The Difference Between Holding Companies and Corporate Mergers

The Difference Between Holding Companies and Corporate Mergers

Pursuant to Article 111 of the Amendment to the Direct Taxation Law enacted in 2001, as well as Item 16 of Article 1 of the Law Amending Certain Provisions of the Fourth Economic, Social, and Cultural Development Plan of the Islamic Republic of Iran and the Implementation of the General Policies of Article 44 of the Constitution enacted in 2007, a merger is defined as follows:

A merger is an act by which two or more companies, while eliminating their separate legal personalities, form a single and new legal entity or are absorbed into another existing legal entity.

In the United States and English law, consolidation and merger in corporate law refer to a situation in which control over two or more commercial companies, particularly joint stock companies, comes under the dominance of one commercial company. In English law, the expansion of joint-stock companies occurs primarily through share acquisitions. The prevailing practice is that joint-stock companies acquire control of other companies by purchasing their shares, and true or statutory mergers occur only rarely. As a result, the various classifications of true mergers observed in United States law are generally not found in English law.

Comparison of the Objectives and Functions of Holding Companies and Mergers

United States courts have developed three theories regarding the effect of mergers on non-transfer clauses and statutory restrictions:

• The theory of transfer by operation of law.
• The theory of breach of condition.
• The intermediate theory.

Under United States law, it is generally accepted that a merger does not, by itself, constitute a breach of a non-transfer clause, as such clauses may hinder free trade and impose restrictive regulations. Proponents of the first and second theories maintain that a mere transfer arising from a merger should not constitute a breach of contractual conditions. However, if the merger results in increased risk or harm to the beneficiary of the condition, the merger may constitute a breach of contractual obligations.

An analysis of legal principles and foundations in Iranian law suggests that the second theory, as articulated in United States law, is more compatible with the Iranian legal system.

In Iran, mergers and acquisitions of control over commercial companies are carried out through the following methods:

• Statutory Merger: A statutory or true merger results in the dissolution of the merged company or companies. In Iranian law, true mergers of private sector companies were not expressly recognized prior to 2001. This lack of regulation contributed to the relative unfamiliarity of the concept of statutory mergers in Iran.
• De Facto Merger: A de facto merger does not require dissolution of the merged companies. It refers to a situation in which a commercial company acquires control over another company or companies by purchasing their shares or assets, without eliminating the legal personality of any of the contracting companies.
• Acquisition of Controlling Shares: A joint stock company may acquire control over another company by purchasing its shares. Through such an acquisition, the acquiring company may enter the board of directors and appoint its preferred managers, thereby exercising effective control. In this case, the legal personality of the controlled company remains intact, but the acquiring company may influence all major decisions and impose its policies on the subsidiary.

Acquisition of Assets

Rather than assuming management control, the acquiring company may purchase the target company’s assets. In this case, although the acquired company retains its legal personality, it is typically removed from active commercial operations.

In practice, joint stock companies may control other companies either by eliminating their legal personality or by exercising control without such elimination.

Differences Between Holding Companies and Mergers

Despite shared objectives in corporate combinations and expansions, holding companies and mergers differ in several key respects.

Difference in Legal Personality of Subsidiaries

In a merger, the acquisition and allocation of the net assets of one or more companies by another company results in the loss of legal personality of the merged company at the time of absorption. The merged company is effectively dissolved.

In contrast, in a holding structure, even when the holding company owns 100% of a subsidiary’s shares, the subsidiary retains its independent legal personality. Each entity remains subject to separate legal rules, and the functions and obligations of each unit are distinct. As a result, unforeseen losses incurred by one unit do not create legal obligations for other units and prevent total exposure of the holding group’s capital to a single risk.

Difference in Organizational Structure

Merged companies generally operate under a centralized organizational structure. Holding companies, however, more commonly adopt a multi-centralized or decentralized structure. Due to their size and diversity, many corporate groups require multiple centers of management. In such structures, separate divisions are established based on market diversity, technical systems, operating environment, historical background, and managerial capacity.

Difference in Accounting and Financial Reporting

One of the most significant accounting issues in holding companies is the consolidation of financial statements and reporting of subsidiary operations. Consolidated financial statements include the financial information of the parent company and all subsidiary companies and provide shareholders with a comprehensive view of profits generated through investments in subsidiaries.

Frequently Asked Questions Regarding the Difference Between Holding Companies and Mergers