Structuring Divisive Mergers Under the Delaware and Texas ...

Structuring Divisive Mergers Under the

Delaware and Texas Statutes

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TUESDAY, APRIL 23, 2019

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

Byron F. Egan, Partner, Jackson Walker, Dallas

William H. Hornberger, Partner, Jackson Walker, Dallas

R. Jason Russell, Partner, Morris Nichols Arsht & Tunnell, Wilmington, Del.

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Strafford Webinar | April 23, 2019

Byron F. Egan

Jackson Walker

Dallas, Texas

[email protected]

William H. Hornberger

Jackson Walker

Dallas, Texas

[email protected]

R. Jason Russell

Morris, Nichols, Arsht & Tunnell LLP

Wilmington, Delaware

[email protected]

Structuring Divisive Mergers Under

the Delaware and Texas Statutes

6

Welcome

7

OutlineI. Delaware and Texas Divisive Merger statutes:

Structuring alternative to M&A spinoffs and carve-outs

II. Mechanics of a divisive merger

A. Plan of a Divisive Merger: Key terms

B. Approval of Divisive Merger

C. Certificate of division or merger

III. Effect of the Divisive Merger: Allocation of assets, properties,

licenses, debts, liabilities and duties of the dividing entity among

multiple survivors

IV. Federal income tax treatment of Divisive Mergers

V. Concerns for lenders and other counterparties and best practices

going forward

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Delaware and Texas Divisive Merger Statutes:

Structuring alternative to

M&A spinoffs and carve-outs

9

Texas Divisive Merger Statute• Divisive mergers have been permitted under Texas law

since 1989

• Applies to corporations, partnerships and LLCs and can

involve entities organized under the laws of another state

so long as such state permits divisive mergers

• TBOC 1.002(55): Defines “merger” to include “(A) the

division of a domestic entity into two or more new

domestic entities or other organizations or into a

surviving domestic entity and one or more new domestic

or foreign entities or non-code organizations.”

10

Texas Divisive Merger Statute• Mechanics

• Must adopt a plan of merger that provides (1) the manner and basis for

allocating and vesting the property of the parties and (2) the manner and basis

of allocating each liability and obligation of the parties or making adequate

provision for the payment and discharge thereof

• Plan should specifically set forth the mechanism under which contingent assets and

contingent liabilities for the parties are to be allocated and satisfied or provided for

• If properly allocated in the plan, all assets and liabilities of the parties to the merger will be

allocated (subject to existing contracts, liens and encumbrances) among the surviving entities

in the manner provided in the plan, and not to any other party.

• If the plan fails to provide for the allocation or vesting of any particular item of property or

any liability or obligation of any party to the merger, TBOC 10.008(b) provides that “the

unallocated property is owned in undivided interest by, or the liability or obligation is the

joint and several liability and obligation of, each of the surviving and new organizations, pro

rata to the total number of surviving and new organizations resulting from the merger”

11

Texas Divisive Merger Statute• Must file a certificate of merger and certificate of formation for new

entities with Secretary of State of Texas

• Approval

• Approve plan of merger in the same manner as a traditional plan of merger unless

otherwise provided in the governing documents of the entity

• Dissent and Appraisal Rights: Shareholders of Texas corporations are

entitled to assert dissenters rights when objecting to a merger (including

a divisive merger) and seeking to be paid the value of their shares as

determined in a judicial appraisal.

• LLCs and partnerships do not have statutory rights of dissent and appraisal unless the

entity’s governing documents expressly grant these rights

• Rights of creditors may be impaired by a divisive merger when the pool of assets

available to satisfy an obligee’s claims are divided, but creditors’ perfected liens and

rights under fraudulent transfer and similar laws remain intact.

12

Delaware Statutory Division• Methods to Separate Assets and Liabilities

• Internal Division (no separation of liabilities)

• Series

• Protected

• Registered (new and effective as of August 1, 2019)

• New Division Statute (effective as of August 1, 2018)

• Note: Statutory division may be available for limited partnerships effective

August 1, 2019

• How to Effect Division Prior to Statute

• Convert to Pennsylvania or Texas entity, divide pursuant to statute,

then convert back to Delaware

• Form wholly-owned subsidiary and drop-down assets and liabilities

13

Delaware Statutory Division• General: New Section 18-217 enables an LLC to divide into two

or more LLCs, with the dividing LLC either continuing its

existence or terminating as part of the division

• Vocabulary:

• “Dividing company”: the LLC effecting a division

• “Resulting company”: a domestic LLC formed as a

consequence of a division

• “Surviving company”: a dividing company that survives

• “Division company”: a surviving company, if any, and each

resulting company

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Delaware Statutory Division• Mechanics

• A division is effected by (i) the adoption of a plan of division setting

forth the terms and conditions of the division, including, among

others, the allocation of assets, property, rights, series, debts, liabilities

and duties of the dividing LLC among the resulting LLCs and, if it

survives, the dividing LLC and (ii) the filing with the Delaware

Secretary of State of a certificate of division and a certificate of

formation for each newly formed LLC

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Delaware Statutory Division• Plan of Division

• How are interests treated: exchanged/converted into cash, property,

rights or securities of, or interests, in, the surviving company or any

resulting company; may remain outstanding

• Is dividing company surviving?

• Name of resulting companies

• Allocation of assets, property, rights, debts, liabilities

• Name and business address of contact person that has a copy of the

plan of division

• Similarities to considerations in a merger

• For example, may amend LLC agreement of surviving company

16

Delaware Statutory Division• Approval

• Division approved as provided in the LLC agreement

• If not specifically addressed and not prohibited, approved in same

manner as for merger or consolidation as set forth in LLC agreement

• If LLC agreement is silent, division must be approved by members

who own more than 50% of the then current percentage or other

interest in the profits of the dividing company

• Fiduciary duties – similar to merger

17

Delaware Statutory Division• Certificate of Division

• Name of the dividing company and whether it survives

• The date of filing of the dividing company’s original certificate of

formation

• The name of each division company

• The name and business address of the contact person

• Effective date

• Division has been approved in accordance with 18-217

• The plan of division is on file and state address

• A copy of the plan of division will be provided to any member of the

dividing company

• Certificate of formation for each resulting company

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Effect of the Divisive Merger• Delaware 18-217(l)(2): For all purposes of the laws of the State of Delaware, all of the rights,

privileges and powers, and all the property, real, personal and mixed, of the dividing company and

all debts due on whatever account to it, as well as all other things and other causes of action

belonging to it, shall without further action be allocated to and vested in the applicable division

company in such a manner and basis and with such effect as is specified in the plan of division, and

the title to any real property or interest therein allocated to and vested in any division company

shall not revert or be in any way impaired by reason of the division

• If debts and liabilities are not allocated by the plan, they shall be the joint and several debts and liabilities

of all of the division companies.

• Texas 10.008(a): Generally provides that, if properly allocated in the plan, all assets and liabilities

of the parties to the merger will be allocated (subject to existing contracts, liens and encumbrances)

among the surviving entities in the manner provided in the plan, and not to any other party.

• If, however, the plan does not provide for such allocation, the unallocated property is owned in undivided

interest by, or the liability or obligation is the joint and several liability and obligation of, each of the

surviving and new organizations, pro rata to the total number of surviving and new organizations resulting

from the merger

• Transfer: Both Texas and Delaware law expressly provide that the interest in the property of the

LLC shall not be deemed, as a result of the division, to have been assigned or transferred

Structuring Divisive Mergers Under the Delaware and Texas Statutes

Federal Income Tax Consequences of a Divisive Merger:

One Size Does Not Fit All

Strafford

April 23, 2019

William H. HornbergerJackson Walker L.L.P.2323 Ross Ave., Ste. 600

Dallas, Texas 75201214-953-5857

© 2019 William H. Hornberger

USE OF DIVISIVE MERGERS WITH C CORPORATIONS

REV. RUL. 2000-5 (SITUATION 1)

Target Corporation

(T)

Acquiring Corporation

(A)

Shareholders Shareholders

AssetB

AssetA

Asset B and certain liabilities pass to A in

divisive merger

Rev. Rul. 2000-5 - Conclusion: The transactions described in Situations (1) and (2) do not qualify as reorganizations under section 368(a)(1)(A). However, the transactions described in Situations (1) and (2) possibly may qualify for tax-free treatment under other provisions of the Code.

Cf. Treas. Reg. § 1.368-2, Example 1 (same facts as above), concluding:

(ii) Analysis. The transaction does not satisfy the requirements of paragraph (b)(1)(ii)(A) of this section because all of the assets and liabilities of Z, the coming entity of the transferor unit, do not become the assets and liabilities of Y, the combining entity and sole member of the transferee unit. In addition, the transaction does not satisfy the requirements of paragraph (b)(1)(ii)(B) of this section because the separate legal existence of Z does not cease for all purposes. Accordingly, the transaction does not qualify as a statutory merger or consolidation under section 368(a)(1)(A). 20

21


REV. RUL. 2000-5 (SITUATION 2)

Target Corporation

(T)

Acquiring Corporation

(A)

Shareholders

Asset B to A in divisive merger

Step 1: Asset B and certain liabilities pass to A in

divisive merger

Asset A Asset B

Acquiring Corporation 2

(A2)Asset A and certain liabilities pass

to A2 in divisive merger

A1 stock

Rev. Rul. 2000-5 – Conclusion: The transactions described in Situations (1) and (2) do not qualify as reorganizations under section 368(a)(1)(A). However, the transactions described in Situations (1) and (2) possibly may qualify for tax-free treatment under other provisions of the Code.

22


D Corporation(C Corporation)

Shareholders

Sub Corporation

(C Corporation)

Substantial Other Assets

100% of the Stock

STEP 1: D Corporation passes group of assets and

liabilities to C Corporation in exchange for 100% of the stock of C Corporation in

divisive merger

STEP 2: D Corporation distributes 100% of stock in

Sub Corporation to shareholders

Taxable or Nontaxable?

Assets

23

USE OF DIVISIVE MERGERS WITH ENTITIES CLASSIFIED AS DISREGARDED ENTITIES FOR

FEDERAL INCOME TAX PURPOSES

Sub LLC1(Disregarded

Entity)

Asset A

22870463v1

Sub LLC2(Disregarded

Entity)

Asset B

HoldingLLC

Asset B and certain liabilities pass to

SubLLC2 in divisive merger

Use of Divisive Mergers With Entities

Classified As Partnerships For Federal

Income Tax Purposes -

Partnership Division Regulations

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• Identify:

– Prior Partnership

– Resulting Partnership

– Divided Partnership

– Recipient Partnership

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• In the division of a partnership into two or more partnerships, the resulting partnerships (other than any resulting partnership the members of which had an interest of 50-percent or less in the capital and profits of the prior partnership) are considered a continuation of the prior partnership. Any other resulting partnership is not considered a continuation of the prior partnership but is considered a new partnership.

• If none of the members of the resulting partnership owned an interest of more than 50-percent in the capital and profits of the prior partnership, the prior partnership is terminated.

• Where members of a partnership that has been divided do not become members of a resulting partnership that is considered a continuation of the prior partnership, such partner’s interest is considered liquidated as of the date of the division.

26

General Rules Concerning Form of

Partnership Division

• Assets - Over Form

• Asset - Up Form

ABCD

PropertyX

PropertyY

PropertyZ

A B C D

40%

40% 10%

10%

AB1 AB2 CD

PropertyX

PropertyY

PropertyZ

A

B C D

PARTNERSHIP DIVISION REGULATIONS(ASSETS-OVER FORM)

Fmv: $500

Fmv: $300

Fmv: $200

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PARTNERSHIP DIVISION REGULATIONS

EXAMPLE

(ASSETS-OVER FORM)

Selected Partnership Transactions

Falling Outside Divisive Merger

Regulations

Partnership Division Regulations

Preamble to Final Regulations:“To have a division at least two members of the prior partnership must be members of each resulting partnership that exists after the transaction.”

Thus, the following is not a division:

ABCPartnership

BusinessX

BusinessY

A

B C

20%

20% 60%

Step 1: Distribution of

X businessCD

Partnership

BusinessX

C D

Step 2: Contribution of

X business

ABPartnership

BusinessY

A B

CDPartnership

BusinessX

C D

AFTER:BEFORE:

30

MemberA

MemberB

AB, LLC(Texas LLC)

Property Pool

X

Property Pool

Y

A, LLC(Texas LLC)

Property Pool

X

B, LLC(Texas LLC)

Property Pool

Y

Divisive Merger

MemberA

MemberB

31

AB, LLC(Texas LLC)

Property Pool

X

Property Pool

Y

A, LLC(Texas LLC)

Property Pool

X

B, LLC(Texas LLC)

Property Pool

Y

Divisive Merger(with Liabilities)

Encumbered by Liability

Encumbered by Liability

What is impact on A, LLC?

MemberA

MemberB

MemberA

MemberB

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AB, LLC(Texas LLC)

Property Pool

X

Property Pool

Y

A, LLC(Texas LLC)

Property Pool

X

B, LLC(Out of State LLC)

Property Pool

Y(located in

TX)

Divisive Merger(Out of State)

MemberA

MemberB

MemberA

MemberB

33

AB, LLC(Texas LLC)

Property Pool

X

Property Pool

Y

A, LLC(Texas LLC)

Property Pool

X

B, LLC(Out of State LLC)

Property Pool

Y(located in

TX)

Divisive Merger(Out of State with Liabilities)

What is impact if Property Pool Y is

encumbered by liabilities?

MemberA

MemberB

MemberB

MemberA

34

AB, LLC(Texas LLC)

Property Pool

X

Property Pool

Y

A, LLC(Texas LLC -

formerly AB, LLC)

Property Pool

X

HOLDCO, LLC(Out of State LLC)

Property Pool

Y(located in

TX)

Divisive Merger Illustration(with Member)

Holdco, LLC

MemberA

MemberB

MemberA

MemberB

35

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Concerns for Lenders & Creditors• A divisive merger/division may alter and reduce the pool

of assets to which a creditor may look for repayment

• A division could result in moving collateral that secures

a loan to a new entity that is not credit-worthy without

breaching the terms of the credit agreement

• Applies to lenders and all other creditors

37

Protections• Delaware:

• Under Delaware statute, with respect to any LLC formed prior to August 1, 2018 that is party to any written

contract, indenture or other agreement entered into prior to August 1, 2018 that by its terms restricts,

conditions or prohibits such LLC from (x) consummating a merger or consolidation with or into another party

or (y) transferring assets, such restriction shall be deemed to apply to a division as if it were a merger,

consolidation or transfer of assets

• A “division contact” must be specified in the plan of division to be available for 6 years following the division

to advise creditors as to the division company to which such creditor’s claim was allocated

• Any action or proceeding pending against a dividing company may be continued against the surviving

company as if the division did not occur and against any resulting company to which the asset, property, right,

series, debt, liability or duty associated with the action was allocated pursuant to the plan of division

• Each division company is jointly and severally liable for any liabilities if the division would constitute a

fraudulent transfer under applicable law

• Texas: Fraudulent transfer protections and creditor will continue to possess all other

rights otherwise available to it under law and contract, including all security interests in

the property of the debtor securing the payment of the creditor’s claim

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Best Practices for Creditors• Delaware Note: For LLCs formed after August 1, 2018, the LLC/borrower

might be able to transfer a secured lender’s collateral to a new LLC that is not

credit-worthy without breaching its credit agreement.

• Agreement (such as a credit agreement) could expressly address division

• Consider expanding definitions of assets sales, mergers, reorganizations, etc. to

address divisions

• Consider expanding negative covenants to prohibit divisions without the consent of

the lender in the same manner as asset sales, mergers, reorganizations, etc.

• Consider whether typical SPE covenants in a bankruptcy remote transaction, provide

sufficient protection.

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Q & A

Structuring Divisive Mergers Under the Delaware and Texas ...

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