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Reverse and Forward Triangular Mergers

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These slides will go into an indepth discussion on the aspects and requirements of reverse and forward triangular mergers. For more information, contact our firm. (08/2016)

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Reverse and Forward Triangular Mergers

  1. 1. Reverse and Forward Triangular Mergers Harpreet S. Walia Royse Law Firm, PC hwalia@rroyselaw.com @harpreetswalia I. Corporate Law Requirements Overview of Structure of Triangular Mergers Legal Requirements Advantages and Disadvantages This presentation and its contents are solely for informational purposes and does not constitute legal advice.
  2. 2. • Structuring an Acquisition – Asset Sale – Stock Sale – Merger • Direct Merger • Forward Triangular Merger • Reverse Triangular Merger CORPORATE REQUIREMENTS OVERVIEW OF STRUCTURE OF TRIANGULAR MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS
  3. 3. Direct Merger • Target merges directly with Acquiror Target Acquiror Target Shareholders Acquiror Shareholders PARTIES INVOLVED- OVERVIEW OF STRUCTURE OF TRIANGULAR MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS
  4. 4. Acquisition Subsidiary Merger Triangular Merger - Same parties as in Direct Merger but includes the formation by the Acquiror of an Acquisition Subsidiary as acquiring entity PARTIES INVOLVED - OVERVIEW OF STRUCTURE OF TRIANGULAR MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS Acquiror Shareholders Acquiror Target Shareholders Target
  5. 5. Acquisition Subsidiary Merger Consideration Merger Forward Triangular Merger  Target merges into newly formed Acquisition Subsidiary, with Acquisition Subsidiary as surviving corporation and Target ceases to exist as a corporate entity.  All assets and liabilities of Target are held by Acquisition Subsidiary.  Target Shareholders receive Merger Consideration (cash/Acquiror stock) and Target shares are cancelled CORPORATE REQUIREMENTS OVERVIEW OF STRUCTURE OF TRIANGULAR MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS Acquiror Shareholders Acquiror Target Target Shareholders
  6. 6. POST MERGER ACQUIROR STRUCTURE – FORWARD TRIANGULAR MERGER REVERSE AND FORWARD TRIANGULAR MERGERS Acquiror Shareholders Acquiror Acquisition Subsidiary
  7. 7. Merger Consideration Merger Reverse Triangular Merger  Acquisition Subsidiary merges into Target, with Target as surviving corporation and Acquisition Subsidiary cease to exist as corporate entity  All assets and liabilities of the Target remain in the Target (with all of the assets and liabilities of Acquisition Subsidiary going to Target)  Target Shareholders receive Merger Consideration (cash/Acquiror stock) and Target shares are cancelled CORPORATE REQUIREMENTS OVERVIEW OF STRUCTURE OF TRIANGULAR MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS Acquiror Shareholders Acquiror Acquisition Subsidiary Target Target Shareholders
  8. 8. REVERSE AND FORWARD TRIANGULAR MERGERS Acquiror Shareholders Acquiror Target POST MERGER ACQUIROR STRUCTURE – REVERSE TRIANGULAR MERGER
  9. 9. Legal Requirements Acquiror: • Formation of Acquisition Subsidiary • Approval of Board of Directors of Acquisition Subsidiary • Approval of Board of Directors of Acquiring Company (as sole shareholder of Acquisition Subsidiary) •Agreement and Plan of Merger (principal transaction document for merger) Target: •Approval of Board of Directors of Target Company •Approval of Target Company Shareholders -State Merger laws typically require majority of Target Shareholder’s consent to approve merger - Dissenting Shareholders can be cashed out •Filing of Certificate of Merger Other Approvals: •Additional Considerations for Public Companies •Regulatory Approvals (Securities and Antitrust) CORPORATE LAW REQUIREMENTS LEGAL REQUIREMENTS REVERSE AND FORWARD TRIANGULAR MERGERS
  10. 10. Advantages of Triangular Merger • Keeps Target liabilities out of Acquiror and contained in Acquisition Subsidiary or Target •Potentially fewer third party approvals •Allows for less disruption to Target operations (especially where earn-outs are part of Merger Consideration) •No consent is required from Acquiror Shareholders to enter transaction • Structure facilitates ability to undertake a tax-free transaction Disadvantages • Requires Shareholder approval of Target Shareholders • Potential Dissenter rights issues • While liability may be walled off Acquiror, no ability to leave behind liabilities of Target • May impede integration process of Target with Acquiror • Ongoing maintenance of Surviving Company as a separate legal entity CORPORATE LAW REQUIREMENTS ADVANTAGES AND DISADVANTAGES REVERSE AND FORWARD TRIANGULAR MERGERS
  11. 11. Reverse and Forward Triangular Mergers Satya S. Narayan Royse Law Firm, PC snarayan@rroyselaw.com 650.521.5745 II. Anti-Assignment Clauses This presentation and its contents are solely for informational purposes and does not constitute legal advice.
  12. 12. DOES THE ACQUISITION/ MERGER CONSTITUTE AN ASSIGNMENT? Asset Acquisition By definition, Target company’s assets (including contracts) are assigned or transferred Direct Merger Target Co. survives Acquiring Co. survives Triangular (Subsidiary) Merger Forward Triangular Merger • Acquiring Co.’s Merger Subsidiary survives Reverse Triangular Merger • Target Co. survives as a subsidiary of the Acquiring Co. REVERSE AND FORWARD TRIANGULAR MERGERS
  13. 13. STATE MERGER STATUTES: “VESTING” LANGUAGE • Effect of Merger: Vesting Language in State Merger Statutes • Current ABA Model Business Corporation Act (“MBCA”) “Vesting” Language:  “all property owned by, and every contract right possessed by, each corporation or other entity that merges into the survivor is vested in the survivor without reversion or impairment” (§ 11.07(a)(3))  Majority of states merger statutes include provisions similar to the effect of merger provision of the MBCA, but not necessarily from the current version of the MBCA • Vesting Language in Delaware Merger Statute: • “… the rights, privileges, powers and franchises of each of [the merged] corporations, and all property, real, personal and mixed, and all debts due to any of said constituent corporations on whatever account … shall be vested in the corporation surviving or resulting from such merger or consolidation; … and shall not revert or be in any way impaired by reason of this chapter…” (Del. Code § 18-259) • Vesting Language in California Merger Statute:  “… the surviving corporation shall succeed, without other transfer, to all the rights and property of each of the disappearing corporations and shall be subject to all the debts and liabilities of each in the same manner as if the surviving corporation had itself incurred them.” (Cal. Corp. Code § 11.07(a)) REVERSE AND FORWARD TRIANGULAR MERGERS
  14. 14. ASSIGNMENT / TRANSFER BY “OPERATION OF LAW” • Question: Does an assignment or transfer by operation of law occur when “vesting” takes place in a merger, triggering anti-transfer or anti-assignment provisions? • The official comment to the current MBCA provides that “a merger is not a conveyance, transfer or assignment” and that “it does not give rise to a claim that a contract with a party to the merger is no longer in effect on the ground of non-assignability, unless the contract specifically provides that it does not survive a merger;” but not all states have based their merger statutes on the current MBCA • The Texas and Georgia merger statutes expressly provide that vesting takes effect without any transfer or assignment • The Virginia merger statute expressly provides that vesting takes effect “except to the extent that assignment would violate a contractual prohibition on assignment by operation of law” • The Pennsylvania merger statute does not use “vesting” or “transfer” language but specifies that each party to the merger plan, except the resulting survivor, ceases to exist entirely, and the rights, privileges, properties, debts, powers etc. of the prior entities continues on within the new entity • Case law is confusing:  Compare PPG Industries, Inc. v. Guardian Industries Corp. (597 F.2d 1090 (6th Cir. 1979)) to TXO Production Co. v. M.D. Mark, Inc. (999 S.W.2d 137 (Tex. App.-Houston 1999)) and Star Cellular Tel. Co. v. Baton Rouge CGSA, Inc. (1993 WL 294847 (Del. Ch. Aug. 2, 1993)(unpublished opinion))  Compare SQL Solutions, Inc. v. Oracle Corp. (1991 WL 626458 (N.D. Cal. 1991)(unpublished opinion)) to Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH (Del. Ch. Feb. 22, 2013) REVERSE AND FORWARD TRIANGULAR MERGERS
  15. 15. ASSIGNMENT / TRANSFER BY “OPERATION OF LAW” (CONTINUED) • Practitioners traditionally assume that forward triangular mergers trigger anti-assignment contractual clauses because the Target Co. does not survive the merger • Permaglass, Inc. merged with Guardian pursuant to Ohio and Delaware laws. Permaglass listed certain non-exclusive patent licenses granted to it by its competitor, PPG, to be vested with Guardian. PPG filed suit to enforce provisions that (i) specified that the agreement is non-assignable without PPG’s written consent and (ii) terminate the agreement if the majority of Permaglass’ common stock becomes owned/ controlled by an automobile or glass manufacturer. • The court interpreted the language, “deemed to be transferred to and vested in … without further act or deed,” in the Ohio merger statute, to be a transfer by operation of law (and not an absence of transfer) and thereby held that the merger violated the Permaglass/ PPG contract’s anti-assignment clause. PPG Industries, Inc. v. Guardian Industries Corp. (597 F.2d 1090 (6th Cir. 1979)) • TXO, a wholly owned subsidiary of Marathon Oil Co., merged with Marathon, whereupon certain data owned by PGI and held by TXO, was automatically transferred to Marathon. PGI’s contract with TXO prohibited the transfer of such data to third parties. • The Texas Court of Appeals interpreting the Texas merger statute held that the merger was not an assignment or transfer that would violate contractual prohibitions on data transfer; but the court distinguished this case from other cases on the fact that the merger was with a related company. Note that the Texas merger statute makes no distinction based on related companies. TXO Production Co. v. M.D. Mark, Inc. (999 S.W.2d 137 (Tex. App.-Houston 1999)) • Baton Rouge, the general partner of a partnership, merged with Star Cellular Tel. Co., a sister corporation. Other partners refused to recognize the surviving corporation as the general partner relying on a provision that required unanimous approval from the other partners for a transfer or assignment. • The Delaware Chancery Court looking to the official comment to the Georgia merger statute that provides that a merger is not a conveyance or transfer held that a merger is neither a transfer or assignment and therefore, the anti-assignment provision was not violated and approval was not required. Star Cellular Tel. Co. v. Baton Rouge CGSA, Inc. (1993 WL 294847 (Del. Ch. Aug. 2, 1993)(unpublished opinion)) REVERSE AND FORWARD TRIANGULAR MERGERS
  16. 16. ASSIGNMENT / TRANSFER BY “OPERATION OF LAW” (CONTINUED) • In a reverse triangular merger, D&N Systems, Inc. merged with SybaseSub, Inc., and the surviving entity took the name SQL Solutions, Inc. Oracle Corporation sought to terminate its agreement with D&N Systems, which contained an anti-assignment clause requiring Oracle’s consent for any assignment or transfer of the agreement to a third party. • The Northern California District Court held that an assignment or transfer of rights had occurred because there was a change in legal form of ownership – the merger of D&N Systems with SybaseSub and on this basis, held that the merger violated the anti-assignment clause in the Oracle/ D&N Systems contract. SQL Solutions, Inc. v. Oracle Corp. (1991 WL 626458 (N.D. Cal. 1991) (unpublished opinion) • This case involved a reverse triangular merger where the question presented to the court was whether a reverse triangular merger is an assignment by operation of law, in which case the merger would result in a breach of the following anti-assignment clause in a Global Consent agreement at the center of the litigation: “Neither this Agreement nor any of the rights, interests or obligations under this Agreement shall be assigned, in whole or in part, by operation of law or otherwise by any of the parties without the prior written consent of the other parties …” • Initially, the Delaware Chancery Court in 2011 denied Roche’s motion to dismiss Meso’s claim. The court then, finding no Delaware case law on point, declined to rule that a reverse triangular merger does not, as a matter of law, constitute an assignment “by operation of law.” In summary judgment proceedings in 2013, however, the court affirmed that a reverse triangular merger does not constitute an assignment by operation of law or otherwise under Delaware law. Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH (Del. Ch. Feb. 22, 2013) • Practitioners traditionally assume that reverse triangular mergers do not trigger anti- assignment contractual clauses (even clauses prohibiting assignments “by operation of law”) because the Target Co. survives the merger; limited case law on the point REVERSE AND FORWARD TRIANGULAR MERGERS
  17. 17. DEFAULT ASSIGNMENT RULES • Contracts are generally assignable without the consent of the other party • Exceptions: • Certain IP licenses are not assignable without the licensor’s consent • Non-exclusive patent and copyright licenses are not assignable or delegable without the licensor’s express consent. (Perlman v. Catapult Entertainment, 165 F.3d 747 (9th Cir. 1999)(patent context)); (Harris v. Emus Records Corp., 734 F.2d 1329 (9th Cir. 1984)(copyright context)). • Trademark licenses are not assignable or delegable without the licensor’s express consent. (N.C.P. Marketing Group, Inc. v. BG Star Prods. Inc., 279 Fed. Appx. 561 (9th Cir. 2008) & In re XMH Corp., 647 F.3d 690 (7th Cir. 2011) (trademark context)). For purposes of assignability, courts have not distinguished between exclusive and non-exclusive trademark licenses. • Agreements for personal services • Other : • Statute, public policy, or contractual clauses prohibit assignment (Restatement (Second) of Contracts § 317(2)(a) (1981)) • Assignment is ineffective if it materially changes the obligor’s duty, increases materially the burden or risk imposed on obligor by the contract, or impairs materially obligor’s chance of obtaining return performance. (U.C.C. § 2- 210(2)) REVERSE AND FORWARD TRIANGULAR MERGERS
  18. 18. TRIANGULAR (SUBSIDIARY) MERGER REVERSE AND FORWARD TRIANGULAR MERGERS TRIANGULAR (SUBSIDIARY) MERGER Forward Triangular Merger Merger Subsidiary survives Generally, an assignment or transfer by “operation of law” Anti-assignment & anti-transfer clauses may be triggered; watch out for contracts that are silent on assignment but contain IP licenses, relate to personal services, or otherwise materially change the obligor’s duty Change of control provisions may be triggered Reverse Triangular Merger Target Co. survives Traditional practitioners’ view: no assignment. Exception: California-related reverse triangular merger may trigger anti- assignment and anti-transfer clauses in light of SQL Solutions v. Oracle Change of control provisions may be triggered
  19. 19. ANTI-ASSIGNMENT CLAUSES: GARDEN VARIETY REVERSE AND FORWARD TRIANGULAR MERGERS 1. “[Target] may not assign its rights or obligations under this Agreement, in whole or in part.” 2. “[Target] may not assign its rights or obligations under this Agreement, in whole or in part, without [the other party’s] prior written consent.” 3. “[Target] may not assign its rights or obligations under this Agreement, in whole or in part, without [the other party’s] prior written consent (not to be unreasonably withheld or delayed).” 4. “[Target] may not assign or transfer its rights or obligations under this Agreement, in whole or in part, without [the other party’s] prior written consent.” 5. “[Target] may not assign or transfer its rights or obligations under this Agreement, in whole or in part, whether by operation of law or otherwise, without [the other party’s] prior written consent.” 6. “[Target] may not assign or transfer its rights or obligations under this Agreement, in whole or in part, without [the other party’s] prior written consent. A change of control of [Target] will be deemed an “assignment” by [Target].” 7. “[Target] may not assign or transfer its rights or obligations under this Agreement, in whole or in part, without [the other party’s] prior written consent, and any attempted assignment without such consent shall be void and without effect.”
  20. 20. ANTI-ASSIGNMENT CLAUSES: GARDEN VARIETY EXCEPTIONS REVERSE AND FORWARD TRIANGULAR MERGERS 1. “[Target] may not assign its rights or obligations under this Agreement, in whole or in part, without [the other party’s] prior written consent, except that it may, without such consent, assign this Agreement to its parent or subsidiary, or to any successor in interest by consolidation, reorganization, merger or acquisition of substantially all of its assets.” 2. “[Target] may not assign its rights or obligations under this Agreement, in whole or in part, without [the other party’s] prior written consent, except that it may, without such consent, assign this Agreement to its parent or subsidiary, or to any successor in interest by consolidation, reorganization, merger or acquisition of substantially all of its assets related to this Agreement.”
  21. 21. OTHER CLAUSES TRIGGERED BY A MERGER / ACQUISITION REVERSE AND FORWARD TRIANGULAR MERGERS • Change of control • Termination • License restrictions (e.g., non-transferability, enterprise restrictions, etc.) • Springing rights
  22. 22. PRACTITIONER’S TIPS REVERSE AND FORWARD TRIANGULAR MERGERS • Understand the transaction structure • Carefully review Target’s commercial agreements:  are there anti-assignment or anti-transfer clauses?  does the agreement include any IP license grants to the Target Co. that will require consent for transfer purposes?  is the agreement for the personal services of the Target Co. that will require consent for transfer purposes?  does the assignment materially change the obligor’s duty?  are there other clauses that would be triggered by a change of control? • As part of your analysis, consider the state merger statute that would be applicable to the merger and the governing law of the commercial agreement
  23. 23. Reverse and Forward Triangular Mergers Roger Royse Royse Law Firm, PC rroyse@rroyselaw.com @rroyse00 III. Tax Aspects This presentation and its contents are solely for informational purposes and does not constitute legal advice.
  24. 24. TRIANGULAR OR SUBSIDIARY MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS Acquiror Tax Consequences • No gain to Acquiror or Target • No gain to Target Shareholders except to extent of boot received • Transferee takes carryover basis in assets • Target Shareholders take basis in Acquiror stock equal to basis in Target stock Forward Subsidiary Merger Reverse Subsidiary Merger Target Acquiror Merger Sub Target Merger Sub Merger Sub
  25. 25. TRIANGULAR OR SUBSIDIARY MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS Target Shareholders Tax Consequences • Merger Sub takes Target’s basis in assets increased by gain recognized by Target • Acquiror takes “drop down” basis in stock of Merger Sub (same as asset basis) Acquiror Merger Sub Target Merger Sub — Statutory merger of Target into Merger Sub (at least 80% owned by Merger Sub) — Substantially all of Target’s assets acquired by Merger Sub — Would have been a good Type A merger if Target had merged into Merger Sub Section 368(a)(2)(D) Forward Triangular Merger 80%
  26. 26. TRIANGULAR OR SUBSIDIARY MERGERS REVERSE AND FORWARD TRIANGULAR MERGERS 80% Tax Consequences • Non-taxable to Target and carryover basis • No gain to Acquiror and Merger Sub under Sections 1032 and 361 • No gain to Target Shareholders except to the extent of boot • Acquiror’s basis in Target stock generally is the asset basis, but Acquiror can choose to take Target Shareholders’ basis in stock (if it is also a B) • If transaction is also a 351, Acquiror can use Target Shareholders’ basis plus gain Acquiror Merger Sub Target Merger Sub • Merger of Merger Sub into Target where – (i) Target shareholders surrender control (80% of voting and nonvoting classes of stock) for Acquiror voting stock and – (ii) Target holds substantially all the assets of Target and Merger Sub Target Shareholders Section 368(a)(2)(E) Reverse Triangular Merger
  27. 27. TRIANGULAR TYPE B REORGANIZATION REVERSE AND FORWARD TRIANGULAR MERGERS 80% Tax Consequences • Acquiror’s basis in Target stock is the same as the Shareholders’ • Solely for voting stock - No Boot in a B • Reorganization Expenses – distinguish between Target expenses and Target Shareholder expenses (Rev. Rul. 73-54) • Creeping B – old and cold stock purchased for cash should not be integrated with stock exchange Acquiror Merger Sub Target Merger Sub • Acquisition of stock of Target, by Acquiror, in exchange for Acquiror voting stock • Acquiror needs control of Target immediately after the acquisition • Control = 80% by vote and 80% of each class Section 368(a)(1)(B) Type B Reorganization Target Shareholders
  28. 28. TRIANGULAR TYPE C REORGANIZATION REVERSE AND FORWARD TRIANGULAR MERGERS Section 368(a)(1)(C) Stock for Assets • Acquisition of substantially all of the assets of Target, by Sub, in exchange for Acquiror voting stock • “Substantially All” = at least 90% of FMV of Net Assets and at least 70% of FMV of Gross Assets • Target must liquidate in the reorganization • 20% Boot Exception – Acquiror can pay boot (non-stock) for Target assets, up to 20% of total consideration; liabilities assumed are not considered boot unless other boot exists Parent Merger Sub Target Merger Sub Target Shareholders Acquiror Stock Acquiror Stock Tax Consequences • Reorganization Expenses – Acquiror may assume expenses (Rev. Rul. 73-54) • Assumption of stock options not boot • Bridge loans by Acquiror are boot • Redemptions and Dividends – who pays and source of funds
  29. 29. TAXABLE STOCK PURCHASES REVERSE AND FORWARD TRIANGULAR MERGERS Cash Reverse Triangular Merger • Treated as Stock Sale • Shareholders have gain or loss • Acquiror takes cost basis in Target shares Acquiror Merger Sub Target Merger Sub Target Shareholders
  30. 30. S CORPORATIONS AND 338(H)(10) REVERSE AND FORWARD TRIANGULAR MERGERS • Character difference – ordinary income assets • California 1.5% tax on S corporations • All Target shareholders must consent on Form 8023 • Deemed 338 election for subsidiaries • 1374 – BIG Tax • Minority shareholders in rollover • Hidden tax in liquidation or deemed liquidation in installment sale Acquiror Merger Sub T (S Corp.) Merger Sub Target Shareholders
  31. 31. SECTION 336(E) REVERSE AND FORWARD TRIANGULAR MERGERS Acquiror Target Shareholder $ Target Stock Basic Model (for stock sales): Target is treated as selling all of its assets to an unrelated person while owned by its former shareholders and then reacquiring same upon acquisition by Acquiror. (Unlike 338(h)(10), no need for corporate acquiror) $ $Assets Assets = Actual Component = Deemed Component Acquiror Shareholder Target Target3rd Party
  32. 32. SECTION 336(E) DETAILS REVERSE AND FORWARD TRIANGULAR MERGERS Tax Consequences • Old target recognizes gain or loss from the deemed asset and then is deemed to liquidate into seller • New target is treated as a new corporation for federal income tax purposes but remains liable for the tax liabilities of old target • Seller does not recognize gain or loss on the disposition of target stock • No effect upon a purchaser • No effect upon minority shareholders, or shareholders other than seller, except in the case of S corporation targets Section 336(e) Basic Model • Old target is treated as selling all of its assets to an unrelated person in exchange for the “aggregate deemed asset disposition price” (ADADP) • New target is treated as acquiring all of the assets from an unrelated for an amount equal to the “adjusted grossed up basis” (AGUB) • After the deemed asset disposition, but before the close of the disposition date, while owned by seller(s), old target is treated as transferring to seller all of the consideration deemed received from new target, generally in complete liquidation of old target • For dispositions involving a distribution, seller is treated as acquiring the stock of new target from an unrelated person and distributing the new target stock, immediately after the deemed liquidation of old target
  33. 33. CASH FORWARD MERGER REVERSE AND FORWARD TRIANGULAR MERGERS AcquirorTarget Target Shareholders Merger Acquiror Survives Variation with Merger Sub Acquiror Merger Sub Target Merger Sub Target Shareholders Asset Sale Followed by Liquidation of Target • Target has gain on sale • Target Shareholders have gain on liquidation (unless 332 applies) • Acquiror takes cost basis in Target assets
  34. 34. DOUBLE MERGER (REV. RUL. 2001-46) REVERSE AND FORWARD TRIANGULAR MERGERS Step 2: A-type Forward MergerStep 1: Reverse Triangular Merger Tax Benefit: A taxable reverse merger has just one tax on the shareholders, while a taxable forward merger has two taxes (one on shareholders and one on corporation). The first step of this double merger disregarded so the transaction is a tax-free A-type merger (where 20% boot limitation does not exist). If the transaction fails to qualify, the tax is incurred on the first step (reverse merger) and avoids corporate level tax. AcquirorTarget Sub 1 Target Shareholders Acquiror T + Sub 1 Sub 2 80% Target Shareholders
  35. 35. DOUBLE MERGER (REV. RUL. 2001-46) REVERSE AND FORWARD TRIANGULAR MERGERS Step 2: A-type Forward MergerStep 1: Reverse Triangular Merger Mergers of corporation into single-member LLC may qualify as A reorganizations. Treas. Reg. § 1.368-2(b)(1). Wholly Owned LLC Scenario AcquirorTarget Merger Sub Target Shareholders Acquiror T + Sub 80% Target Shareholders LLC
  36. 36. HORIZONTAL DOUBLE DUMMY REVERSE AND FORWARD TRIANGULAR MERGERS • Employs with two interim (‘dummy’) subsidiaries, which participate in reverse triangular mergers to create final structure. • Each side potentially qualifies for §§368(a)(1)(B) (due to subsidiary being ignored) or (a)(2)(E). • Special feature: Shareholders of Acquiror and Target control Holdco under §368(c); overall transaction therefore generally a good Code §351 exchange, allowing for very high amounts of boot for some and nonrecognition for others. TargetAcquiror Merger Sub New Holdco Merger Sub Merger Acquiror survives Merger Target Survives Acquiror Shareholder Target Shareholder Target Stock New Holdco Stock + $ New Holdco Stock Acquiror Stock
  37. 37. USE OF WHOLLY OWNED LLC REVERSE AND FORWARD TRIANGULAR MERGERS Merger of Corporation into LLC • Reg. 1.368-2(b)(1) – by operation of law, all assets and liabilities of Target become those of LLC, and Target ceases legal existence • A-Type Reorganization LLC Target Shareholders AcquirorTarget
  38. 38. USE OF WHOLLY OWNED LLC REVERSE AND FORWARD TRIANGULAR MERGERS Merger of Corporation with LLC where Corporation Survives • Reg. 1.368-2(b)(1) – does not qualify as a statutory merger because Target does not cease to exist • Possible Type B, C or D Reorganization or 351 transaction LLC Target Shareholders AcquirorTarget
  39. 39. LLC TECHNIQUES REVERSE AND FORWARD TRIANGULAR MERGERS Step 2Step 1 Acquiror Target $ Target Former Target Shareholders LLC LLC Target Shareholders Target
  40. 40. Reverse and Forward Triangular Mergers Alan Haus Royse Law Firm, PC ahaus@rroyselaw.com IV. Employment Law This presentation and its contents are solely for informational purposes and does not constitute legal advice. The lead employment lawyer’s role in advising about Reverse vs. Forward triangular mergers is a combination of easy, impossible and irrelevant. Plan in advance about where to turn for support.
  41. 41. DUE DILIGENCE REVERSE AND FORWARD TRIANGULAR MERGERS • Some documents to gather during Due Diligence: • Employee handbooks / personnel policies • Personnel files • Contracts with employees, including intellectual property assignment agreements and covenants not to compete • Contracts with independent contractor service providers • Health and retirement plan documents (as amended) and summary plan descriptions • Executive compensation agreements and plans • Files re: recent or pending lawsuits or claims with agencies • Labor union related documents • EPL, workers compensation and related insurance certificates and policies • Request an employee census showing job title, nationality or immigrant work authorization, compensation levels, FLSA exemptions, etc.
  42. 42. ISSUES FOR CONSIDERATION IN BOTH FORMS OF MERGER REVERSE AND FORWARD TRIANGULAR MERGERS • Warn Act Notifications (State and federal) • Nonqualified Deferred Compensation: the seller’s dormant 409A errors can be costly • HIPAA Privacy and Security Concerns: • Seller may be asked to provide claims data (including participant names) from its medical plan to the buyer • Privacy and security rules do not allow seller to transfer information directly to the buyer • Can the seller disclose? Since participant authorizations are usually impractical, request only anonymized protected health information • Structure as a Plan to Plan Transfer: • Privacy Rules allow the medical plan to disclose PHI for its own health care operations. • Thus, disclose data from one plan administrator to the other (or via a Business Associate) to ensure that the buyer, in its role as employer, does not have access to the data (to avoid a reportable breach)
  43. 43. ISSUES FOR CONSIDERATION IN BOTH FORMS OF MERGER REVERSE AND FORWARD TRIANGULAR MERGERS • Nondiscrimination: buyer should determine the potential impact of including or excluding the employees of the acquired business in its benefit plans, its ADA compliance, its gender and other wage parity decisions, etc. • COBRA definition of “M&A qualified beneficiary” is different as between Reverse and Forward triangular mergers • Misclassification: employee or independent contractor, exempt or non- exempt • Consider requiring pre-closing resolution of some issues (e.g. correction of 409A errors, settlement of some (e.g., non-EEOC) potential or pending claims etc.) • Whether personnel policies and practices have created a legally enforceable right to severance payments • Are non-competition and non-solicitation agreements enforceable? • Union Issues: the NLRA applies to union and non-union employers • Immigration matters • Foreign operations of seller • Whether the transaction itself might be creating employee claims, e.g., whistleblower retaliation claims under the Sarbanes-Oxley act
  44. 44. REVERSE AND FORWARD TRIANGULAR MERGERS • The employee benefits and compensation plans that receive the most attention during the due diligence process are: • Health plans • Qualified retirement plans • Executive compensation plans PLANNING FOR EMPLOYEE BENEFITS EFFECTS
  45. 45. REVERSE AND FORWARD TRIANGULAR MERGERS Reverse Forward • Benefit plans and employees remain undisturbed in the deal – no change in the “employer” • Buyer thus assumes all liabilities relating to Seller’s benefit plans • This greater risk requires higher level of due diligence and stronger contract provisions (representations, warranties and indemnification) • Has potential for “seamless” integration of employees and benefit plans • Even though integration is less complicated legally in a Reverse, challenges of integrating corporate cultures remain • Employees will have a change in their “employer” • Buyer does not normally assume Seller’s benefit plans or plan liabilities • Buyer may agree to assume benefit plans as part of union negotiations or for other reasons • Risk is lower if benefit plans are not assumed: • Buyer may still have to provide COBRA • Risk of “successor employer” liability for unpaid contributions to multiemployer plans • Employee and benefits integration may be more complicated
  46. 46. REVERSE AND FORWARD TRIANGULAR MERGERS Reverse Forward • Collective bargaining agreements may restrict changes to benefit plans • Collective bargaining agreements may be assumed; likely requirement to bargain in good faith as successor employer • Retiree medical plans warrant special attention because of the large liabilities they impose on their sponsoring employers • Typical transition services: • Payroll administration • Continued participation in Seller’s benefit plans: • Multiple employer plan issues – amendment and testing • Insurers may refuse coverage if advance consent not obtained • Employee leasing: • Seller continues to employ employees during a transition period • Issue of who is the common law employer
  47. 47. REVERSE AND FORWARD TRIANGULAR MERGERS Reverse Forward • Severance benefits may be payable as a result of the transaction (even if employees are rehired by the buyer) • Buyer and seller can specify whether employees who transfer to buyer will be deemed separated from service: • All employees must be treated consistently • Must be arms’ length transaction • Must state in writing • Have to look at facts to determine whether separation from service will occur for all purposes • Notwithstanding general rule that liabilities are not assumed by a buyer of assets, the 7th Circuit has found successor liability for FLSA violations in an asset deal (and thus presumably in a forward triangular merger)
  48. 48. REVERSE AND FORWARD TRIANGULAR MERGERS Reverse Forward • Retiree Benefits – Medical, Dental, Life Insurance: • Absent a specific carve-out of liabilities to another seller-related entity, acquiring entity will become responsible for the liabilities • Contractual Limitations on Termination: • Generally retiree health plans are not subject to typical “vesting” provisions even for retirees who have already retired • Buyer should review documents to make sure reservation of rights language is contained in the plan documents, since courts have held that retiree benefits can contractually vest and cannot be terminated • Retiree Benefits – Medical, Dental, Life Insurance: • Buyer rarely will agree to a transfer of the seller’s retiree healthcare obligations, especially with respect to employees who retired prior to the sale • With respect to active employees, buyers may be more willing to accept the transfer of such obligations; can be made subject to a purchase price adjustment to reflect cost of providing coverage
  49. 49. 49 PALO ALTO 1717 Embarcadero Road Palo Alto, CA 94303 LOS ANGELES 11150 Santa Monica Blvd. Suite 1200 Los Angeles, CA 90025 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Palo Alto Office: 650-813-9700 CONTACT US www.rroyselaw.co m @RoyseLaw MENLO PARK 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 LOS ANGELES 445 S Figueroa St 31st Floor Los Angeles, CA 90071 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Menlo Park Office: 650-813-9700 CONTACT US www.rroyselaw.com @RoyseLaw

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