Inverness-Matria: Merger agreement gives new details

E-Mail

Discussion

Print Story

Published February 7, 2008 at 12:12 PM

« Previous Story Home Next Story »

The information contained in the press release describing the merger agreement entered into by Inverness Medical Innovations, Inc. and Matria Healthcare, Inc. was, as it turns out, incomplete. (See previous entry.)

Continue reading below

Also on Dealscape

Thus, the press release stated that Inverness , through the mechanism of a reverse triangular merger, was going to acquire the stock of Matria in exchange for a combination of cash ($6.50) and newly-issued convertible preferred stock intended to be worth, as of the effective time, some $32.50. However, the holders of preferred stock would not possess the right to particpate in the election of Inverness directors and, therefore, for tax purposes anyway, the preferred stock would be viewed as non-voting stock. See Rev. Rul. 69-126, 1969-1 C.B. 218. At the same time, the press release stated that the transaction was intended to qualify as a tax-free reorganization with the result that each exchanging shareholder's gain from the exchange (of her Matria stock for the merger consideration) would be recognized but in an amount not in excess of the cash. See Sec. 356(a)(1).

However, an acquisition of stock (structured as a reverse triangular merger) can only qualify as such a tax-free reorganization (under Sec. 368(a)(1)(A) by reason of Sec. 368(a)(2)(E)) if certain requirements are satisfied. Most notably, under Sec. 368(a)(2)(E)(ii), the former shareholders of the surviving corporation (Matria), "in the transaction", must exchange for voting stock of the controlling corporation (Inverness), an amount of stock in such surviving corporation which constitutes control of such corporation. In short, a reverse triangular merger can only qualify as an 'A' reorganziation (by reason of Sec. 368(a)(2)(E)) if at least 80 percent of the consideration conveyed to the target shareholders in exchange for their stock therein is comprised of voting stock of the controlling corporation. Thus, from the information contained in the press release, it seemed clear that the transaction would not constitute a reorganization because no portion of the consideration to be furnished to the shareholders of Matria consists of voting stock issued by Inverness .

Forward Merger

The press release has now been supplemented by the merger agreement which adds details, not previously disclosed, that suggest that the transaction embodies an additional step that will, in our judgment, permit the fully consummated transaction to qualify for treatment as a reorganization. Thus, the merger agreement provides that the "reverse merger" (the merger in which a newly-created Inverness subsidiary merges with and into Matria) will be followed "as soon as reasonably possible" by a merger of the surviving corporation (Matria) with and into the parent (Inverness). Moreover, it is intended that the reverse merger be "mutually interdependent" with the "upstream merger" (of Matria with and into Inverness).

Accordingly, the merger agreement is telling us that the reverse merger is simply a step in an integrated plan which will culminate with the upstream merger of Matria with and into Inverness . Thus, for tax purposes, under a pervasive doctrine of tax law known as the "step transaction" doctrine, the reverse merger step would be disregarded and the transaction is properly analyzed as though it had been structured as a direct merger of Matria with and into Inverness . See Rev. Rul. 2001-46, 2001-2 C.B. 321.

So viewed, the transaction should qualify as a tax-free reorganization. It will qualify as a "two-party" 'A' reorganization because, in that case, there is no requirement that any portion of the consideration consist of voting stock of the acquiring entity. In that case, the only requirement that must be complied with is the so-called "continuity of interest" requirement. That requirement is met if a "substantial part" of the value of the proprietary interests in the acquired corporation is "preserved" in the potential reorganziation. See Reg. Sec. 1.368-1(e)(1)(i). A proprietary interest will be so preserved if, as here, it is exhanged for a proprietary interest in the issuing corporation. Here, much more than a substantial part (which is as little as 40 percent) of the value of the proprietary interests in Matria will be preserved in the transaction because in excess of 80 percent of the stock of Matria will be exchanged for stock issued by Inverness: The fact that the stock to be issued is non-voting preferred stock does not detract from this conclusion. It is well-settled that the target shareholders can maintain the requisite continuing interest in the properties transferred through their ownership of preferred stock of the issuing corporation. See John A. Nelson Co. v. Helvering, 296 US 374 (1935) and Rev. Rul. 78-142, 1978-1 C.B. 111. Accordingly, now that all of the details have come out, it seems highly likely that the transaction, as the press release suggested, will qualify as a reorganization with the result that an exchanging shareholder's gain will be recognized but in an amount not in excess of the cash received by such shareholder. - Robert Willens

See Soapbox: "Qualifying a deal"
Read the full column
See TheDeal.com story on Inverness-Matria