Cendant’s “Reverse Triangular” Merger With Galileo

Lehman Brothers tax expert Robert Willens explains why the reverse merger structure influences the cash/stock mix
Robert WillensJune 19, 2001

Cendant Corp.’s acquisition of Galileo International will be structured as a “reverse triangular” merger.

A wholly-owned, newly-created, subsidiary of CD will merge into GLC (Galileo) and the latter will be the surviving entity and become a wholly-subsidiary of CD.

This is the principal advantage of using this structure: It preserves the target’s corporate entity and, in the process, obviates the need to secure assignments of contracts, and other items, which, if they were transferred out of “corporate solution,” might entail a re-negotiation of their terms and conditions. This is the same format used by DT in connection with its acquisition of VoiceStream.

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For a reverse merger to qualify as a tax-free reorganization, two special requirements (in addition to the “normal” reorganization requirements such as continuity of interest, continuity of business enterprise and business purpose) must be met:

First, the surviving entity (Galileo) must hold “substantially all” of its properties as well as a similar quantum of the properties of the merging subsidiary (other than the parent stock it “delivers” to the target’s shareholders and certain cash contributed to it by the parent). The “holds” requirement does not impose requirements that would not have applied had the corporation transferred its assets to another corporation in an attempted ‘C’ reorganization.

Thus, in recently-issued Rev. Rul. 2001-25, the I.R.S. said the holds requirement was satisfied even though the surviving corporation, as part of the plan, sold 50 percent of its “historic” business assets to an unrelated third party and retained the proceeds of sale. This conclusion was reached because in Rev. Rul. 88-48 the I.R.S. said that such a disposal of assets (and retention of proceeds of sale) would not adversely affect the target’s claim to ‘C’ reorganization treatment and, as Rev. Rul. 2001-25 makes clear, the substantially all test is applied, in the case of a reverse merger, in the same manner it’s applied in the ‘C’ reorganization arena.

The second requirement states that, in the transaction*, the former shareholders of the surviving entity must exchange, for voting stock of the issuing corporation, an amount of stock in such survivor that constitutes “control” thereof.

Since control means, for this purpose, stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and 80 percent of the total number of shares of each class (if any) of the non-voting stock, it is clear that at least 80 percent of the value of the aggregate conveyed by the issuing corporation must consist of its voting stock.

Moreover, this measurement is made not when the managements agree to the terms of the business combination, or at some intermediate point in the process, but, instead, when the transaction is consummated. This is why the possibility exists that the cash component may have to be reduced—in the event CD stock trades below the lower band of the collar. In that case, the cash element of the transaction would have to be reduced to insure that the value of the stock element—on the relevant date; the date of closing—comprises, at that time (and at that time only), the requisite percentage of the aggregate consideration conveyed.

If the “80 percent requirement” is adhered to, the transaction will constitute a “good” reverse merger such that the GLC (Galileo) shareholders who exchange their stock for CD stock will be able to do so on a tax-free basis.

* In recently-issued Rev. Rul. 2001-26, the I.R.S. indicated that stock acquired in a preliminary tender offer would count towards the determination of whether the requisite amount of survivor stock was acquired in the transaction. Stock acquired in both the tender offer and ensuing merger will count as acquired in the transaction if, under general principles of tax law, including the “step-transaction” doctrine, the steps are properly viewed as an “integrated” acquisition; that is, due to the avowed intentions of the parties, the steps are really component parts of a single course of action directed at a specific and well articulated result.