M&A/Bankruptcy Case Studies
Mergers & Acquisitions
RCP Transactional Insurance
Situation: A Fortune 500 pharmaceutical absorbed a private firm for $95 million, and requested that the seller deposit $5 million in escrow for a period of 3 years. Since the seller's expected return on capital was 15% and an escrow offers no tax deduction, if the seller had instead invested for 3 years at a 15% rate of return, his $5 million would have otherwise accumulated approximately $2.6 million in earnings. By subtracting the amount earned on money in the escrow account (assuming 3% per annum), approximately $500,000 from $2.6 million in potential earnings - the total cost of using a traditional escrow account would have been $2.1 million. However the seller was not comfortable with loosing $2.1 million in addition to setting aside $5 million of proceeds. As a result RCP was engaged to identify and structure a cost effectively transactional insurance solution that would meet both buyer and seller requirements.
Result: RCP developed a transactional insurance solution with an upfront cost of $350,000 for a total limit of $5 million. Since the $350,000 premium was tax deductible, RCP’s structure would also yield $120,000 in tax deductions (approx. 1/3). If invested for 3 years at the seller's 15% rate of return, $350,000 would accumulate to approximately $180,000 in earnings. The total cost of RCP’s innovative insurance based solution was therefore $410,000 ($350,000 plus $180,000 minus $120,000). Far less than $2.1 million…with equivalent protection for the buyer.
By using an RCP transactional insurance solution, the seller had transferred any potential future liability due to a breach in reps and warranties provided in the purchase and sale agreement for a fraction of the cost when compared against a traditional escrow account. Since any future claims would be remunerated by a highly rated 3rd party, the buyer had reduced potential friction with the seller who was now part of the buyer's current management team. RCP reduced the time taken to complete the transaction while meeting the needs of both buyer and seller with an innovative solution that had not been suggested by other deal-team advisors.
Mergers & Acquisitions
Acquisition-Related Asbestos Liability
Situation: An American industrial corporation was interested in purchasing a European subsidiary of a de-diversifying European conglomerate. The industry of the subsidiary was one where there has been a large amount of asbestos liability in the United States and the UK, but very little in its domiciliary country. However, the asbestos litigation situation was fluid and litigation was increasing exponentially in the domiciliary country.
Issue: Although the acquisition was structured to minimize contingent asbestos liability for the American company—both through the assets purchase method and seller warranties and indemnities, there was real concern that purchasing a stream of asbestos payouts would negatively impact the stock price of the American company. This worry continued even though the rational stream was only a trickle. Tradition insurance brokers indicated that the asbestos liability was an uninsurable risk, placing the M&A transaction in peril.
Result: RCP was able to deconstruct, re-characterize and transform much of the risk into a policy that more closely resembled a credit risk not a pure asbestos liability. In addition to structuring a unique policy form for the transaction, RCP identified appropriate insurers in the market who had the following characteristics: a) relatively little asbestos liability; b) sound understanding of European political and judicial risk. In the end, the RCP solution was favorably priced and placed with a highly rated carrier thereby meeting the fiscal guidelines outline by management while meeting the risk transfer requirements of their board. RCP’s innovative solution and insurance market relationships were credited for eliminating a potential deal-breaking risk - leading to a successful acquisition.
STRUCTURING A TRANSACTION AS TAXABLE IN ORDER TO REALIZE A "STEP-UP" IN BASIS OF ACQUIRED ASSETS AND INCREASING EXPECTED AMORTIZATION DEDUCTIONS OF CERTAIN INTANGIBLE ASSETS
Situation: Pursuant to a bankruptcy plan of reorganization, a newly-formed company purchased most of the assets and took over the operations of a debtor-in-possession. The transaction was structured as a taxable transaction for the purpose of realizing a "step-up" in basis of the assets acquired, thereby generating substantial potential depreciation and amortization deductions in the years to come.
Issue: If the structure of the taxable transaction were not respected, the Insured would forfeit millions of dollars of expected amortization deductions with respect to the company's intangible assets (discounted to present value). Given the Insured's projected EBITDA, the Insured could ill-afford to lose the expected tax deductions could result in a liquidity crisis threatened the Insured's ability to sustain itself. The Tax Insurance policy covers the risk that the Insured's future deductions will be disallowed under any of the legal grounds identified by the two firms hired by the Insured to analyze the risk, which were identified as: (1) the transaction could be re-characterized as a tax-free reorganization; (2) the deductions with respect to certain intangible assets could be challenged under anti-churning rules of Section 197; and (3) the transaction lacks a business purpose under Section 269.
IRC Sections Implicated: §§ 368(a)(1)(G), 197, 269
RISK OF EXCESS LOSS RECAPTURE ARISING OUT OF A TAX-FREE MERGER EFFECTUATED BETWEEN PARENT AND SUBSIDIARY AS PART OF BANKRUPTCY PLAN OR REORGANIZATION
Situation: Company A, engaged in due diligence in preparation to submit a bid to acquire Target, became concerned about the following tax risk. The Target and its wholly owned subsidiary filed for bankruptcy in 1999. At such time, Company X had an excess loss account arising out of tax losses and dividends received from the subsidiary that produced a negative basis in its stock of the subsidiary. By effectuating a tax-free merger between the Target and the subsidiary shortly before the new company emerged from bankruptcy protection, however, the Target claimed to avoid any excess loss account recapture.
Issue: The merger, consummated as part of a plan of bankruptcy reorganization, might have been ineffective in removing the excess loss account for a number of reasons, including the prospect that the merger could be characterized as a deconsolidation and/or a disposition of worthless stock as such terms are used in the excess loss account rules under Treasury Regulation 1.1502-19. The Tax Insurance policy covered this risk of loss, allowing Company A to submit what ultimately proved to be the successful bid for the Target.
IRC Section Implicated: §§ 368(a)(1)(G), 1502