Spin-Off Agreements

Houston Transactional Attorneys for Spin-Offs, Split-Offs, Split-Ups, and Reverse Morris Trust Transactions

The transactional attorneys at Hendershot Cowart P.C. have the business and tax law experience you need to execute an efficient and successful spin-off transaction. Backed by more than 100 years of combined experience and with hundreds of complex transactions under their belts, our team can help you anticipate roadblocks, protect the tax-free status of the separation, and help you navigate the process from planning to execution.

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Tax-Free Corporate Divisions

A corporate division is a transaction that allows a business to separate assets from the company in a tax-free manner. Companies may pursue a corporate division to hone the management team’s focus, streamline operations, spin off an unrelated business line, separate a high-liability product line to manage insurance costs, or to better manage the capital needs of a subsidiary.

A corporate division may also precede M&A activity if an acquirer only wants to purchase one of a parent company’s business lines or set of assets.

Types of Corporate Divisions

A tax-free corporate division can be accomplished in several ways. The most common methods are described here:

  • Spin-off, or acquisitive D reorganization: This is the simplest variation of a corporate division. The parent company sets up the assets and liabilities of a business line as a separate legal entity. Shares of this new entity are then distributed to the parent company’s shareholders as a special non-cash dividend, giving shareholders a pro-rata ownership interest (i.e., in proportion to their original ownership percentage) in both entities. At the end of this transaction, shareholders of the parent company own stock in both entities – the parent and the spin-off.
  • A split-off, or divisive D reorganization: The parent company spins off the assets and liabilities of a business line into a separate legal entity and distributes shares of the spun-off entity to some but not all shareholders in exchange for shares of the parent. Shareholders that receive a stake in the spin-off surrender their shares in the parent. This is often used as a device to resolve a shareholder dispute.
  • A split-up: The parent company divides its assets and liabilities into two or more separate entities and then exchanges shares in the parent company for shares in these newly created entities. At the end of this transaction, shareholders in the parent company have exchanged all their shares of the parent for one or the other of the split-off entities, and the parent company is liquidated.
  • Spin-off by way of merger (or Reverse Morris Trust transaction): The parent company spins off the assets and liabilities of a business line into a separate legal entity which is immediately merged with a third party. After the transaction is complete, shareholders in the parent company own a pro-rata interest in the newly merged company. This is known as a Reverse Morris Trust, named after the defendant in a 1966 federal court case that determined that such a transaction could be non-taxable.

The Requirements of a Tax-Free Spin-Off

Corporate divisions are tax-free for the parent company and shareholders if they meet the requirements of section 355 of the U.S. Internal Revenue Code.

To qualify as a “section 355 transaction”, the transaction must meet these requirements, among others:

  • Control. The parent company have control of the business line to be separated before the transaction;
  • Distribution. The parent company must relinquish that control after the transaction by distributing at least 80% of its voting and non-voting shares;
  • Valid corporate business purpose. The spin-off must take place for a valid business purpose, such as to facilitate an acquisition or to focus on core business lines;
  • Device restriction. The transaction cannot be a device for the tax-free distribution of earnings and profits;
  • Continuity of interest. Shares in the newly created entities must be distributed pro-rata, or in direct proportion to the shareholder’s ownership percentage in the parent, and shareholders must preserve that ownership percentage after the separation to preserve “continuity of interest”; and
  • Continuity of business enterprise. The parent company and the separated business line must have been actively conducting business for the previous five years and continue to be actively engaged in business following the transaction.

The IRS scrutinizes these transactions carefully for evidence that the entities may not be truly separated and conducting business independently, or that the transaction may have been carried out as a disguised distribution of profit and earnings.

The tax advantages of a tax-free transaction are significant but require careful navigation of the requirements and complexities of the U.S. Internal Revenue Code. Consult the experienced tax attorneys at Hendershot Cowart P.C. to ensure your transaction qualifies as a non-taxable event.

When Should You Should Get a Tax & Transactional Attorney Involved?

A spin-off transaction or other corporate division can take up to six months or more, from the planning phases to execution. The best time to get an attorney involved is during the planning process. A transactional attorney is instrumental to the entire reorganization process, contributing professional advice and assistance on issues ranging from identifying and allocating business assets and liabilities to the tax implications of the separation and the capital structures of the parent and the new entity.

Our tax and transactional attorneys have experience in all aspects of a reorganization transaction, including:

  • Helping to identify and allocate assets and liabilities between the parent company and new entity
  • Counseling clients on capital structures of the parent and spin-off
  • Advising clients on regulatory and legal duties
  • Advising clients on employee matters, such as benefits or equity-based compensation plans
  • Preparing the transaction agreement and other ancillary agreements
  • Preparing governance documents, such as operating or shareholder agreements, for the newly created entity
  • Formalizing any ongoing business relationships between the parent and the newly formed entity via contracts and licensing agreements, etc.
  • Counseling clients on maintaining and protecting the transactions tax-free treatment before, during, and after the transaction.

What Is Included in a Spin-Off, Split-Off, or Split-Up Agreement?

A corporate division agreement – whether for a spin-off, split-off, or split-up – is a legal document that outlines the terms of the reorganization and guides the transaction. The agreement aims to ensure that all parties involved are informed and are in consensus about how and when the division will take place, thus avoiding potential litigation or disputes.

Generally, a spin-off, split-up, or split-off agreement will define and set the terms for:

  • The parties to the agreement and the subject matter of the spin-off
  • Separation and transfer of assets and liabilities, including tax liabilities
  • Assignment of intercompany accounts and contracts
  • Transfer of books and records, and access to information
  • Effective date of the spin-off
  • Conditions for the distribution of the spin-off company’s shares
  • Employee matters
  • Parent company representations and warranties
  • The spin-off entity’s representations and warranties
  • Indemnity
  • Dispute resolution
  • Confidentiality and intellectual property protection before, during, and after the transaction

The agreement may also be accompanied by ancillary agreements, such as an employee matters agreement or a tax matters agreement. Your transactional attorney will advise you on the type and content of the agreements necessary to accomplish your business goals.

Speak With a Houston Spin-Off/Split-off Attorney Today

Tax-free corporate divisions are complex. If your company is considering a reorganization or speaking to a potential merger partner about the acquisition of a business line or division, speak to our team of tax and transactional attorneys now. We can ensure that your business objectives are met while preserving a favorable tax treatment for your spin-off or other corporate division.

From planning to execution and beyond, our Houston-based law firm is here to help business owners and shareholders achieve their goals.

Send us a message online to schedule a consultation today.

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