Corporate Reorganizations – Measuring Continuity of Interest: IRS Proposes New Regulations for Measuring Continuity of Interest in Corporate Reorganizations

Sullivan & Cromwell LLP - December 23, 2011
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On December 16, 2011, the Internal Revenue Service (the “IRS”) and Treasury Department issued final and proposed regulations (“the Final Regulations” and “the Proposed Regulations,” respectively) that generally provide rules for the proper timing of the valuation of consideration offered in respect of a reorganization, for purposes of satisfying the “continuity of interest” requirement for tax-free reorganizations. The Final Regulations issue in finalized form rules previously described in temporary regulations, which allow in certain circumstances for the valuation of consideration on the date prior to the signing of a merger agreement, known as the “signing date” rule, with some additional clarification.

The Proposed Regulations would expand the signing date rule and would allow for the use of an average share price under certain circumstances. Specifically, under the Proposed Regulations, for purposes of determining whether the “continuity of interest” requirement is satisfied:

  • where (i) a binding merger agreement provides for adjustments in the amount of non-share consideration as a result of fluctuations in the share price of the issuing corporation’s stock, but only above a certain floor price, (ii) the value of a share of the issuing corporation on the date prior to signing is greater than or equal to the floor price, and (iii) the value of a share of the issuing corporation on the date of the closing of the merger is below the floor price, the value of the consideration is measured as of the day prior to the signing date, using the floor price as the value of the issuing corporation’s shares;
  • where (i) a binding merger agreement provides for adjustments in the amount of non-share consideration as a result of fluctuations in the share price of the issuing corporation’s stock, but only below a certain ceiling price, (ii) the value of a share of the issuing corporation on the date prior to signing is less than or equal to the ceiling price, and (iii) the value of a share of the issuing corporation on the date of the closing of the merger is above the ceiling price, the value of the consideration is measured as of the day prior to the signing date, using the ceiling price as the value of the issuing corporation’s shares; and
  • where (i) a merger agreement utilizes an average price for the issuing corporation’s shares to determine the number of shares and the amount of non-share consideration to be paid pursuant to the merger, and (ii) the average price is based on prices of the issuing corporation’s shares between the signing and closing dates, the value of the consideration is measured using the average price of the issuing corporation’s shares.