Spin-Offs and Carve-Out Divestitures: Navigating Legal and Tax - - PowerPoint PPT Presentation

Spin-Offs and Carve-Out Divestitures: Navigating Legal and Tax Challenges

Key Considerations for Deal Structuring, Economic Terms, Due Diligence, Asset Transfers, and More

Today’s faculty features:

1pm East ern | 12pm Cent ral | 11am Mount ain | 10am Pacific

The audio portion of the conference may be accessed via the telephone or by using your computer's

• speakers. Please refer to the instructions emailed to registrants for additional information. If you

have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

THURS DAY, AUGUS T 28, 2014

Presenting a live 90-minute webinar with interactive Q&A

Andrew M. Eisenberg, Partner, Jones Day, Washington, D.C. Peter E. Izanec, Partner, Jones Day, Cleveland

Tips for Optimal Quality

S

• und Qualit y

If you are listening via your computer speakers, please note that the quality

• f your sound will vary depending on the speed and quality of your internet

connection. If the sound quality is not satisfactory, you may listen via the phone: dial 1-888-450-9970 and enter your PIN when prompted. Otherwise, please send us a chat or e-mail sound@ straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Qualit y To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

FOR LIVE EVENT ONLY

Continuing Education Credits

For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps:

• In the chat box, type (1) your company name and (2) the number of

attendees at your location

• Click the S

END button beside the box If you have purchased S trafford CLE processing services, you must confirm your participation by completing and submitting an Official Record of Attendance (CLE Form). Y

• u may obtain your CLE form by going to the program page and selecting the

appropriate form in the PROGRAM MATERIALS box at the top right corner. If you'd like to purchase CLE credit processing, it is available for a fee. For additional information about CLE credit processing, go to our website or call us at 1-800-926-7926 ext. 35.

FOR LIVE EVENT ONLY

Program Materials

If you have not printed the conference materials for this program, please complete the following steps:

• Click on the ^ symbol next to “ Conference Materials” in the middle of the left -

hand column on your screen.

• Click on the tab labeled “ Handouts” that appears, and there you will see a

PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.

FOR LIVE EVENT ONLY

Spin-off and Carve out Divestitures – Navigating Legal and Tax Challenges

Andrew M. Eisenberg, Partner – Washington D.C. ameisenberg@jonesday.com Peter E. Izanec, Partner – Cleveland, Ohio peizanec@jonesday.com

Note

6

This presentation and the accompanying oral discussion should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our

• discretion. This presentation and the accompanying oral discussion is not intended to, and

does not, create any attorney-client relationship. The views set forth in this presentation and given in the accompanying oral discussion are the personal views of the authors and do not necessarily reflect those of Jones Day.

Subjects

1. Overview – Transaction Types 2. Tax Issues

• Basic Requirements

– The As, Bs and Cs

• Traps

– North-South; Creating Control; Indemnity Payments

• Planning Opportunities

– Cash-rich split offs and REIT Spins (OpCo/PropCo structures) 3. Getting It Done

• Overview of SEC filing requirements
• Overview of the corporate issues

7

1. Overview – Transaction Types

8

Tax Efficiency in Divestitures

• Aims at minimizing taxable capital gains (and, if applicable, ordinary

income) recognized in the transaction

• A concept of the utmost importance in M&A: if a tax-free structure

can be found that satisfies the non-economic corporate goals of the divesting parent, then it will often present a compelling value that taxable structures will be unable to match

9

The Basics: Types of Structures

• “Spin-Off”
• “Split-Off”
• “Split-Up”
• “Reverse Morris Trust”
• “Asset Swap”

10

Spin-Offs (Distribution)

A spin-off is a transaction in which each D shareholder receives C stock with respect to such holder’s D stock.

11

D S/Hs C (Pro-rata) distribution of C stock to S/Hs D S/Hs C

Before After

Split-Offs (Redemption)

A split-off is a transaction in which the D corporation distributes C stock in redemption of a portion of its stock.

D S/H1 C S/H2

Before After

Distribution of C stock to S/H2 in redemption

• f D stock

(non pro-rata) D S/H1 C S/H2

12

Split-Ups (Liquidation)

A split-up is a transaction in which the D corporation liquidates and distributes the C1 and C2 stock in complete liquidation.

C1 S/H1 C2 S/H2

Before After

Distribution of C stock to S/H2 in liquidation of D (non pro-rata) D S/H1 C1 S/H2 C2

13

Reverse Morris Trust Transactions

An RMT is a spin-off or split-off combined with a second step merger in which C merges with another entity C stock is typically converted into stock of the surviving entity in the merger

14

D

Legacy S/H

Merged Entity

Legacy/ tendering D S/H

Before Step 1: Spin/Split Step 2: Merger and Result

D

Legacy S/H

C D

Legacy S/H

Legacy S/H (or tendering S/H)

C

RMT Partner S/H

Asset and Stock Swaps

• As name suggests, structured as a like-kind exchange of one collection
• f assets for another
• Typically would be structured as an exchange of shares in subsidiaries
• f the two transacting parties, and potentially coupled with a right-

sizing dividend on one side to make the transferred values match

15

Tax Aspects of Asset and Stock Swaps

• Asset Swaps – Could be tax-free if like-kind exchange rules apply – i.e., the

groups of assets are personal properties of a like class and are considered to be

• f a “like kind” for purposes of section 1031
• Stock Swaps – Like-kind exchange rules not applicable to stock swaps.

Section 1031(a)(2)(B)

• Pre-Stock Swap dividend to equalize values – may be tax-free if both the target

subsidiary and the exchanging shareholder are members of the same consolidated group, but tax-free distribution results in downward basis adjustment under consolidated return rules

16

2. Spin-off Tax Issues & Requirements

17

Tax-Free Break Ups – Section 355 Transactions/D Reorganizations

• Section 355
• Spin-Offs
• Split-Offs
• Split-Ups
• Divisive “D Reorganizations” – Section 368(a)(1)(D) transactions are

generally the same as Section 355 transactions, except that property is transferred to the “Controlled” corporation in the transaction.

• Like-kind exchanges and asset swaps

18

General Tax Effects of Qualifying as a Section 355 Transaction

• The Distributing Corporation
• Generally will not recognize gain or loss on distribution of C (or C1 and C2) stock.

– Exceptions for distribution of appreciated property other than C stock and C stock in Section 335(d) and (e) transactions.

• The Shareholders
• Generally will not include any amount in taxable income, or recognize gain on receipt of C stock.

– Exception for boot – Boot in a spin-off → Section 301 distribution – Boot in a split-off or split-up → Gain = to lesser of gain realized or FMV of boot

• C stock tax basis = portion of D stock basis based on FMV (Carryover basis)
• Tacked holding period
• The Controlled Corporation
• Asset basis = C’s historical tax basis (Carryover basis)
• C may succeed to a portion of D’s E&P

19

Requirements of a Section 355 Transaction

a. Active Trade or Business - Both D and C must be engaged in the active conduct of a trade or business b. Business purpose – There is a substantial not-tax purpose for the distribution c. Control –D owns C stock satisfying the 80% control requirement, and D distributes C stock satisfying the 80% control requirement. d. Device – The transaction is not principally a device for the distribution of the E&P to the D shareholders at capital gain rates. e. Neither section 355(d) or section 355(e) is violated f. The distribution must satisfy both continuity of shareholder interest (COSI) and continuity of business enterprise (COBE).

20

Active Conduct of a Trade or Business Requirement

• Both D and C must be engaged in the active conduct of a trade or

business (“ATB”) immediately after the distribution

• Trade or Business
• a specific group of activities carried out for the purpose of earning

income or profit, including every operation that forms a part of the process of earning income or profit, including collection of income and payment of expenses

• Active Conduct
• perform active and substantial managerial and operational

functions

• Use of independent contractors alone is not sufficient

21

Active Conduct of a Trade or Business - Five-year requirement

• A corporation is engaged in an ATB only if:
• The corporation itself is engaged in the trade or business;
• The trade or business has been actively conducted throughout the

5-year period ending on the date of the distribution;

• The trade or business was not acquired by D or C in a taxable

transaction within the 5-year period (unless an expansion of existing trade or business); and

• Control of the C which was conducting the 5-year trade or

business was not acquired directly by D within the 5-year period in a taxable transaction (unless an expansion of existing D trade or business).

22

• A purchased, created, or acquired trade or business is not

acquired in a taxable transaction during the 5-year period if the trade or business is in the same line of business as an existing 5- year trade or business (the “Expansion Doctrine”)

• The Expansion Doctrine generally applies unless the purchase,

creation, or acquisition “effects a change of such a character as to constitute the acquisition of a new or different business.”

23

Active Conduct of a Trade or Business - Expansion Exception

• Historical business of manufacturing and selling potato wash

lines and sorting machinery parts and supplies to potato shippers expanded to manufacturing and selling harvesters, vine beaters, and other field equipment directly to farmer – Lockwood's Estate v. Commissioner, 350 F.2d 712 (8th Cir. 1965)

• Historical brand X automobile dealer expanded its business to

sell brand Y automobiles – Rev. Rul. 2003-18

• Historical retail shoe store business expanded its business to

include a website to sell shoes – Rev. Rul. 2003-38

24

Active Conduct of a Trade or Business - Expansion Exception Examples

• Minimum Amount of Trade or Business Assets Required
• Safe harbor – 5% of assets in controlled corporation should be

active trade or business assets – Rev. Proc. 96-30 standard, replaced with no standard in Rev. Proc 2003-48

• Problem Assets
• investment assets: stock, securities, land, or other property held

for investment purposes

• owner-occupied or leased real property

– Rental activities may constitute an ATB if the owner directly provides significant management and maintenance services

Active Conduct of a Trade or Business - Substantiality

25

• For purposes of the ATB requirement, all members of a corporation's Separate

Affiliated Group (“SAG”), are treated as a single corporation.

• A SAG is generally determined by treating D as the “parent entity” of the

“DSAG” and C as the parent entity of the “CSAG” and including all corporations for which each parent directly or indirectly owns at least 80% of the total voting power and 80% of the total value of the stock of such corporation in such SAG.

• Meaning: A stock acquisition resulting in a corporation becoming a SAG

member is treated as an asset acquisition by that SAG parent; and transfers within the SAG are disregarded

• Note: This control requirement is different from the control requirement that

governs tax-free distribution treatment, which requires 80% of the total voting power and 80% of the total number of shares of all other classes of stock.

26

Active Conduct of a Trade or Business - Affiliated Group Rule

• For 5 years, C directly conducts ATB1 and S directly conducts ATB2.
• In year 8, D distributes the stock of C. Because, D owns Section 1504(a)(2) control of S (even

though it is not adequate section 368(c) control), D and S are treated as one corporation for ATB

• purposes. Therefore, D is treated as conducting a 5-year ATB. See Prop. Reg. §§1.355-

3(b)(1)(ii) and -3(d)(2), Ex. 3.

27

C (ATB1) S (ATB2) S/Hs D 100% 100% Vote 80% Value Distribution

• f C’s stock

Active Conduct of a Trade or Business - Affiliated Group Rule Example

Individuals

0% Vote 20% Value

• For 5 years, C directly conducts ATB1 and S1 and S2 directly conducts ATB2 (similar activity in

different geographical location). In year 6, D acquires 100% of C in a taxable transaction and then distributes the C stock to the D S/Hs in year 7.

• Because C becomes a member of the D’s SAG, and ATB1 is an expansion of ATB2, D can

distribute C in a tax-free distribution.

28

S1 (ATB2) S2 (ATB2) D S/Hs D 100% 100% Distribution

• f C’s stock

2 C (ATB1) U Stock for $$$$ 1

Active Conduct of a Trade or Business - Affiliated Group & Expansion Rule Example

U S/Hs

Business Purpose

• Generally viewed as the most important requirement for tax-free

treatment under Section 355.

• There must be a business purpose for the distribution of C, in

which there is no impractical or unduly expensive nontaxable alternative.

• Rarely violated in public spin-off transactions and public or

private split-off transactions

29

Business Purpose – IRS Approved Purposes

• Approved business purposes include:
• To provide equity interest to key employee
• To facilitate post-distribution stock offering
• Cost savings
• Facilitate borrowings that would yield an increased borrowing capacity or better

non-financial terms

• To address management, systemic, and other corporate related problems (“fit &

focus)

• Regulatory or labor problems
• Required divestiture
• See also Rev. Proc. 96-30, Appendix A

30

Control

• Control requires direct ownership of stock possessing 80% of

the vote power, and 80% of the number of shares of each class

• f non-voting stock. See section 368(c).
• Control of C cannot be acquired within the 5-year period ending
• n the date of the distribution in a taxable transaction (unless the

C business is an expansion of the D business).

31

Distribution Not Principally a Device for the Distribution of E&P

• The goal of this “requirement” is to prohibit a bail-out of a corporation's E&P at capital gains

rates.

• Purely a facts and circumstances test at the shareholder level.
• Examples of Factors of “non-device”
• Distribution would be treated as a redemption (i.e., capital gain treatment) instead of a

distribution if it was not a Section 355 transaction

• D is publicly traded and there are no 5% shareholders
• Neither D nor C have any E&P
• Business purpose for distribution is substantial
• Examples of Factors of “device”
• Distribution is pro-rata or substantially pro-rata
• Subsequent taxable sale of stock of either D or C

– If pursuant to a pre-arranged agreement – strong evidence – If not pursuant to a pre-arranged agreement – mere evidence

• Assets spun off are liquid assets that are not needed in the business

32

North – South Transactions – Transactions Between S/H and Distributing

Shareholder transfers property to D near in time to a distribution of C stock from D to the D shareholder. Are the contribution and the distribution respected as separate transactions or are they treated as an exchange? Impact being no distribution of section 368(c) control (the 80% requirement).

33

D S/Hs C D S/Hs C C Stock Property Step 1 Step 2

North – South Transactions – Transactions Between Distributing and Controlled

Steps:

• Step 1: C distributes property to D.
• Step 2: D contributes property to C.
• Step 3: D distributes C stock to S/H.

Implications:

• If Steps 1 and 2 are integrated and treated as an exchange,

then the property distributed by C is treated as boot.

• If Steps 1 and 2 are not integrated (i.e., respected as separate

transactions), then the property distributed by C is treated as a dividend separate from the D reorganization.

34

Taxpayer’s Representation: “There is no regulatory, legal, contractual, or economic compulsion or requirement that [D] make part or all of the [D] Contribution as a condition to the distribution by [C]

• f the [Property] Distribution.”

IRS Ruling: Steps 1 and 2 are not integrated and so the property distribution of Step 1 is treated as a section 301(a) distribution, and not as boot. (PLR 201136009) Impact of Ruling: The taxpayer’s form matters. If Steps 1 and 2 were documented as an exchange and there is equivalent value, then it is an exchange and the steps are integrated for tax purposes, unless the Code says otherwise (e.g., 302 or 304). D S/H C D distributes C stock C distributes property D contributes property

Section 355(d) – Recently Acquired Stock

• Prevents disguised sales of C stock
• D is taxed on the built-in gain in the C stock if:
• A “person” (or persons acting in concert)
• acquires at least 50% of D
• before the distribution
• by “purchase”
• during the 5-year period ending on the date of the

distribution

35

Section 355(e) – Stock Acquired Pursuant to a Plan

• Prevents disguised sales of C stock
• Distributing is taxed on the built-in gain in the C stock if:
• One or more persons
• acquires at least 50% of D or C
• Before, as part of, or after the distribution
• “pursuant to a plan”

– Statute presumes that all transactions occurring either 2 years before or 2 years after the spin‐off are part of the plan. – Intent is relevant, however …

36

Section 355(e) – Stock Acquired Pursuant to a Plan

• The section 355(e) regulations limit this 2-year presumption by using safe

harbors and providing plan/non‐plan factors.

• Whether any of these apply will depend on the facts and circumstances of the

transaction.

• Super Factor: In the case of an acquisition (other than involving a public
• ffering) after a distribution, the distribution and the acquisition can be part of a

plan only if there was an agreement, understanding, arrangement, or substantial negotiations regarding the acquisition or a similar acquisition at some time during the two‐year period ending on the date of the distribution.

37

Recapitalizing into Control

• Change in voting structure must be a “permanent

realignment.”

• No plan or intention for C to realign its voting structure

after the distribution.

• Voting structure can be unwound after the distribution

if: – C did not anticipate the market and business conditions that ultimately gives rise to the need to revise its capital structure; or – at the time of the recapitalization, there is no binding commitment to unwind the voting structure and subject to independent shareholder vote.

38

Recapitalizing into Control –

• Rev. Rul. 69-407

Before Transaction

C has 1,000 common shares outstanding of which D owns 70 percent and A and B own 30%. Both D and C have been engaged in an active business for more than 5 years, and D has

• wned its stock in C for more than 5 years.

Recapitalization

Pursuant to a plan of recapitalization: C issues (1) 200 shares of C Class A voting stock to A and B in exchange for their 300 C shares, (2) 800 shares of C Class B voting common stock to D in exchange for its 700 D shares. The value of the stock received is equal to the value of the stock surrendered and the recapitalization qualifies as a tax-free reorganization under section 368(a)(1)(E).

39

D S/Hs A B D C 70% 30% D S/Hs A B D C 80% Vote 70% Value 20% Vote 30% Value

Recapitalizing into Control –

• Rev. Rul. 69-407

D distributes its C Class B shares to its shareholders. Conclusion: D “controlled” C for purposes of section 355 because the recapitalization that preceded the distribution resulted in “a permanent realignment of voting control” as opposed to being “transitory and illusory.” (Rev. Rul. 63-260).

40

S/Hs A B D C Class B 80% Vote 70% Value Class A 20% Vote 30% Value Distribution

• f C Stock

Unwinding Prior Recapitalization

• Rulings to unwind dual-class voting structure: “Controlled

did not anticipate the market and business conditions that now give rise to the need to revise its capital structure” See PLR 200527004 (Mar. 24, 2005); PLR 200403041 (Oct. 8, 2003); PLR 200347013 (Aug. 19, 2003).

• Controlled “presently expects” that, after the distribution,

at the next shareholders' meeting, its Board will consider a proposal to eliminate the dual-class voting structure. See PLR 200837027 (Mar. 14, 2008).

• No binding commitment
• Independent shareholder vote

41

Indemnity Payments in Spin-Off Transactions: Generally Straight Forward

When indemnity payments are made between D and C, the IRS allows such payments to be treated as consideration transferred between D and C in the Spin-off transaction, not as per se income to the Indemnitee when received. IRS Ruling Position: Any Indemnity Payment will be characterized in the same manner as if such payments had occurred immediately before the Distribution. See Arrowsmith v. Commissioner, 344 U.S. 6 (1952); Rev. Rul. 83-73, 1983-1 C.B. 84.

42

D S/Hs C D S/Hs C

Treatment as if Pre-Spin-off Payment

Post-Spin-off Payment

Indemnity Payments in Split-Off Transactions: Make Sure Corporation is Payee

When indemnity payments are made between D and C, the IRS allows such payments to be treated as consideration transferred between D and C in the Split-off transaction, not as per se income to the Indemnitee when received, but indemnity payments made by D to C shareholders,

• r C to D shareholders, may be fully taxable.

43

D S/H 1 C D S/H 1 C

Treatment as if Pre-Split Payment

Post-Split Payment

S/H 2 S/H 2

Planning Opportunities Section 355(g) – Cash Rich Split-offs

• Section 355 will not apply, if immediately after the transaction:
• Either D or C is a Disqualified Investment Corporation, and
• Any person owns a 50 percent (vote or value, applying section 318

attribution) or greater interest in any Disqualified Investment Corporation, but only if such person did not hold such an interest in such corporation immediately before the transaction (excludes pro-rata distributions from being subject to this rule).

44

Planning Opportunities Section 355(g) – Cash Rich Split-offs

• A Disqualified Investment Company is any corporation in which 2/3 or more
• f the FMV of all of its assets constitute “Investment Assets”:
• Cash, stock or securities, certain partnership and subsidiary interests,

debt, options, forward or futures contract, notional principal contract, derivative, foreign currency, or any similar asset.

• Exception for:

– Certain assets used in active conduct of lending, banking, or insurance business and – Securities mark‐to‐market assets.

45

History of REIT Spin-Offs: Before 2001

• In Rev. Rul. 73-236, D spun off its sales business and assets as a

separate entity, retaining its property rental business and assets. Immediately after the distribution, D elected REIT status.

• At the time, section 856(d)(3) prevented entities from qualifying as

REITs if they provided services to tenants or managed/operated property.

• IRS concluded that, under section 856(d)(3), a REIT could not

satisfy the ATB requirement of section 355(b)(1).

46

• Rev. Rul. 2001-29
• The Tax Reform Act of 1986 amended section 856(d)(2)(C) to operate in

conjunction with Treas. Reg. section 1.512(b)-1(c)(5), allowing REITs to provide services usually or customarily rendered in the ordinary course of renting property.

• Rev. Rul. 2001-29 concluded that REITs could now satisfy the ATB

requirement of section 355(b)(1). Rev. Rul. 73-236 was obsoleted.

• Rev. Rul. 2001-29 cautioned that ‘‘the obsolescence of Rev. Rul. 73-236

does not imply a view whether a distribution of stock involving a REIT election by the distributing or controlled corporation would otherwise satisfy the requirements of section 355, including the business purpose requirement.”

47

REIT Spin-Offs and Business Purpose

• Obtaining favorable U.S. federal tax treatment is not a valid business purpose for a section

355 distribution.

• IRS will “carefully scrutinize” separations of owner-occupied real estate for business purpose.
• REITs are permitted to deduct, at the corporate level, any income distributed as dividends,

effectively eliminating one level of tax.

• Is the goal of obtaining REIT status for D or C an impermissible business purpose?
• Is intent to elect REIT status following a spin-off evidence of device?
• The IRS will no longer rule on what constitutes a valid business purpose.

– The IRS has accepted a representation stating that a spin-off’s business purpose is to increase C’s value to investors by electing REIT status for C. – IRS granted tax-free treatment to the spin-off of newly-formed C, followed by the merger of C with and into a REIT, with the surviving REIT continuing to operate as such. – The IRS may be sympathetic to spin-offs where D owns a substantial amount of real estate, wants to separate the real estate from its other businesses due to regulatory constraints, but is not able to effect the separation unless C can compete in the marketplace as a REIT.

48

Recent PLR – REIT Spin-Off

• In its 8K filed November 16, 2012, OpCo announced that it will contribute all of its real

estate assets to newly-formed PropCo, then distribute PropCo to OpCo’s shareholders.

• As part of the same plan, PropCo will elect to be a REIT, distribute its historical subchapter

C E&P in a taxable dividend, and lease the majority of its real estate back to OpCo.

• To comply with REIT income rules that apply section 318 attribution, shareholders will

reduce their indirect interest in PropCo to under 10% as part of the spin-off.

• In the 8K, OpCo disclosed that it had obtained a PLR relating to “the tax treatment of the

separation and the qualification of PropCo as a REIT.”

• This PLR has not yet been released.
• This planning strategy, the “McREIT,” had not been previously tested in a PLR.

49

Post-Spin-Off OpCo/PropCo Structure

50

Shareholders OpCo PropCo Non-REIT Qualifying Assets Leasehold Assets Real Estate Taxable REIT Subsidiary Operating Assets Lease Payments Dividends

3. Getting It Done – Corporate Considerations

51

Why A Spin- Or Split-Off?

• Market undervalues large companies (e.g., “conglomerate discount”)
• Provide investors with more investment options
• Focused management may increase value of each company
• Equity compensation will reflect the efforts of management
• Each company can implement corporate structure that meets its needs

52

Fiduciary Duty Considerations

• Absent special circumstances (e.g., director conflicts of interest or a

pending takeover bid), a Board’s decision to authorize a spin- or split-

• ff should enjoy broad deference under the business judgment rule
• The Board should meet with its advisors (financial and legal) and

management to discuss the impact of proposed separation transaction and alternatives

• Liability – Directors should consider obtaining opinions from advisors

as (under DE law) they will be protected in relying in good faith on the information, opinions and statements presented by management and by

• utside experts as to matters they reasonably believe are within their

professional or expert competence

• In Delaware, the Board of Parent does not have a duty to future

stockholders of Spinco

53

Legality of Dividend

• Under Delaware law (DGCL 170), dividends must be paid out of a

corporation’s (i) “surplus” or (ii) net profits for the fiscal year in which the dividend is declared and/or net profits for the preceding fiscal year

• Under DGCL 174, in the case of any willful or negligent violation in

declaring a dividend, directors may be personally, jointly and severally liable to the corporation and its creditors for the full amount of any dividend not in compliance with DGCL 170 (6 year SoL)

• Consider obtaining appraisal and opinions to determine the value of net

assets and statutory surplus

54

Common Gating Issues

• In addition to the satisfaction of tax requirements, commonly

encountered gating issues that need to be addressed early in the spin-

• ff process include:
• Non-transferability issues relating to key agreements
• Restrictive covenants found in parent indebtedness arrangements
• Difficulties in creating financials for Spinco (2 years of audited

balance sheet; 3 years of audited income statement and cash flows; 5 years of selected financial data)

• Establishment of formation, capitalization, organization and

structure of Spinco management and resolution of social issues (location of HQ; division of company names)

• Treatment of shared assets

55

Typical Transaction Agreements

• Contribution/Separation Agreement
• Agreement and Plan of Merger (For RMTs)
• Transitional Services Agreemnts
• Tax Sharing Agreement
• Other Ancillary Commercial Agreements
• Conveyancing Documents (IP assignments, assignment & assumption

agreements, etc.)

• Support Agreements (Possibly For RMTs)

56

Spin-Offs – The Simplest Execution

• In essence, is a unilateral divestiture – Parent has significant control over the

deal terms

• Spinco will typically retain counsel in the process, and negotiation of

separation, etc. agreements can have a quasi-adversarial dynamic, but Parent typically is able to implement the terms that it would like

• Need to be mindful of fraudulent conveyance and similar issues

57

Spin-Offs – The Simplest Execution

• As with all divestitures, clearly defining the deal perimeter will be essential

(“exclusively related” vs. “primarily related” standard, etc.)

• Subsidiaries
• IP
• Employees
• Personal Property
• Balance Sheet Assets
• Real Property
• Contracts
• Spinoffs generally do not involve the making of reps and warranties, and

Parent retains the right to abandon the spin-off up to the closing date

58

Spin-Offs – SEC filings

• Spinoffs do not involve the sale of securities and do not require ’33 Act

registration statements; they do, however, require registration for ’34 act reporting purposes, which is accomplished with an information statement and Form 10

• Staff Legal Bulletin 4: ’33 Act registration not required where:

– Parent’s stockholders do not provide consideration for Spinco shares – Spinoff is pro-rata to Parent shareholders – Adequate information is provided to Parent shareholders (Form 10) – Valid business purpose – If parent spins off “restricted securities,” Parent must have held those securities at least two years

59

Spin-Offs – SEC filings

• Form 10s generally require disclosures akin to what would be needed

in an IPO, with some exceptions to reflect the fact that no sale of securities is taking place

• The review process typically takes at least a couple of months –

not dissimilar to what might be expected with an IPO

60

Split-Offs

• In a split-off, a sale is taking place – shares of the Parent are being

exchanged with shares of the entity to be spun out

• As such, a registration statement is needed, as well as the filings that

are necessary for tender offers

• In essence, it is the combination of an IPO of Spinco and an

exchange offer

• Parent’s obligation to consummate the tender offer may be subject to

conditions, but they cannot be so discretionary as to render Parent’s tender offer illusory

61

Reverse Morris Trust transactions

• A Reverse Morris Trust transaction is, in essence, the combination of a

spin-off or split-off with a merger.

• Similar SEC filings, except that a Form S-4 would be needed in

connection with a split-off RMT.

• These transactions, particularly when executed in split-off form,

present a number of added complexities:

• Consideration to be received by parent tied to market reception of

transaction

• Potential lengthy freezeout from share repurchase program due to

application of Rule 14e-5

62