form faster. The winner is the one who understands in advance how the structure will stand the test of time, creditors and the tax authority.