M&A Vocabulary – Understanding the Experts: “Debt Push Down”

The term Debt Push Down refers to a series of mechanisms aimed at “pushing down” a portion of the liabilities incurred by the acquirer of a company (or the acquisition vehicle established specifically for this purpose) to the level of the acquired operating target company.

The intended purpose may be driven by tax or financial motives:

• In the absence of a tax group for income tax purposes between the acquisition company and the target company, the liabilities incurred by the acquisition company and the resulting interest expenses often cannot be utilized for tax purposes. Since the acquisition company has no operating business and therefore generates no significant taxable income, the interest expense cannot be offset, or only partially so. The operating target company, on the other hand, is taxable in most cases. The corporate tax liability could be reduced if the liabilities were at the level of the target company rather than the acquisition company;
• From a financial perspective, the acquisition company’s liabilities are structurally subordinate to the repayment of the acquired target company’s liabilities and are therefore granted on less attractive terms compared to debt financing at the level of the operating target company. The closer a lender is to the assets and cash flow, the better their financing terms.

As a rule, a Debt Push Down takes the form of an extraordinary dividend distribution, a repayment of share premiums or capital reserves, or a capital reduction. This means that, in practice, the Debt Push Down is limited by the amount of distributable reserves (excluding share capital, legal reserves, statutory reserves, and revaluation reserves). To maximize the amount of distributable reserves, the operating target company can, by applying the Parent-Subsidiary Directive or the participation exemption, decide at its level to distribute the retained earnings of its subsidiaries without triggering significant tax burdens. Alternatively, a capital reduction of the subsidiaries can also be resolved.

If the companies involved are members of a tax group, another possibility would be the sale of fixed assets between group members. Under French tax law, any capital gains generally enjoy a tax deferral as long as the selling group member does not leave the tax group and the sale is economically justified. In legal systems that do not recognize tax deferral for transfers within a tax group and tax capital gains normally, the acquisition company’s interest expenses can at least be offset against the capital gains.

Debt Push Downs can be challenged on the grounds of abuse of majority power. According to the French view, this requires proof that the decision was made contrary to the corporate interest, with the aim of favoring the majority shareholder to the detriment of the minority shareholder’s interests.

Therefore, it is essential to be able to demonstrate that the target company will be able to continue to develop and repay its liabilities without difficulty despite the increased debt. For this purpose, it is recommended to obtain a credit rating report for the target company before carrying out the Debt Push Down.

An alternative to the above-mentioned mechanisms is the merger of the acquisition company into the target company, a so-called downstream merger. The interest and principal repayment burden is transferred to the target company. However, legal and tax issues can also arise here, particularly due to the frequent lack of interest on the part of the target company’s minority shareholders.

In practice, in the case of a Leveraged Buy Out (LBO) transaction, such a downstream merger can generally only be recommended 24 months after the original transaction has been carried out.

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