Areas of Practice
Business Law - Mergers & Acquisitions
Introduction
Corporations are not necessarily static entities. For a variety of reasons, a corporation may change its corporate structure. Sometimes these changes are unwanted and are the result of a hostile takeover. However, often they are the result of a transaction negotiated by the management of the corporation in question. Two such ways in which corporations may combine are mergers and acquisitions. In a merger, one or more corporations fuse to form one corporation, while in an acquisition one company takes over another but both parties retain their separate legal existence. The choice affects the form and liabilities of the resulting corporation, the protections available to its shareholders, and the taxation of each corporation and its shareholders.
Mergers and Acquisitions
While the kinds of mergers we most often hear about are “mega-mergers” involving huge publicly traded corporations, most mergers and acquisitions involve smaller privately held corporations. There are many reasons to go forward with a merger or acquisition. A small company might benefit by teaming with the more sophisticated management of another larger corporation, or might achieve an increase in its market share. The combination might also improve channels of delivery for the parties to the transaction, helping them compete more effectively. Or, there may be estate planning or retirement motives. In deciding whether or not to proceed with a merger or acquisition, a corporation should keep in mind that a corporate combination could be structured in a number of functionally identical ways, but that different structures affect different sets of legal protections for shareholder and creditors. Also, sates have enacted laws, which regulate business within that state. In addition to state laws, there are federal regulations that affect business transactions. These laws address taxation, antitrust and securities issues. Depending on the form the structural change takes, different aspects of these laws will be triggered.
Overview of Mergers
A merger is an absorption of one or more corporations by another in which the absorbed corporations cease to exist as legal entities. One straightforward way in which corporations can merge is through a “statutory merger”, so called because the rules by which the merger is achieved are governed by state statute. While many states are similar in a number of respects, laws do vary from state to state. These state laws govern whether or not shareholders have a right to vote on the transaction and whether or not a dissenting shareholder will have the right to cash out of the deal if the transaction proceeds. In a statutory merger, the acquiring corporation (Company A) completely absorbs another (Company B), acquiring all of Company B’s assets and liabilities. It is also substituted for Company B in any pending litigation. Company B ceases to exist and the shareholders of Company B either receive cash or shares in Company A. In another kind of statutory merger, sometimes called a “combination”, Company A and Company B may combine to create a completely new corporation with the existing corporations disappearing following the merger.
A statutory merger is initiated when the board of directors of corporations, which desire to merge, adopt a document known as the “plan of merger”. This document must set forth the name of the surviving corporation, the terms and conditions of the merger, including how the shareholders will vote on the merger, and the manner in which the shareholders will be compensated for their interests in the merged company. In approving the merger, the board of directors is bound by its fiduciary duties to the shareholders to act in the best interests of the company. If the transaction is one in which stock will be issued, shareholders receiving shares for their stock are entitled to additional disclosure and antifraud protection under federal law.
After the board of director adopts a plan of merger, the plan must usually be submitted to the shareholders of each corporation for approval. Approval of the acquired corporation’s shareholders is always required because the merger fundamentally changes their interests. On the other hand, the effect on the acquiring corporation may or may not be significant. When a large corporation acquires a small corporation, the effect may be so minimal as to make the cost of a shareholder vote not worthwhile. Many states have guidelines for determining when an acquiring corporation must get shareholder approval. Because shareholders can not opt out of a merger, usually states provide that shareholders who are entitled to vote and who disapprove of the merger, have the right to cash out of the transaction and receive the appraised fair value for their shares.
Overview of Acquisitions
An acquisition takes place when Company A acquires the assets or stock of Company B, but Company B continues to exist as a separate legal entity, as in the following to scenarios. The first scenario occurs when Company A acquires all the assets of Company B. In this scenario, the Company A would either issue stock or pay cash for the assets of Company B. Company B could remain a separate legal entity after the sale, but, typically, the selling corporation dissolves and the cash or stock it received from the buyer is distributed to its shareholders. In this case, Company A may assume all or only a portion of Company B’s liabilities. The two companies may also agree that some or all of Company B’s officers and directors will join Company A’s management.
Another possibility is for Company A to buy a controlling block of shares in Company B, either from the corporation or directly from its shareholders. Again, Company A could either pay cash or issue its own stock for the shares in Company B. In this case, Company B would become a subsidiary of Company A and could continue to operate essentially unaffected by the transaction, or could be liquidated and merged into Company A. Whether these two transactions would be viewed as mergers or acquisitions depends on whether Company B continues to exist after the transaction.
Corporate combinations may be structured in a non-statutory way for tax reasons or in an effort to avoid some of the consequence of a statutory merger, such as appraisal rights to dissenting shareholders. For this reason, some states have adopted the “de facto merger” concept. This doctrine grants the same rights to dissenting shareholders that they would have had if the transaction had been structured as a statutory merger. Other states have simply granted appraisal rights to shareholders in the case of any major transaction, providing a standard procedure covering mergers, exchange of shares and sales of assets, as well as amendments to the articles of incorporation, which significantly affect shareholder rights.
Most states treat the sale of assets by one corporation to another in essentially the same way as if a merger had taken place. Though state laws differ, usually a sale of assets requires the approval of the board, the approval of shareholders of the selling corporation, and the dissenters’ appraisal rights. When a sale of assets is in the normal course of business, such as a real estate holding company that regularly sells its inventory, the transaction is treated as any other business transaction and only board approval is required. But when the sale is outside of the normal course of business, and can be construed as a sale of substantially all of one corporation’s assets, then the statutory protections are usually triggered. A transaction is viewed as a sale of assets when it fundamentally affects corporate ownership and use of the corporation's assets. Most statutes do not consider a pledge, mortgage or deed of trust to secure the debt of the corporation to be a “sale”. A sale of “substantially all” assets has been understood to have taken place not only when nearly all the assets of a corporation are sold, but also when that portion sold was of vital significance to the corporations operations thereby affecting the existence of the corporation.
This is but a rudimentary overview of mergers and acquisitions. Variations on these basic scenarios are used to provide corporate and shareholder protections. A good understanding of state and federal laws can be invaluable in minimizing the costs of the transaction, as well as maximizing the potential of the combination.
Conclusion
A corporate combination can be structured in a number of functionally identical ways, each affecting the protections available to shareholders and creditors. These combinations also generate tax and accounting consequences and potential antitrust considerations. If you are a corporation considering a structural change, it is important to consult an experienced business attorney to fully understand the legal consequences of the proposed deal. Likewise, if you are shareholder, a qualified attorney can help you determine your rights during a corporate merger or acquisition.
