BUSINESS SALES MERGERS STRATEGIES
MERGERS

Terminology

The terms “merger” and “acquisition” are commonly used interchangeably in the business community. To an attorney, however, a “merger” is the statutory process of combining the acquired corporation into the acquiring corporation, often referred to as a “statutory merger”. Unless the context otherwise clearly indicates, the word “merger” is used in that sense throughout this web stie.

Despite any differences in terminology, the substantive result of either a merger or acquisition is the same: one corporation obtains ownership of another corporation

Five Basic Acquisition Methods

One corporation can obtain ownership of another corporation by any of the following methods:

  • The purchase of all the outstanding shares of one corporation by another corporation for cash or promissory notes
  • The purchase of all assets of one corporation by another corporation for cash or promissory notes
  • The statutory merger of corporations
  • The exchange of all shares of one corporation for shares of the other, acquiring, corporation
  • The exchange of all assets of one corporation for shares of another corporation

What is the Governing Law for Mergers?

There are two different laws that apply to Mergers: California Corporate Law and the Internal Revenue Code

California Corporation Law
[a] Generally

Four of the five principal methods by which one corporation can obtain ownership of another corporation are regulated by statute in California. The statutes regulating those four methods are contained in four consecutive chapters, Chapters 10–13, of the General Corporation Law [see Corp. Code §§ 1000–1313;  The fifth method, a cash purchase of shares, is not subject to specific statutory regulation.

[b] Sale of Assets for Cash

The General Corporation Law does not treat the sale of all assets by one corporation to another corporation for cash or promissory notes as a method of corporate acquisition, or define it as a form of “reorganization,” as are the other regulated acquisition methods [see Corp. Code § 181; . However, the sale of all assets by one corporation to another corporation for cash or promissory notes is regulated by the provisions of Chapter 10 of that law [Corp. Code § 1001(a)], which imposes special requirements on the sale or attempted sale by a corporation of all or substantially all of its property and assets [see Corp. Code §§ 1000–1002;. An exchange of all assets of one corporation for shares of another corporation, however, is defined as a “reorganization” [see [d], below] and is excluded from the requirements of Chapter 10 of the General Corporation Law, even though it may be considered a sale of assets for some purposes [Corp. Code § 1001(a)].

[c] Statutory Merger

The merger of two or more corporations into one corporation [see Corp. Code § 1100], commonly known as a “statutory merger,” is defined by California’s General Corporation Law as a form of “reorganization” called a “merger reorganization” [see Corp. Code § 181(a);. The procedural requirements and effect of a statutory merger of corporations are set forth in Chapter 11 of the General Corporation Law [Corp. Code §§ 1100–1113]. The shareholder consent requirements for a valid statutory merger or “merger reorganization” are set forth in Corp. Code §§ 1200 and 1201. Short-form mergers, or mergers of wholly owned or 90-percent-owned subsidiary corporations into their parent corporations, are expressly excluded from the statutory definition of a “reorganization” [see Corp. Code § 181(a)]. They are governed in their entirety by Corp. Code § 1110

[d] Exchange of Shares for Shares or Assets for Shares

The third and fourth types of corporation acquisition methods regulated by statute in California are the exchange of all shares of one corporation for shares of another corporation, and the exchange of all assets of one corporation for shares of another corporation. The present General Corporation Law defines both of these types of corporate acquisition methods as well as statutory mergers as “reorganizations” [see Corp. Code § 181(b), (c);. That law subjects all reorganizations to the same shareholder consent requirements, which are set forth in Chapter 12 of the General Corporation Law [Corp. Code §§ 1200, 1201;

[e] Dissenters’ Rights in Reorganizations

Acquisitions defined as “reorganizations” are subject to Chapter 13 of the General Corporation Law, entitled “Dissenters’ Rights” [Corp. Code §§ 1300–1313]. Those sections also apply to short-form mergers. They do not apply, however, to the sale of all assets by one corporation to another corporation for cash or promissory notes [see Corp. Code § 1300(a)].

Generally, Corp. Code §§ 1300–1313 provide a procedure by which a “dissenting shareholder” in a corporation that is a party to a “reorganization” or short-form merger, and who is entitled to vote on the transaction, may require the corporation to purchase his or her “dissenting shares” for cash at the fair market value they had on the day of, and immediately prior to, the first announcement of the terms of the proposed “reorganization” or short-form merger [Corp. Code § 1300(a)]. Each shareholder of a disappearing corporation in a short-form merger is also entitled to require the purchase of his or her dissenting shares [Corp. Code § 1300(a)]. “Dissenting shareholder” and “dissenting shares” are terms of art expressly defined by statute [see Corp. Code § 1300(b), (c);

[2] Internal Revenue Code
[a] Tax-Free Reorganizations Generally

Transactions involving the purchase or sale of some or all of the business of a corporation can be a complicated areas of corporate practice. While these transactions involve considering a number of legal and non-legal factors that bear on the structuring and consequences of these transactions  the tax consequences of the transaction usually are of primary concern. The most obvious distinction between a taxable and tax-free transaction is that gain or loss is recognized in the former but not in the latter

I.R.C. § 354 provides that no gain or loss will be recognized for federal income tax purposes when stock or securities in a corporation that is a party to a “reorganization” is exchanged, pursuant to the plan of reorganization, solely for stock or securities of the corporation or another corporation that is a party to the reorganization [I.R.C. § 354(a)]. I.R.C. § 361 provides that no gain or loss will be recognized for federal income tax purposes when a corporation that is a party to a “reorganization” exchanges property, pursuant to the plan of reorganization, solely for stock or securities in another corporation that is a party to the reorganization [I.R.C. § 361(a)]. The receipt of other property (“boot”), however, that is not distributed pursuant to the reorganization will result in the recognition of gain equal to the fair market value of the property (or the amount of money received) [I.R.C. § 361(b)].

The key word in both sections is “reorganization.” The transaction is tax-free under either section (that is, no gain or loss is recognized for federal income tax purposes), only when the corporations involved are parties to a “reorganization” and the exchange of shares for shares [I.R.C. § 354(a)] or property for shares [I.R.C. § 361(a)] is made pursuant to a plan of “reorganization” [see I.R.C. § 368(a) (definition of reorganization); see also [b], below].

[b] “Reorganizations” for Federal Tax Purposes

I.R.C. § 368 defines “party to a reorganization” and “reorganizations” for purposes of I.R.C. §§ 354 and 361 [see I.R.C. § 368(a)(1), (b)]. A “party to a reorganization” is defined as including a corporation resulting from a reorganization, and both corporations when the reorganization results from the acquisition by one corporation of shares or property of another corporation [I.R.C. § 368(b)].

I.R.C. § 368(a)(1) lists seven types of corporate transactions that will be considered “reorganizations” for purposes of the tax-free provisions of the federal income tax law [see I.R.C. § 368(a)(1)]. The first three types of transactions on the list are acquisition methods by which one corporation seeks to obtain ownership of another corporation and are similar to the acquisition methods defined as “reorganizations” by California’s General Corporation Law [see I.R.C. § 368(a)(1)(A)–(C); see also Corp. Code § 181]. The fourth type of transaction on the list is a method of dividing a corporation, and the fifth and sixth types of transactions are corporate recapitalization methods [see I.R.C. § 368(a)(1)(D)–(F)]. The final type of transfer qualifying as a “reorganization” basically involves a transfer of all a corporation’s assets to another corporation in a Title 11 bankruptcy or similar case, and a corresponding distribution of stock of the corporation to which the assets are transferred in a transaction that qualifies under I.R.C. §§ 354–356 [see I.R.C. § 368(a)(3)(G)].

Because the types of transactions set forth in I.R.C. § 368(a)(1) are lettered with capital letters, the three acquisition methods  have come to be known as “A reorganizations,” “B reorganizations,” and “C reorganizations”. They may be described as follows [see I.R.C. § 368(a)(1); see also § 11.23[2]]:

  • A statutory merger (“A” reorganization).
  • An exchange of shares of one corporation for shares of another corporation (“B” reorganization).
  • An exchange of all assets of one corporation for shares of another corporation (“C” reorganization).

Although the same three general types of acquisition methods are also defined as “reorganizations” by California’s General Corporation Law [see Corp. Code § 181; , the requirements a particular acquisition transaction must meet before it can be treated as a “reorganization” under the General Corporation Law of California or as a tax-free “reorganization” under I.R.C. § 368 are somewhat different. Therefore, understanding the purpose and meaning of the “reorganization” definition contained in the General Corporation Law and in I.R.C. § 368 is important;