LA 405: Business Organization

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations

Based on Study Guide by J. Renee Moore, Esq.

MERGER.................................................................................................................................2
• Upstream..........................................................................................................2
• Downstream.....................................................................................................2
• Triangle............................................................................................................2
• Reverse Triangle..............................................................................................3

SHARE EXCHANGES.............................................................................................................3

CONSOLIDATIONS................................................................................................................3

STATUTORY MERGER AND SHARE EXCHANGE PROCEDURES.................. ..............4

1. MERGER..........................................................................................................4
2. SHARE EXCHANGES or "PLAN OF EXCHANGE"....................................4
3. ADOPTION OF PLAN........................................................................ ...........4
4. DUE DILIGENCE AND PRE-CLOSING........................................................5
5. CLOSING..........................................................................................................5
6. POST-CLOSING...............................................................................................5

ASSET AND STOCK ACQUISITIONS........................................... ......................................6

ASSET ACQUISITION........................................................................................6
STOCK ACQUISITION.......................................................................................6
PROCEDURE.......................................................................................................6
DUE DILIGENCE................................................................................................7
CLOSING & POST CLOSING............................................................................7

AMENDMENTS TO ARTICLES OF INCORPORATION.....................................................7

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations 1

Chapter 14.4: Changes in the Corporate Structure and Corporate
Combinations
This is another area or corporate formation and organization that can form the basis of an
entire career. It has been a fairly interesting to watch mergers over recent years because of
the large mergers within the telecommunications industry. Mergers have slowed down
significantly due to the recession, but had been slowing down even before the current
financial crisis. However, there have been some relatively recent, notable combinations, with
one of the most notable being the combination of Sears and K-Mart (well, Sears' acquisition
of K-Mart) and more recently the merger of Delta Airlines with Northwest Airlines. Previous
mergers include Time/Warner, Disney/Capital Cities/ABC. There are lots of huge merger
deals out there that have taken place in only the last few years and those have gotten a great
deal of attention. More frequently at the moment we here of efforts of large corporations to
rid themselves of some of the companies they have acquired such as GM’s effort to sell the
Opel car company in Europe the sale of Hummer to a small Chinese company.

There are many, many more day-to-day mergers of smaller companies that go on nearly un-
noticed. This combining of businesses takes place in several different ways and it is
important for students of the law of business organizations to have a basic understanding of
each process. We’re going to first focus on the merger, either a statutory merger or a share
exchange, then we’ll look at consolidations.

MERGER
A merger is a transaction in which two or more corporations come together - one survives
and “absorbs” the other one(s). The survivor takes on all of the assets and liabilities of the
other merging company(ies). If you do not take anything else away from this lesson, please
remember what you just read: THE SURVIVOR TAKES ON ALL OF THE ASSETS AND
LIABILITIES OF THE OTHER MERGING COMPAN(IES).

What about the stock holders in all of this? The general rule is that the share holders of the
merging company get stock in the surviving company in the exchange. But, they don’t have
to. The surviving company is free to convert the merged company’s shares, obligations or
other securities into cash or other property, in whole or in part. So, while it may be customary
to exchange stock for stock, there’s no reason why the surviving company couldn’t end up
buying some or all of the merging company’s outstanding shares.

Some of the most typical types of mergers are:

• Upstream. An upstream merger occurs when a subsidiary merges into a parent. There is
no shareholder approval required as long as the parent owns at least 90% of the
subsidiary’s outstanding stock. Minority shareholders would not be able to block the
merger because they do not have enough voting power.

• Downstream. A downstream merger is just the opposite of an upstream merger, because

the parent company merges “down” into the subsidiary.

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations 2

 • Triangle. Obviously, from the name, you know it involves three companies. Usually,
the parent forms a subsidiary and funds the subsidiary with sufficient assets to merge
with a third (target) company. The target becomes part of the subsidiary and then
both the parent and the subsidiary survive.

• Reverse Triangle. This is another example of a three-way merger. In this situation, the
subsidiary is merged into the target and the target then becomes a subsidiary of the
parent. Like the book points out, this may be an appealing situation when the target
company is one which is a difficult one to form or when it owns non-assignable
contracts.

SHARE EXCHANGES
Share exchanges are a little bit different from the merger - this is a transaction where one
company acquires all of the outstanding shares - either ALL shares or all of a class or series.
The interesting thing is that this is a compulsory exchange with the shareholders of the target
corporation. Shareholders in the target corporation may receive stock in the acquiring
corporation, stock in a third corporation, or cash. Both companies survive, but the target
becomes a subsidiary of the acquiring corporation.

CONSOLIDATIONS
Consolidation involves the merger of two or more corporations into a newly formed
corporation. The two merging corporations disappear and take on the new identity.

THE IMPORTANCE OF CHOSING THE RIGHT PROCEDURE

The type of transaction chosen to combine businesses is important. For example in a merger
transaction, all debts, liabilities and duties of the merging corporation are transferred over
into the surviving corporation. There may be times when we do not want that to happen and
therefore chose a different method for one company acquiring another. In any case we will
want to be careful to determine which company is best able to deal with all those debts,
liabilities and duties, so we know whether an upstream or downstream merger is best.

When a corporation voluntarily chooses a formal merger, it must take the “bad will” along
with the “good will.” Think about it for a minute . . . the wrongful acts of a company that no
longer legally exists SURVIVE in the merger and the new parent company is held
responsible. Does that seem fair to you? What if you were the plaintiff? What if you held
shares in the "new" company and suffered an economic loss for the acts of a company with
which you never dealt? If you think it's not fair to allow, for example, punitive damages to
survive the merger(s), then take that logic one step further. If we don't allow punitive
damages to survive merger transactions, then the easiest way to get rid of them would be for
a company which committed some wrongful act to simply "go away" in a merger. It is up to
the legal team to see that the proper method of consolidation is chosen to optimize the
situation of the surviving corporation.

STATUTORY MERGER AND SHARE EXCHANGE

PROCEDURES

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations 3

Some of what’s required is going to depend on the size of the corporations being combined,
whether or not they’re publicly traded, and what the relationship is between the companies
and their respective stockholders. Please don't skip completely over the section in your book
devoted to antitrust laws. I don't plan to add anything to that material here, but it's worth a
careful read. Generally, these laws are aimed at preventing a monopoly. Our society wants to
encourage free trade and prevent unfair methods of competition.

Let’s take a look at the general processes by which consolidations take place.

1. MERGER

• LETTER OF INTENT

Obviously, for the process to begin, there’s going to be some sort of meeting of the minds
between the parties to the merger. The parties get together and decide what their overall
goals and intentions are and usually set it out in some detail in a letter of intent. The letter
of intent is not the full, formal agreement, but is just a preliminary outline of what the
parties plan to accomplish, together with contingencies such as shareholder approvals,
dates, etc...

• PLAN OF MERGER

The next step is the Plan of Merger. This is the actual, formal agreement. It has some very
stringent statutory requirements that are described in your reading on 397, 399-400
(skipping figure 10.5). The plan generally has to be approved by the shareholders and
board of directors of each corporation which will be a party to the merger (the exception
being upstream mergers when 90% of the subsidiary's stock is owned by the parent). The
board will recommend the plan of merger to the shareholders unless it determines that no
recommendation should be made (and even then, the board discloses why - i.e., conflict
of interest). The voting shareholders vote “yes” or “no.”

DISSENTING SHAREHOLDERS - If a shareholder votes “no” he may choose to

exercise a right to dissent and object to certain actions being taken by the corporation in
respect to the merger, such as the price being paid for the shares. There are certain
formalities that have to be followed under the law in order for a shareholder to exercise
this right (such as a written notice of intent) and before the shareholder can dissent. But
in dissenting, he can basically “opt out” of the merger and demand payment for his
shares.

• ADOPTION OF PLAN

Once the plan has been adopted, the ARTICLES OF MERGER have to be filed with the
SOS. The articles contain the plan, any statement that shareholder approval was not
required or a statement setting forth the approval and detailing the number of votes for
and against, by voting group.

2. SHARE EXCHANGES or "PLAN OF EXCHANGE"

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations 4

This process is mechanically much the same as the merger. After negotiation and the letter of
intent, then there is a Plan of Exchange worked out, just like there was a Plan of Merger. It
goes up for shareholder vote. The same rule applies about dissents. If the plan of exchange is
carried by vote, a shareholder who voted against the exchange can still come forward and
dissent and may have the right to obtain payment for his shares and withdraw from the
corporation.

3. ADOPTION OF PLAN

Once the plan has been adopted, the Articles of Share Exchange have to be filed with the
Secretary of State, much like the articles of merger were. It contains the plan of exchange and
voting details.

4. DUE DILIGENCE AND PRE-CLOSING

This is almost common sense. When the parties sit down to discuss merger or exchange,
financial information and information about the merging companies is necessarily going to
have to be exchanged. It logically follows that there is a legal obligation for the responsible
parties to go beyond the faces of the documents. When these things go up for a vote, it’s
usually the board that is putting them up for recommendation, so this is similar to the
business judgment rule. There has to be a more detailed investigation than simple acceptance
of the facts on the face of the matter.

EXAMPLE: Recently, there was a case out of Alcorn County (it actually involved a
simple acquisition rather than a merger, but the illustration still works) and the facts
indicated that the purchasers accepted the seller’s representations of the company’s
cash flow, assets and floor plan (it was a car dealership) at face value. Then, when the
purchasers got in and started running the business, they found that the representations
could not possibly have been true. So, of course, they sued for damages. They lost
because, among other things, they didn’t exercise common business judgment - or
due diligence - when they didn’t even attempt to look more closely at the actual
financial condition of the company.

Of course, what is actually needed in order to close the deal will differ from transaction to
transaction, depending on what sorts of businesses are involved. If it’s a car dealership, there
might be a need to see the Floor Plan, but that wouldn’t hold true if it was an airline. And this
duty really flows both ways. The merging company, before it suggest the merger to its
shareholders, will want to investigate the finances of the acquiring company to see whether
or not it looks like the acquiring company will be able to maintain the merging company.
Likewise, the acquiring company will want to know about the finances of the merging
company to make sure it’s getting the business deal that has been represented between the
parties.

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations 5

5. CLOSING

Just like in real estate transactions, this idea of “closing” involves a meeting at which
documents and funds are exchanged to actually effect the transfer.

6. POST-CLOSING

There will also be details to take care of post-closing. Deeds or other closing documents will
have to be recorded, titles transferred, new corporate records organized, and such.

ASSET AND STOCK ACQUISITIONS

There are other ways to combine corporations without statutory merger or stock exchange,
such as through asset acquisition or stock acquisition.

ASSET ACQUISITION.
The term simply means that one corporation purchases all of the assets of the target
corporation. The target corporation then dissolves. The advantages here are

1. The buyers know exactly what they’re getting, and

2. The acquiring company doesn’t assume any of the liabilities of the subsumed
company simply by purchasing its assets.

The payment made for those assets is used by the target corporation in its dissolution process
to settle its liabilities. There are laws in place to help prevent this sort of device being used to
cheat creditors, e.g., laws preventing the shareholders of one company from forming a new
company to buy all the assets of the old company at far below market value just to get rid of
the debt and start over as a new business.

STOCK ACQUISITION.
This term simply means that one corporation, person or group of people acquires a
controlling number of shares in a target corporation. It’s simpler than a merger because with
the acquisition of stock, the ownership is essentially transferred.

PROCEDURE.
There really are no statutory procedures to be followed for this type of acquisition. There will
be a negotiation and letter of intent, and probably a purchase agreement (especially in the
case of an asset transfer). And with assets, there will be some form of identification for each
asset to be purchased. And, since asset transfers are not done in the ordinary course of
business, it will require shareholder approval. With stock purchase agreements, there will
also be some sort of agreement (unless its in the vein of a takeover by acquisition of a
controlling share through the open market - but here, we’re assuming that the acquisition will
be by agreement between the parties).

DUE DILIGENCE.

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations 6

Again, there is a duty of diligence imposed on the parties. Just like before, there’s good
reason to go behind the face of the documents and investigate the assets. The buyer is
charged with some responsibility in ascertaining things like whether the assets actually exist,
their condition . . .or in the case of a stock transfer, the financial condition of the corporation,
outstanding contracts, and such. Many, many lawyer and paralegal hours go into conducting
due diligence on these types of transactions.

CLOSING & POST CLOSING.

Again, this is the process at which the parties meet to exchange documents and funds. And
then post-closing, there will be documents that have to be recorded such as deeds or
corporate filings. With stock, the old certificates have to be surrendered and new ones issued.

AMENDMENTS TO ARTICLES OF INCORPORATION

We already know that Articles can be amended, and that some situations actually require it.
Some of the amendments will require shareholder approval and some won’t. Mergers and
acquisitions are generally things that are going to require shareholder approval at some point.
Generally, things that are not typically done in the ordinary course of business will require
shareholder approval. Approval is typically required for transactions that will affect the
shareholders’ rights. The Board of Directors generally recommends any amendments to the
Articles, unless there is some reason the board declines to make a recommendation, such as a
conflict of interest.

ALL Shareholders get notice. The notice must inform shareholder that amendment is being
considered and give the shareholder a copy or summary of the amendment. The shareholders
then vote.

Again, the shareholder may be entitled to dissent if the amendment carries and he or she
voted against it, but only if the amendment was one that materially affects the dissenting
shareholder’s rights. If successful, the shareholder can force the corporation to purchase his
shares and he can withdraw from the corporation.

ARTICLES OF AMENDMENT. When the amendment is voted and passed on, it has to be
recorded with the SOS in something called Articles of Amendment.

FINALLY - REORGANIZATION

The term reorganization usually (but not always) involves a distressed corporation and its
takeover by a number of means, including merger or acquisition. Reorganization may also be
used to refer to a particular type of bankruptcy proceeding, but that is a topic of another
course offered periodically as an LA elective at a campus near you.

Chapter 14.4: Changes in the Corporate Structure and Corporate Combinations 7