So What Happens After the Acquisition?

When structuring a reorganization, pay attention to form.
Robert WillensAugust 23, 2001

The term reorganization includes seven different forms of corporate adjustments, each of which has its own unique requirements. From a policy point of view, it’s difficult to justify the sometimes subtle variations in these formal reorganization requirements. Nevertheless, attaining reorganization status can be a worthwhile goal. If a transaction qualifies, the exchanging shareholders of the purchased corporation (in the case of an acquisitive reorganization) can receive stock in the acquiring corporation on a tax-free basis. Just as important, the target’s assets can be moved out of its ”corporate solution” on a similar basis.

A recent letter ruling (LTR 200132007) deals with a foreign corporation’s acquisition of the assets of a domestic company. The transaction, which was found to constitute a reorganization, highlights many of the difficult issues that often arise in these transactions.

First, some background. The foreign corporation (FP) sought to annex the assets of a US corporation (T). In the transaction, managers at FP wished to convey to T’s shareholders an equal mix of stock and cash. In addition, FP’s management wanted the assets of T to be lodged in a third-tier subsidiary. Complicating matters; at the time of the acquisition, FP had a stock repurchase plan in place.

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Since managers at FP were keen to use a substantial amount of cash, neither a ‘B’ reorganization nor a reverse triangular merger, under Sec. 368(a)(2)(E), could be accomplished. Those formats require the use of voting stock alone, or the combination of voting stock and cash not exceeding 20 percent of the aggregate consideration to be conveyed.

Thus, only a ”forward” merger structure could be employed here. A ”straight” two-party merger could not be implemented. Why? Because under Sec. 368(a)(1)(A), a ”statutory merger” is a merger effected in pursuance of the laws of the United States, or a state or territory thereof. In short, a foreign corporation, such as FP, cannot be a party to a statutory merger (See Rev. Rul. 57-465).

Therefore, of the various forms of reorganization, only the forward triangular merger format remained available to FP. In a forward triangular merger with a foreign corporation as the issuer, the issuer typically creates a domestic subsidiary (S), then merges the takeover target with that subsidiary.

Such a transaction qualifies as a reorganization under Sec. 368(a)(2)(D) if, among other requirements, S acquires substantially all of T’s assets without using S stock in the transaction — and if the merger would have qualified as an ‘A’ reorganization if effected directly into, in this case, FP. This condition, called the could-have-merged requirement, can be met here even though, as indicated, a direct merger into FP would not have qualified as an ‘A’ reorganization. The could-have-merged condition mean only that the general requirements of a reorganization are satisfied, such as continuity of interest and continuity of business enterprise. For these purposes, whether the merger could have been affected pursuant to corporation law is not relevant (See Rev. Rule 74-297).