What measures should be taken to best prepare for a corporate reorganisation?
Internal communication with regional business leaders, finance controllers and local directors of the companies involved is key in reorganisation projects. Lines of communication and a lead team should be established before commencing a reorganisation to ensure the project is implemented efficiently and on time, particularly in relation to the information-gathering process. There are a number of key teams that need to be involved by the lead team from the start. The client’s treasury team should arrange for bank transfers throughout the project to pay the purchase price of shares or assets being transferred, grant loans or promissory notes, settle accounts payable and receivable between subsidiaries, or make cash dividend distributions up the chain of companies. Consequently, having the treasury team on board early is key to ensuring necessary treasury planning is taken care of before implementation of the transactions, more so when there are payments in different currencies, cash pools arrangements, hedges to be put in place, etc.
Additionally, shares and assets must be transferred for arm’s-length compensation. As a result, third-party economists, transfer pricing specialists or an internal team should get involved before commencing the reorganisation to perform the necessary valuations.
Auditors should also review, comment and approve the reorganisation. Typically, it is best to involve the auditors as early as possible in the process .
It is also advisable to begin due diligence early in the project to review shareholdings of subsidiaries, officers and directors, and other signatories, and the types of agreements that might need to be transferred in the reorganisation. If agreements or assets are being transferred or assigned, it is important to confirm if notifications to, or consents from, third parties are required before implementing the transfers. For example, in IP reorganisations, the transfer of licence agreements may require third-party consent. Alternatively, if shares of companies being transferred are pledged, the pledge may need to be temporarily released. In case the transactions in the project involve companies with employees, notifications to the same or consultation with unions could be required.Employment issues
What are the main issues relating to employees and employment contracts to consider in a corporate reorganisation?
A main issue relating to employees in a corporate reorganisation is the assessment of whether employee talent is an important driver underlying the corporate reorganisation. This is usually the case if the reorganisation is driven by an acquisition involving knowledge acquisition (as opposed to, for example, acquiring patents, real estate or commodities). Depending on the answer, an acquirer may need to focus on employee retention, and require an increase in total deal value by inclusion of retention packages (possibly including acquirer equity) for continuing employees, or may wish to negotiate that it will only acquire a limited number of employees and others are to be laid off pre-closing or continue with the target.
The corporate reorganisation’s ultimate structure also determines potential employee issues. A share acquisition generally does not involve a change of employer, and, therefore, the impact on employees and their terms and conditions of employment is usually limited. As a good practice, an informal welcome letter may still be issued to notify employees of the change in ownership of their employing entity. Assuming employment with the target entity was at-will, changes to terms and conditions are usually easily implemented.
An asset acquisition or merger often involves transferring employees from one entity to another. A new employment-offer letter or employment agreement should be issued or entered into to document the change in the employing entity. The transferee entity will often recognise employees’ prior service years at the transferor entity. Because employment transfer technically involves a termination of employment with the transferor entity, in some states, accrued vacation or paid time off is required to be paid out at the time of the transfer unless the employee consents to carrying over the vacation or paid time off balance to the transferee entity.
When employees are transferred from one entity to another, the total headcount at the transferee entity, after the reorganisation, may reach or exceed certain thresholds triggering additional employer obligations. For example, employee transfers in connection with a corporate reorganisation could cause the transferee entity to have 50 or more employees in total and render the transferee entity subject to the federal Family and Medical Leave Act and state statutes providing similar leave to employees.
A corporate reorganisation is sometimes accompanied by a reduction in force (RIF). Special attention should be paid to determine whether the RIF could trigger obligations under the federal Worker Adjustment and Retraining Notification Act or its state equivalent statute (the WARN Act). The obligations include providing advance notice of the RIF (for example, 60 days’ notice under the federal WARN Act) to the affected employees or their representative (for example, union representative), and to state and local governments. Usually a loss of 50 employees at a single employment site during a 30-day period is a good indicator that federal WARN obligations are triggered, although state law may have a lower job loss threshold for triggering state WARN obligations.
When a corporate reorganisation involves the transfer or reduction of union employees, the applicable collective bargaining agreement or agreements should be reviewed and counsel should be involved early in the process to ensure the reorganisation does not breach the CBA, and to identify and plan for potential labour relations issues.
What are the main issues relating to pensions and other benefits to consider in a corporate reorganisation?
With regard to pensions, the main issues in the US are determining if any of the following are present:
- if any single employer-defined benefit pension plan is sponsored by the target entity or its affiliates;
- if the target entity or its affiliates contributes (or has been obliged to contribute at any time in the past five calendar years) to any multi-employer defined pension plan;
- use of employer securities or employer real property as a plan asset within any defined contribution pension plan sponsored by the target;
- whether the target company sponsors a retirement plan that is an employee stock ownership plan (ESOP); or
- whether 25 per cent or more of any class of securities of the target company is, in the aggregate, held by retirement plans or individual retirement accounts or annuities.
If any of the foregoing pension issues are present, they will likely play a significant role in assessing material liabilities in the US and may even alter the structure or negotiation of the corporate reorganisation.
In terms of non-pension issues, in the US we suggest assessing the following main issues:
- treatment of equity compensation (eg, stock options, share schemes, restricted share units) in the reorganisation;
- change-of-control benefits (either ‘single trigger’ or ‘double trigger’);
- severance benefits, including ‘good reason’ or ‘constructive termination’ rights; and
- whether the transaction will give rise to any ‘golden parachute’ taxes under section 280G of the IRC. We would also suggest looking into key employee compensation arrangements and confirming compliance with section 457A or 409A of the IRC.
Is financial assistance prohibited or restricted in your jurisdiction?
The US does not have strict prohibitions against companies using their own funds to acquire shares in themselves or another company, as is seen in civil law jurisdictions; however, we would advise looking at the particular tax rules that may impact any such arrangement. In the US, there are laws against fraudulent transfers (transfers with either the intent to deceive or defraud creditors, or that have the constructive effect of leaving a transferor insolvent or unable to continue its business at the time of the transfer). The fraudulent transfer laws are typically applied in a bankruptcy scenario, however, and would be unlikely to be applied in an intercompany project. Nevertheless, in order to avoid any such claims, and to comply with arm’s-length requirements, companies should confirm receipt of fair market value in exchange for their transfers.Common problems
What are the most commonly overlooked issues or frequently asked questions in a corporate reorganisation?
Commonly overlooked issues relating to employees include obligations under the WARN Act when a RIF is involved, and additional obligations for the transferee entity when its headcount is increased because of the reorganisation.
There are also considerations from a more practical point of view. In post-merger reorganisations where employees are important to the acquirer, a commonly overlooked issue is blending employee cultures and how to integrate acquired employees. Acquirers perform reorganisations to shape the business of the combined company going forward, but if the acquired employees leave or are not enthusiastic about the path of the combined company, the transaction may fail to achieve the acquirer’s ultimate business objective.
As already indicated, another overlooked issue is the need for valuations, which in turn requires that any internal books and accounts are up to date. Additionally, reorganisation plans will often require that cash is moved around the organisation chain, but subsidiaries will often not have separate bank accounts, so pre-planning is required.
Signatory availability can also be an issue, especially when an organisation has only appointed three to four persons as signatories for all subsidiaries in the organisation, or in post-acquisition integration scenarios, when the target’s signatories have already been terminated.
Accounting and taxAccounting and valuation
How will the corporate reorganisation be treated from an accounting perspective? How are target assets and businesses valued?
The accounting treatment depends on all the facts and circumstances surrounding the reorganisation. The company’s accounting team should review and comment on the contemplated reorganisation beforehand.
Section 482 of the IRC follows the arm’s-length standard to value property and provides specific methodologies for determining the value to be used for the transfer of property between related parties for federal tax purposes. The taxpayer must use the method that provides the most reliable estimate of the arm’s-length price. State and local tax authorities generally follow the valuation rules set forth in section 482.Tax issues
What tax issues need to be considered? What are the tax implications of carrying out a corporate reorganisation?
The federal, state and local tax implications of a reorganisation depend on all the facts and circumstances and should always be considered before implementing a reorganisation. Generally, both taxable and tax-free reorganisations are possible in the US. If taxable, tax may apply at shareholder or entity level.
If a US taxpayer’s non-US subsidiary or assets held by such non-US subsidiary are transferred in the reorganisation, then US tax may be triggered because of the Subpart F or global intangible low-taxed income (GILTI) rules. If a US taxpayer makes a payment to a related party located outside of the US as part of a corporate reorganisation, they should consider the base erosion and anti-abuse tax (BEAT) implications of the payment.
The following should also be considered when implementing a reorganisation:
- arm’s length: transactions between related parties should be arm’s length;
- document review: tax advisers should always review the draft, governing documentation in advance to ensure it aligns with the desired tax treatment;
- interest: if debt is issued as part of the reorganisation, care should be given to ensure the interest is deductible for tax purposes. If interest will be paid across borders, consider whether withholding tax will be triggered; and
- reporting: certain types of transactions must be reported to the taxing authorities.
With regard to employee benefits, we recommend reviewing how compensation-based equity awards (eg, stock options, share schemes and restricted share units) are treated in the reorganisation transaction to ensure that the tax implications for the corporate entities, individual executives and key employees are considered and appropriately structured.