• Business Mergers & Acquisitions Law
  • Forms of Corporate Change Compared
  • Classical Mergers
  • Tax Considerations
    • Federal Tax Issues Regarding Corporate Change
    • State Tax Issues Regarding Corporate Change
  • Avoiding Liability
  • Due Diligence
  • Conclusion
  • Resources

Business mergers and acquisitions are a small part of the virtually limitless world of corporate change. As to mergers alone, the Department of Justice (DOJ) has established and published guidelines for defining markets, classifying mergers, analyzing market impact, and assessing proposed mergers. However, the DOJ itself is quick to warn that because the guidelines are applied to such a vast range of factual circumstances, each proposed corporate change is handled differently from the last. Corporate change always has economic and legal implications. Many forms of corporate change also have tax implications, although it is possible to structure a tax-free reorganization. The area of corporate change is so complex and detailed that every proposal is a new challenge that is best handled by a professional familiar with the ramifications of any decision that might be made.

Mergers and acquisitions are an important part of corporate change. Some terms for corporate change are erroneously used interchangeably, but the reality is that the subtle differences have grave legal implications. The following is a brief list of terms relevant to corporate change and the appropriate definition for each.

• Acquisition: An acquisition is the acquiring of control of one corporation by another. An acquisition may be by agreement or it may be the result of a hostile takeover. The acquisition may be in the form of cash, stock, or other assets.

• Consolidation: Consolidation occurs when two or more organizations are combined into one new legal entity. Typically, a consolidation is a friendly, cooperative deal in which the new entity takes the "best" of the former corporations. Presumably, under a consolidation each former corporation enters into the new venture on equal footing.

• Divestiture: Divestiture is the disposition of all or part of a business. A divestiture may take the form of a selloff (for cash) or a spinoff (for shares) and is often a tool used in creating a joint venture.

• Hostile takeover: A hostile takeover develops when the directors of the target corporation concede that the target company's sale is inevitable. Hostile takeovers are regulated by the federal Williams Act, state takeover statutes, and common law principles of target management duties.

• Initial public offering: An initial public offering is the sale of newly issued stock to the public for the purpose of raising capital for future corporate development. Often, the initial public offering is the first stage in the creation of a new publicly held corporation.

• Leveraged buyout: A leveraged buyout is the acquisition of a business through the use of borrowed funds, which are repaid later from the business' profits or sale of assets. Usually there is a complete restructuring of the corporation's balance sheet with the transfer of ownership. The so-called "leveraging" of the corporation's balance sheet is what distinguishes a leveraged buyout from a traditional acquisition.

• Liquidation: A liquidation is the conversion of assets into cash with the intent of paying off creditors and distributing the balance to corporate owners.

• Merger: A merger is the combination of two or more entities by direct acquisition of all assets by one corporation. Typically, a merger includes the exchange of stock, resulting in a surviving corporation. A merger is distinguished from a consolidation in that one of the corporations survives the others.

• Recapitalization: Recapitalization is the adjustment of a corporation's capital stock. For example, a corporation may exchange its stock for debt securities, resulting in a leverage against its capitalization.

• Reorganization: A corporate reorganization is the adjustment of the corporation's capital structure. Often reorganization is used in conjunction with Chapter 11 bankruptcy to allow the corporation to stay in business.

• Restructuring: A corporate restructuring is used to maximize corporate assets. Restructuring may occur in conjunction with divestiture, spinoff, recapitalization, or acquisition.

Generally speaking, a classical merger begins with an agreement between two corporations to merge together, resulting in the exchange of the transferor corporation's securities to the surviving corporation's control. Usually, after negotiations are completed, representatives from each corporation sign a preliminary agreement or letter of intent. If the merger is approved by the board and shareholders of each corporation, the articles of merger are filed with the Secretary of State. Upon acceptance of the filing, the surviving corporation has all the rights, privileges, franchises, and assets of the transferor corporation. Other than in exceptions such as the small-scale merger and the short-form merger, most classical mergers require approval by a two-thirds vote of the outstanding shares of each corporation as well as appraisal rights for the shareholders of each corporation. Upon completion of the merger, the transferor corporation loses its identity, which is fused into the surviving corporation.

The federal and state tax laws surrounding mergers and acquisitions and other corporate changes can be quite complex. This chapter cannot possibly provide or identify information regarding all the possible pitfalls and obligations one must consider. Instead, this section will attempt to outline the major areas of concern for the parties to consider when entering into a merger, acquisition, or other such corporate change.

Federal Tax Issues Regarding Corporate Change

Federal tax liability varies greatly depending upon the structure of the corporate change. In general, however, the seller is taxed consistent with the general principles of gain recognition and the buyer is treated on the basis of acquired assets.

Typically, a buyer will want to allocate as much of the purchase price as possible to assets that provide an immediate or early tax benefit. Allocations to inventory, therefore, are favored because the inventory is immediately sold and, in turn, increases the cost-of-goods benefit. The second objective for a buyer is to allocate the purchase price to equipment and other tangible personal property that can be quickly recovered through depreciation deductions. Next most favorable is the allocation of assets like leases, service contracts, and other assets that can be amortized over 15 years. The least desirable classification to the buyer for tax purposes is any benefit that will only occur as a capital gain when the property is resold.

The sale of a business, for tax purposes to the seller, is generally treated like the sale of any other asset. The assets are treated as having been disposed of into a taxable transaction unless a provision of the tax law exempts the resulting gain from being taxed. The taxable gain or loss is the difference between the amount realized on the sale (usually the sale price) and the adjusted tax basis from the property transferred (usually the amount it cost to acquire the property).

If the sale of the business is a tax-free reorganization, usually a substantial part of the sale includes the stock of the acquiring corporation. In such a case, the seller is only taxed on that portion of the transaction that exceeds the amount of stock received.

Besides the typical taxable gain or loss or the tax-free reorganization, it is important for a seller to consider the following issues for tax liability purposes: tax liability for sale of subsidiary stock; apportionment or allocation of gain; basis in targeted assets; sale of the target corporation's assets; net operating loss carryovers; tax effects of transfers, sales, and leases; property taxes; sales taxes; use taxes; and possible exemptions that can be claimed. An attorney experienced in corporate change issues can help identify taxable aspects of a transaction.

State Tax Issues Regarding Corporate Change

Texas imposes a sales and use tax on most retail sales of tangible personal property. Some isolated sales of tangible personal property are exempt. For example, the sale of the entire operating assets of a business or of a separate division, branch, or identifiable segment of a business is considered an "occasional sale" and is exempt. Of course, there are exceptions to the general occasional sale exemption that may require payment of sales tax. For example, a person cannot sell inventory as an "occasional sale." Other exemptions include tangible personal property that will become a component of the ultimate sale or that will be fully used for the ultimate sale. Transfer of property to a commencing corporation in exchange for all the corporate stock also is exempt.

Texas has detailed disclosure laws related to taxes due and qualification for exemptions. Due to the complexity of these laws, it is best to consult a legal professional familiar with Texas mergers and acquisitions tax laws before engaging in such a corporate change.

One of the most common methods for avoiding liability with corporate change is to obtain regulatory approval. However, the time it takes to obtain regulatory approval can make or break a transaction. If it is necessary to obtain regulatory approval, the business should work with the regulators early. Being prepared and knowledgeable about a prospective transaction can go a long way toward a liability-free transaction. Furthermore, it is imperative to deal with the regulators openly and honestly. Here is a checklist of tactics that can help a corporation be properly prepared:

• Research the target organization.

• Develop an acquisition structure designed to allow the purchaser to acquire the appropriate assets, but that avoids or minimizes complex regulatory approvals.

• Schedule meetings with regulators early. Educate those who must be involved with the transaction so that when their approval is needed, there is no "down time."

• Ask regulators early in the transaction what approval or filings are required.

• Present the transaction to the regulator with balance. Let the regulator know why both sides will benefit from the transaction. Address anticipated concerns of the regulator before the regulator is forced to make an inquiry.

• Be prepared to be flexible and anticipate when negotiations with the parties and the regulators are required.

• If possible, obtain pre-approval of the proposal from the regulators.

• Develop and adjust the detailed structure of the transaction.

• Submit filings in a timely manner.

• If possible, request an early decision from the regulators.

Be aware that different transactions require contact with various regulators. Some regulators that may need to be contacted regarding your transaction include:

• Federal Authorities

• Department of Justice

• Federal Trade Commission

• Securities and Exchange Commission

• Health Care Financing Administration

• Department of Defense

• State Authorities

• State securities regulators

• Department of Insurance

• Department of Health

• Professional licensing groups

• Medical groups

• Professional corporations

In addition to concerns regarding proper filing of a corporate change, each party to a corporate change has a fiduciary obligation in the form of due diligence. This fiduciary obligation is owed to corporate shareholders and others affected by the business dealings of the corporation. Basically, the law imposes on each corporate director a general obligation of good faith and fair dealing based upon a reasonably informed judgment. There are some basic questions that can go a long way toward determining whether the duty of each party has been fulfilled. For example:

• Each party should be able to show that a majority of directors are not "interested parties" or that the board exercised due care in reaching its decision. In addition, the parties must show an intrinsic fairness to all parties to the transaction.

• If the transaction involves (a) sale of control, (b) takeover response, or (c) change in the fundamental nature of the corporation, the parties must show that they acted in a way to maximize the value and fairness of the transaction.

• Regardless of the nature of the transaction, the parties must be able to show that the transaction does not result in unreasonable harm to those who have an interest in the corporation, but who are not directly involved with the decisions that led to the corporate change.

• A party must research the previous sales history of the other party to ensure that all tax liabilities are properly disclosed.

Stock or asset acquisitions, mergers, or other corporate change entails an intricate mixture of economics, business, and law. Each transaction requires a great deal of investigation and valuation. It is important to structure the transaction in the best interest of the parties as well as within the confines of the law. After the terms of a corporate change have been negotiated, the regulators enter the scene to ensure that the interests of all parties are properly balanced. It is strongly recommended that every corporate change proceed only with the assistance of an experienced professional.

The following federal authorities may need to be contacted for information concerning, or regulatory approval of, corporate change.

Department of Justice, 10th & Constitution Avenues, N.W., Washington, DC 20530, (202) 514-2007; Southwest Region, 1420 Mockingbird Lane #250, Dallas, TX 75247, (214) 655-8175.

Federal Trade Commission, 6th Street & Pennsylvania Avenue N.W., Washington, DC 20580, (202) 326-2222; Dallas Region, 100 Central Expressway North #500, Dallas, TX 75201, (214) 767-5503.

Securities and Exchange Commission, 450 Fifth Street N.W. #31024, Washington, DC 20549, (202) 942-8088; Region IV, 1801 California Street #4800, Denver, CO 80202, (303) 391-6809; Fort Worth District, 801 Cherry Street 19th Floor, Fort Worth, TX 76102, (817) 885-6469.

Health Care Financing Administration, 200 Independence Avenue S.W. #314G, Washington, DC 20201, (202) 690-6726.

Department of Defense, The Pentagon, Washington, DC 20301-1000, (703) 697-5131.

These state authorities also may have information and regulatory requirements for corporate change.

Secretary of State, State Department, P.O. Box 13697, Austin, TX 78711, (512) 463-5701 or (512) 463-5555.

Corporations, Department of Insurance, 333 Guadalupe, Austin, TX 78701 or P.O. Box 149104, Austin, TX 78714-9104, (512) 463-6464, FAX (512) 475-2005.

Department of Health, 1100 West 49th Street, Austin, TX 78756, (512) 458-7111.