Stock Purchases and Back-End Mergers

Summary: A tender offer followed by a back-end merger can be structured as an integrated transaction. Where such structure is agreed to by acquiror and the target, it is easy to establish that the parties intended an integrated transaction qualifying for reorganization treatment under the step transaction doctrine. Even in a hostile tender offer, the step transaction ought to allow reorganization status if Section 368 is satisfied on an integrated basis.

Author Stephen Tolles writes: Recitals as to the overall intent set forth in the parties' agreements should provide further comfort that the transaction is one covered by Revenue Ruling 2001-26 . Even in a hostile tender offer where the offeror makes it clear that it intends to proceed with a back-end merger if a sufficient percentage of the target stock is obtained in the tender, the step transaction ought to allow reorganization status provided the requirements of Section 368 are met on an integrated basis. King Enters. v. United States, 189 Ct. Cl. 466 (Ct. Cl. 1969).

[In King Enters. v. United States, 189 Ct. Cl. 466 (Ct. Cl. 1969),] the court rejected the government's argument that a binding commitment must be found before the two steps may be integrated, asking instead whether the ultimate result was intended from the outset. Finding sufficient evidence in the record to support the conclusion, the court held that the upstream merger was the intended result of the transaction all along. However, no hard evidence of intent to follow the purchase with a merger existed. Rather, the court assumed a merger was intended,... and seemed to think all parties probably could be deemed to have such intent because the tax benefits should have been obvious to 'sophisticated businessmen.'

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[In J.E. Seagram Corp. v. Commissioner, 104 T.C. 75 (T.C. 1995), however,] the court held that DuPont had a binding commitment to complete the merger once the tender offer ended and the tender and the merger were an integrated transaction, as a result. The fact that some contingencies existed did not change the fact that the merger, in fact, occurred. The court also rejected Seagram's argument that continuity failed on the grounds it was not an historic shareholder.

The IRS addressed a fact pattern broadly similar to King Enterprises and Seagram in Revenue Ruling 2001-26...

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The ruling concluded that all of the T [acquired company] shareholders that exchanged their T stock for P [purchasing corporation] stock in the transaction would be treated as having exchanged their T stock in return for P stock pursuant to a plan of reorganization. Therefore, T shareholders that exchanged their T stock solely for P stock in the transaction recognized no gain or loss under Section 354. T shareholders that exchanged their T stock for P stock, and cash, in the transaction recognized gain to the extent provided in Section 356. In both Situations (1) and (2), neither P, nor S [purchasing corporation's transitory subsidiary], nor T recognized any gain or loss in the transaction, and P's basis in the T stock was determined by treating P as having acquired all of the T stock in the transaction and not before.

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A comparison of Revenue Ruling 67-274 and Revenue Ruling 2001-26 highlights the extremely important difference between a second-step liquidation, and a second-step upstream merger. The liquidation throws the transaction onto the dangerous shoals of the 'C' reorganization rules, while an upstream merger directs the transaction towards the relative safety of the 'A' reorganization rules. The distinction can cause dramatically different outcomes.

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There are several rulings in which the Service has analyzed the tax treatment of two-step (or even multi-step) transactions to determine whether a reorganization occurred under one of the provisions of Section 368. One of the most important of these rulings is Revenue Ruling 67-274, discussed above. Revenue Ruling 67-274 plays an important role in the recent rulings that address the interaction of Section 338 and the application of the step transaction doctrine to two-step transactions.

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The cited rulings, and cases such as King Enterprises and Seagram, demonstrate that the step transaction doctrine is firmly entrenched in the reorganization arena. Where two (or more) steps are part of an integrated plan, those steps are viewed as a single transaction for purposes of determining whether a reorganization under IRC Section 368 has occurred. However, application of the step transaction doctrine in the reorganization context may be limited by IRC Section 338 and its underlying policy.

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