Reverse Merger and the Merger of Dormant Companies: Strategic Planning or Sham Transaction?

This article examines the use of reverse mergers and the merger of dormant companies as tools for corporate reorganization, focusing on the distinction between lawful strategic planning and simulated or fraudulent schemes. The analysis considers the legal treatment of corporate mergers, the typical objectives pursued in reverse transactions or involving inactive entities, and the limits imposed by civil, tax, and corporate law. Doctrinal and case law criteria are highlighted to assess the legality and economic substance of such operations.

Corporate restructuring is a legitimate and widely adopted instrument for operational optimization, business succession, tax efficiency, and the reorganization of corporate groups. Among the mechanisms recognized under Brazilian law are mergers, spin-offs, and incorporations (Articles 1,116 to 1,122 of the Civil Code and Articles 227 to 229 of the Corporations Law).

Among these, incorporation refers to the operation by which one or more companies are absorbed by another, with the full transfer of their assets and liabilities. A particular variation — the reverse merger — occurs when a parent company is merged into its own subsidiary, thus reversing the traditional merger logic.

Another common yet legally sensitive practice is the merger of dormant companies (i.e., companies without active operations, maintained for accounting, tax, or registration purposes).

This article analyzes the legal aspects of such operations, differentiating lawful planning from artificial or simulated structures based on corporate law, the Civil Code, and prevailing jurisprudence.

2. Reverse Merger: Concept and Legal Basis

2.1 Concept

A reverse merger occurs when a parent company is absorbed by its subsidiary, resulting in the formal dissolution of the parent and the continuation of the subsidiary as the surviving entity.Example: Company A, which controls Company B, is merged into B. A ceases to exist as a legal entity, and B assumes its entire estate, including A’s stake in B.

2.2 Legal Basis

Corporate law does not expressly prohibit reverse mergers, provided that:

·         There is proper resolution by the competent corporate bodies;

·         The transaction is duly documented and registered as required by law;

·         The interests of the company and its shareholders are preserved (Arts. 1,116–1,122 of the Civil Code).

3. Lawful Purposes of Reverse Mergers

·         Simplification of corporate structure (eliminating intermediate holding levels);

·         Use of tax benefits or accumulated tax credits in the subsidiary;

·         Succession planning, particularly in family holding companies;

·         Centralization of specific assets or liabilities, enabling accounting and administrative efficiency.

Courts and legal scholars acknowledge the legitimacy of reverse mergers when supported by a lawful business purpose, proper documentation, and economic substance.

"Although uncommon, a reverse merger is permissible when its economic purpose is proven and there is no fraud or sham involved." (São Paulo Court of Appeals, Civil Appeal No. 1001982-23.2020.8.26.0100, judgment dated 05/11/2022)

4. Merger of Dormant Companies: Risks and Legal Boundaries

4.1 Concept

This refers to the incorporation of companies with no regular business activity, which remain legally registered—sometimes with specific assets or liabilities, or with no relevant transactions at all.

4.2 Identified Risks

·         Use of the dormant company to absorb liabilities of the merging entity;

·         Attempt to "revive" a legal entity without economic purpose;

·    Simulated reorganization aimed at asset concealment, debt redirection, or hindering enforcement proceedings.

"The merger of a dormant company without a demonstrable business purpose may be disregarded by the courts if characterized as a sham or fraud." (STJ – Superior Court of Justice, REsp 1.689.718/SP, Reporting Justice Paulo de Tarso Sanseverino, judgment dated 10/14/2020)

5. Criteria for Distinguishing Lawful Planning from Simulation

Lawful Planning	Simulated or Fraudulent Structure
Clear economic purpose	No real business activity or objective
Regular documentation and legal filings	Flawed or incomplete documentation
Functional and economic substance	Shell company or merely a formal “vehicle”
Valid and transparent shareholder decisions	Concealment of shareholders or controllers
Compliance with accounting standards	Misuse for asset shielding or improper purpose

The ality of a transaction will often depend on the demonstrable economic substance and good faith in structuring and executing the corporate acts.

6. Relevant Case Law

"Corporate reorganization does not preclude liability where the misuse of legal entities to conceal assets or commingle patrimony is proven." (STJ, REsp 1.780.245/SP, Reporting Justice Ricardo Cueva, judgment dated 06/23/2021)

"The absorption of a dormant company without real business activity may constitute fraud on execution if carried out after the debt became known." (Minas Gerais Court of Appeals, Civil Appeal No. 1.0000.21.102931-1/001, judgment dated 02/02/2022)

"The validity of a merger depends on a legitimate economic purpose and the absence of harm to creditors or third parties." (São Paulo Court of Appeals, Civil Appeal No. 1011122-67.2021.8.26.0100, judgment dated 09/30/2023)

7. Best Practices for Structuring Reverse or Dormant Mergers

·         Explicitly justify the economic purpose of the transaction;

·         Properly register all corporate acts with the Board of Trade and Federal Revenue;

·         Maintain active and regular accounting records for the involved entities;

·         Avoid corporate movements during enforcement proceedings without a clear purpose;

·         Adhere to transparency principles and protect minority shareholders’ interests.

8. Final Considerations

Reverse mergers and the incorporation of dormant companies are legally recognized transactions, but their validity hinges on economic substance, transparency, and alignment with legitimate business goals.

When used for asset concealment, sham transactions, or creditor fraud, such operations may be annulled by courts, potentially triggering the disregard of legal personality and liability for shareholders, managers, and third parties involved.

Preventive legal counsel plays a crucial role in ensuring that strategic operations are not perceived as abusive, thereby safeguarding their legality, economic function, and documentary integrity in corporate reorganizations.