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What a Difference a Day Makes to Some Mergers

Last week, Equinix announced it was acquiring Switch & Data in a cash and stock deal. But the deal timing, and its prospects for tax-free treatment, will be constrained by IRS rules.
Robert Willens, | US
October 26, 2009

Equinix Inc. and Switch & Data Facilities Company entered into a definitive agreement last week, in which Equinix aims to buy its rival in a cash and stock deal worth $689 million. The transaction is intended to qualify as a tax-free exchange and, presumably, is conditioned on securing an opinion of counsel regarding such qualification.

The press release strongly suggests that the business combination will be structured as a reverse triangular merger. Thus, Equinix will be creating a subsidiary to which it will convey the merger consideration. In turn, that subsidiary will, as part of the plan, merge with and into Switch & Data. In connection with the merger, the stock of the transitory subsidiary will be converted into Switch & Data stock, and the Switch & Data stock held by its shareholders will be exchanged for the merger consideration.

We can infer this from the fact that the overall consideration to be paid by Equinix will be "80 percent Equinix stock, 20 percent cash." The Switch & Data shareholders will have the opportunity to elect to receive either 0.19409 shares of Equinix stock, or $19.06 in cash for each share. However, if the cash or stock portion of the package is oversubscribed, the merger consideration will be pro-rated to preserve the 80%-20% mix.

Control for Voting Stock
For a reverse triangular merger to qualify as a reorganization under the tax code1, several requirements must be met. Most notably, the so-called "control for voting stock" condition must be complied with. This requirement is met if, "in the transaction," share-holders of the surviving corporation (Switch & Data) surrender stock in exchange for voting stock of the controlling corporation (Equinix).

Moreover, the stock surrendered (for voting stock of the controlling corporation) must constitute control of the surviving corporation. For this purpose, control is defined in Section 368(c) of the tax code. According to that section, control is characterized as ownership of stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote, and ownership of at least 80%of the total number of shares of each class of non-voting stock.

What's more, this determination will be made as of the "effective time," not as of the date on which the deal was announced or at some other intermediate point in the process. For purposes of determining whether a transaction meets the continuity of interest requirement2, the consideration to be exchanged may be valued on the last business day before the first date on which the contract is a binding contract. That exculpatory rule cannot be extended by administrative fiat to the provisions of the statute which define the term "reorganization." Indeed, Congress decreed that a reverse triangular merger satisfy the control for voting stock requirement and, for this purpose, the amount of stock constituting control is measured immediately before the transaction. Accordingly, the clause permitting Equinix to vary the mix of consideration to satisfy the dictates of the tax code (Section 368(a)(2)(E)) seems eminently proper.

In fact, it seems clear that the determination of whether the requisite percentage of the merger consideration consists of the controlling corporation's voting stock is made on only one date: the effective time. This determination cannot be made on the date the deal is announced or at any other time.

Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for

1 Section 368(a)(1)(A) by reason of Section 368(a)(2)(E).
2 A transaction meets the continuity of interest requirement if a substantial part of the value of the proprietary interests in the target is "preserved" in the transaction.