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Section 368A, states that the term reorganization applies to seven different
types of corporate restructurings or rearrangements.
Each type is defined in a separate sub-paragraph denoted by letters
A through G.
Let's briefly examine each item of this so-called reorganization alphabet.
A type A reorganization is defined by code section 368A 1A.
As a statutory merger or consolidation.
The terms statutory refers to a merger or consolidation pursuant to local or
state corporate statutes.
At a high level, type A reorganizations are stock-for-asset acquisitions.
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In a statutory merger, two or more corporations combine together
with one of the corporations retaining its existence and absorbing the others.
In this case, either the target or
the acquiring corporation can cease to exist by operation of state law.
This transaction design alternatives create several sub-types
of statutory mergers.
For example Marley Corporation can acquire the assets and liabilities of
Sunchaser Shakery Corporation by transferring Marley stock to Nicholas
in exchange for 100% stock ownership in Sunchaser which tend ceases to exist.
This type of merger is called an upstream or ford acquisition, due to the fact
the target Sunchaser is merged into the acquiring corporation Marley.
Alternatively, Sunchaser could be the surviving corporation
with Marley dissolving by operation of state law.
This type of merger is known as down stream or reverse acquisition.
In either case,
there are a few limits placed on the type of consideration transfer to Nicholas for
his stock so long as it satisfies the continuity of interest principle.
That is 40% of the consideration transferred must be voting or non-voting,
common or preferred stock of Marley.
This figure illustrates the organizational structure after a statutory merger.
Naturally, there are advantages and
disadvantages to structuring a transaction as a statutory merger.
Type A mergers do allow for more flexibility in transaction design than
many of the other reorganizations you will learn about.
For example, both type B and C reorganizations require transfer of
voting stock, whereas voting stock is not required for type A arrangements.
In terms of disadvantages, every corporation in a type
A reorganization must obtain re-approval from a majority of its shareholders.
State laws often allow dissenting shareholders to demand that their shares
be purchased by the corporation.
Another key disadvantage is, the cost of reassigning asset ownership which can
include title fees and transfer taxes paid to local or state tax authorities.
Such costs can sometimes be alleviated by using a variation of a type A merger.
Let's discuss two of them.
First, in a forward triangular merger Marley corporation forms a subsidiary
corporation Root Subsidiary.
Which holds Marley stock.
Sunchasers Shakery Corporation then merges into Roots such that Nicholas receives
the Marley stock and exchange for his Sunchasers stock.
In the end, Sunchasers assets and
liabilities are isolated in a wholly owned subsidiary of Marley.
This merger variation is common when a parent corporation is a holding company or
its stock is publicly traded.
To qualify for tax deferral, a forward triangular merger might satisfy all
requirements mentioned earlier plus one additional condition.
That is the acquisition subsidiary Root, must require substantially all
of Sunchasers assets which the IRS defines as 70% and
90% of the fair market value gross and net assets respectively.
Additional considerations may apply, but are beyond the scope of our discussion.
Second, in a reverse triangular merger, Sunchaser's existence is preserved.
For instance, if Sunchaser owns a valuable asset such as patents on its coconut zip
line drink delivery system that cannot be easily transferred to another entity.
It makes little sense to dissolve Sunchaser as the valuable asset
would be lost.
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However, Marley can create a subsidiary corporation like before
that holds Marley's stock.
The subsidiary Roots can then merge into Sunchaser
with Nicholas receiving Marley's stocks in exchange for his Sunchaser stock.
In the end Sunchaser remains legally intact.
Aside from the general requirements this merger variation must also satisfy three
additional requirements.
First, Sunchaser must hold substantially all of assets of both Roots and Sunchaser.
Second, Nicholas must transfer an amount of stock in Sunchaser that constitutes
control of Sunchaser, that is 80% or more.
Finally, Nicholas must receive Marley voting stock in exchange for
his Sunchaser stock that constitutes control of Sunchaser in the exchange.
This final requirement is often very difficult for publicly traded companies to
meet as they are sensitive to the amount of stock issued in an acquisition.
Due to its adverse effects on earnings per share the other denominator,
that is the number of outstanding shares.
A reverse triangular merger was used in the $7.4 billion
acquisition of Pixar by World Disney.
Specifically an acquisition subsidiary merged into Pixar, with the former
shareholders of Pixar receiving Disney stock in exchange for their Pixar stock.
You can learn more about this merger in the reading design for this module.
Spoiler alert, the story ends with Mickey, Mouse, and
Nemo becoming corporate cousins, typical Disney.
Finally, in a statutory consolidation, the assets of two or
more corporations are transferred to a newly created entity,
followed by dissolution of the two pre-existing transfer corporations.
The shareholders of each transfer corporation become shareholders in the new
corporation, by operation of law.
For example, both Sunchaser and Marley can transfer their assets and liabilities
to a newly formed entity, West Indies Corporation in exchange for its stock.
Marley and Sunchaser will then cease to exist by operation of state law.
Michael P Donohoe, PhD, CPAAssociate Professor of Accountancy and PwC Faculty Fellow
