Alternative Structure Clauses
(Merger Transaction)

This template contains alternative structure clauses for tax-free merger transactions that are often used as savings clauses for tax-free triangular mergers. To ensure that certain mergers qualify as tax-free under U.S. federal income tax laws, counsel may employ a double merger structure or other change to the transaction structure to qualify the merger as tax-free if the reverse triangular merger requirements of I.R.C. § 368(a)(2)(E), or requirements of another intended tax-free reorganization chapter of the I.R.C., are not met. This template includes practical guidance and drafting notes. Generally, double mergers consist of a reverse triangular merger followed by either an upstream or sideways merger that, taken together, qualify as a tax-free merger under I.R.C. § 368(a). The double merger structure arose as a result of Rev. Rul. 2001-46, (I.R.S. 2001), in which the IRS affirmed the tax consequences of a double merger. If the overall transaction qualifies as tax-free, the two mergers are integrated and treated as an overall tax-free merger. If the overall transaction is not tax-free, the overall transaction is not treated as a failed forward triangular merger or basic merger (which results in double taxation); rather, the first step is respected as separate and is treated as a stock purchase (subject to one level of taxation). The second step is then respected as either a tax-free reorganization or a I.R.C. § 332 liquidation (depending on the structure). See Rev. Rul. 90-95 (I.R.S. 1990). The parties, however, can choose to make a Section 338 election to treat the first step as an asset acquisition. Thus, the parties have flexibility to treat the first step as either an asset acquisition or a stock acquisition. In any case, the IRS does not require mandatory double taxation on a failed tax-free double merger structure. The alternative structure clauses in this template only allow acquiror to change the structure in a manner that maintains tax-free treatment to target equity holders. If the transaction fails to qualify as a tax-free reorganization, then typically a closing condition of the merger will have failed so that the transaction will not close unless the parties can agree to an alternative transaction and waive the closing conditions and/or amend the merger agreement. Note that for public company mergers, SEC approval and an amended S-1 or F-1 may be required for the new structure and deal terms. This annotated clause is helpful as a fallback in the event that a triangular merger fails to qualify as tax-free, because the amount of cash consideration exceeds the 20% threshold (in a reverse triangular merger) or because the acquiror's subsidiary fails to acquire "substantially all" of T's assets (in either a reverse or a forward triangular merger). The clause is a savings clause that can be drafted into the merger agreement to provide that in the event the contemplated transaction fails to qualify as a tax-free merger, the parties will either follow-on with a sideways merger or a basic merger within a certain period of time or simply enter into a straight merger of target into acquiror or acquiror's wholly owned limited liability company (which also qualifies as a straight merger under federal income tax law). Note that in the context of public company reorganizations, typically a double merger is effected for shareholder approval reasons. Tax counsel should discuss the shareholder approval requirements with corporate M&A counsel to ensure that the alternate proposal does not affect the manner in which shareholder approval is attained. For a more detailed discussion of double mergers, see Double Merger Transactions. For a discussion of tax-free reorganizations, see Tax-Free Acquisitions, and for taxable transactions, see Taxable Acquisitions.