Reverse reversal

BAC will be creating a single-member limited liability company, which, for tax purposes but not for corporate law purposes, will be a "disregarded entity." CFC will merge with and into such LLC. In the transaction, the LLC will, by operation of law, be assuming CFC's liabilities and will be conveying to CFC 0.1822 shares of BAC common stock regarding each share of CFC.

The transaction is intended to qualify as a reorganization, under Sec. 368(a)(1)(A), and there is no reason to believe it will not so qualify. Thus, no gain or loss will be recognized by CFC on the exchange of its assets for BAC's stock and the assumption of its liabilities and no gain or loss will be recognized to CFC on the distribution of the BAC stock it receives to its shareholders in exchange for, and in cancellation of, their CFC stock. Moreover, no gain or loss will be recognized to the CFC shareholders on the exchange of their CFC stock for the stock of BAC to be distributed to them.

The fact that Sec. 354(a) provides for nonrecognition of the gain or loss realized on the exchange is probably not welcome news for the majority of CFC's shareholders who have "unrealized" losses with respect to their stock. They would prefer to recognize those losses at the time of the exchange. However, such recognition will be prevented by Sec. 354(a) and, therefore, in order to "cash in" their losses, the CFC shareholders will have to sell or otherwise dispose of their newly acquired BAC stock in which their basis will be equal to the basis they had in their CFC stock.

BAC will be creating a single-member limited liability company, which, for tax purposes but not for corporate law purposes, will be a "disregarded entity." CFC will merge with and into such LLC. In the transaction, the LLC will, by operation of law, be assuming CFC's liabilities and will be conveying to CFC 0.1822 shares of BAC common stock regarding each share of CFC.

The transaction is intended to qualify as a reorganization, under Sec. 368(a)(1)(A), and there is no reason to believe it will not so qualify. Thus, no gain or loss will be recognized by CFC on the exchange of its assets for BAC's stock and the assumption of its liabilities and no gain or loss will be recognized to CFC on the distribution of the BAC stock it receives to its shareholders in exchange for, and in cancellation of, their CFC stock. Moreover, no gain or loss will be recognized to the CFC shareholders on the exchange of their CFC stock for the stock of BAC to be distributed to them.

The fact that Sec. 354(a) provides for nonrecognition of the gain or loss realized on the exchange is probably not welcome news for the majority of CFC's shareholders who have "unrealized" losses with respect to their stock. They would prefer to recognize those losses at the time of the exchange. However, such recognition will be prevented by Sec. 354(a) and, therefore, in order to "cash in" their losses, the CFC shareholders will have to sell or otherwise dispose of their newly acquired BAC stock in which their basis will be equal to the basis they had in their CFC stock.

The merger will qualify as a reorganization under Sec. 368(a)(1)(A) because it "meets the terms of the specifications" -- it is a statutory merger in connection with which all of the assets and liabilities of each member of one or more "combining units" (CFC) become the assets and liabilities of one or more members of one other combining unit (BAC and the newly created LLC) and, in connection with the merger, CFC will cease its separate legal existence.

In addition to meeting the terms of the specifications, the transaction will satisfy their "underlying assumptions and purposes." Thus, the transaction will exhibit "continuity of interest" (a substantial part, in fact 100%, of the value of the proprietary interests in CFC will be preserved in the transaction) and will demonstrate "continuity of business enterprise" because, we have every reason to believe, BAC will, through the LLC, be continuing the "historic business" of CFC. Thus, the transaction should qualify as a "two party" "A" reorganization.

The format employed by the parties to accomplish the transaction is an increasingly popular one. Historically, corporations in these situations would structure the transaction as a "forward triangular merger" in which the target would merge with and into a subsidiary (almost always newly created for the occasion) of the issuing corporation in exchange for stock (or a combination of stock and other property or money) of the issuing corporation and the assumption by the newly created subsidiary of the target's liabilities.

Such a transaction qualified as an "A" reorganization, by reason of Sec. 368(a)(2)(D), as long as:

1) The corporation into which the target was merged was a first-tier subsidiary of the issuing corporation;

2) no stock of the subsidiary was used to compensate the target shareholders for their stock;

3) the subsidiary acquired "substantially all" of the target's properties, and;

4) the transaction would have qualified as a reorganization under Sec. 368(a)(1)(A) had the target merged directly with and into the issuing corporation.

This test only means that the general requirements of such an "A" reorganization (such as continuity of interest and continuity of business enterprise) must be met (in addition to the special requirements set forth in Sec. 368(a)(2)(D)). It is not relevant, for purposes of this test, whether the merger could have been effected under corporate law.

These forward triangular mergers were popular because the assets of the parent group would be insulated from exposure to the creditors of the target corporation. Only the assets of the acquiring subsidiary would be so exposed. In addition, except in cases where more than 20% of the parent's stock was to be issued in the transaction, the use of the forward triangular merger format obviated the necessity of securing the approval of the parent's shareholders for the merger.

Now, however, the forward triangular merger format has been largely superseded by the LLC format employed by BAC and CFC. This is because such LLC formats provide the parties with all of the nontax benefits (insulation of assets from the claims of target's creditors and avoidance of a shareholder vote) that a forward triangular merger provides yet, for tax purposes, only requires the parties (in order to secure reorganization status for the merger) to meet the more liberal "two party" "A" reorganization requirements. Most notably, for a merger to qualify as a "good" two party "A" reorganization, there is no requirement that the acquiring corporation obtain substantially all of the target's properties. Accordingly, it is safe to say that, in cases where the business combination is intended to qualify as a reorganization, the LLC format adopted by BAC and CFC has become the most widely used acquisition technique.

The merger agreement does not indicate that BAC is guaranteeing, or otherwise providing support (other than moral), for the debt of CFC that the LLC is assuming. Accordingly, although the market has reacted as though such formal support was forthcoming, such reaction may have been overdone: It appears that the same assets, those of CFC only, which were available to defray CFC's indebtedness before the business combination, will be available to discharge such indebtedness after the transaction.

Robert Willens is president of Robert Willens LLC. He is also an adjunct professor of finance at Columbia Business School.