244 5 Equity and Shareholders’ Capital
Valuation. Valuation questions are a source of legal risk due to the openness of
valuation rules. Valuation questions can therefore give rise to litigation. They can
also give rise to other kinds of legal risks.
This can be illustrated by the US case of AOL Time Warner. A share exchange or a formal
merger can enable a shareholder to benefit from differences in the market valuation or dif-
ferent firms. During the dot-com bubble, the unrealistically high valuation of Internet firms
enabled them to merge with traditional firms on terms that benefited their shareholders; in
some cases, a large share block in a nearly insolvent company became a large share block
in a financially sound company. A classic example is the merger of Time Warner and
America Online in 2000. A new company called AOL Time Warner was created. The
smaller AOL had, in fact, bought out the far larger Time Warner. Because market condi-
tions at the time of the merger valued Internet-related shares much higher than traditional
media shares, the shareholders of AOL ended up owning 55% of the new company while
Time Warner shareholders owned only 45%. It turned out that this was favourable for AOL
shareholders but quite the opposite for Time Warner shareholders, because the profitability
and market valuation of internet companies fell soon after the merger. This forced a good-
will write down, causing AOL Time Warner to report a loss of $99 billion in 2002. At the
time, this was the largest loss ever reported by a company. In response to the huge loss in
2002, the company dropped the “AOL” from its name (see Wikipedia).
5.11.4 Mergers and Company Law
General Remarks
Although all legal entities can merge, the commercially most important merger
form is that of two limited-liability companies combining to form a single entity.
There are three basic merger forms: One or more companies can merge with one
existing company that survives the merger (merger by acquisition).^536 Alterna-
tively, two or more companies can merge and form a new company that survives
the merger (merger by the formation of a new company).^537 The third basic merger
form is the merger of a wholly-owned or almost wholly-owned subsidiary with its
parent company. It is a particular merger form, because it is subject to simplified
formalities.^538
Consequences of a merger. A merger has several consequences.^539 In the EU,
the most important consequences are as follows:^540 (1) The company designated as
the surviving entity continues its existence. (2) The separate existence of the com-
pany or companies that are merged into the surviving entity ceases. (3) All the as-
(^536) Article 3 of the Directive 78/855/EEC (Third Company Law Directive).
(^537) Article 4 of Directive 78/855/EEC (Third Company Law Directive).
(^538) Article 24 of Directive 78/855/EEC (Third Company Law Directive); Article 15 of Di-
rective 2005/56/EC (Directive on cross-border mergers).
(^539) See Bainbridge SM, Mergers and Acquisitions. Foundation Press, New York (2003) pp
155–156, referring to MCBA § 11.07.
(^540) Article 19 of Directive 78/855/EEC (Third Company Law Directive); Article 14 of Di-
rective 2005/56/EC (Directive on cross-border mergers); Article 29 of Regulation
2157/2001 (SE Regulation).