Buying or selling a member of a consolidated group?

• Author: Salem, Irving

Buying or Selling a Member of a Consolidated Group?

INTRODUCTION

Too often the tax adviser is given an unduly limited role in the development of the language for the acquisition contract. Indeed, it is not unusual for us to be the last to know a contract is about to be signed. The corporate lawyer will begin with his standard agreement (no doubt a prehistoric version) and with less than 24 hours before the signing of the contract, will say, "You don't have any problems with the tax reps, do you?"

And things are getting worse! Many corporations are being sold through an auction process, whereby the seller drafts the contract and prospective buyers are told to fill in the purchase price blank and "note any changes on the contract." The day before the bid contract is to be returned, the corporate lawyer will once more say: "You don't have any problems with the tax reps, do you?" He will also add, "You realize that the fewer the changes, the better our shot at winning the bid."

In any event, with the added complexity of the Code and the rapid pace at which deals are cut, it behooves us to try to be ready to react on a moments notice. With that in mind, this article provides an overview of what you are up against if you are the tax adviser on the base case which, for purposes of the accompanying catalogue and model agreement is, as follows:

The basic facts assumed are that Target is a 100-percent subsidiary in Selling Group, that Target and its wholly owned Subsidiaries are being acquired in a taxable purchase by Acquiring Group, no section 338 election is being made and both Selling Group and Acquiring Group file consolidated returns.

It is also assumed that (i) Selling Group and Acquiring Group enter into an agreement for the purchase and sale of Target's stock (the "Acquisition Agreement"), and (ii) that the closing of such purchase and sale will occur on a subsequent date, the "Closing Date." While this base-line case is being used to simplify the analysis, it should be noted that most of the consolidated return rules would apply if Target were the common parent of Selling Group, or if the acquisition is in the form of a tax-free reorganization, although the contractual protections may be different.

THE ECONOMIC SIGNIFICANCE

OF REPRESENTATIONS,

COVENANTS, AND

INDEMNITIES

To place the suggested contractual provisions in perspective, keep in mind that the basic purpose of the various provisions is to identify and possibly reduce the risks in the transaction, primarily from the buyer's standpoint. Broken down, the risk identification and reduction is achieved as follows:

1. Representations have three principal purposes:

   1. Discovery: By requiring disclosure of, for example, all material tax elections, representations smoke out the hidden problems.

   2. Right to Walk: If the representations are not materially true as of the time made or as of the closing date, the buyer has bought the right to walk (and consequently the right to renegotiate the purchase price).

   3. Economic Protection: If the buyer is damaged by a misinterpretation discovered after the closing, the buyer may sue the seller. That assumes the representations survive the closing, something surprisingly easy to obtain from seller with respect to taxes.

2. Covenants are promises to do something positive (e.g., pay all taxes for pre-closing date returns) or refrain from taking certain action. Again, buyer can walk if seller has not complied with any pre-closing obligation or can sue if the seller fails to comply with any post-closing covenant.

3. Indemnity provisions provide for the payment of damages for breach of representations or covenants. The indemnity provisions will spell out the obligations, the conditions, and the procedures for enforcing such indemnities.

   MODEL AGREEMENT: TAX

   REPRESENTATIONS AND

   INDEMNITY PROVISIONS

   The following are representations and indemnity provisions that might appear in an Acquisition Agreement to resolve the competing interests of the Selling and Acquiring Groups. This is not intended to be a definitive or model agreement because the agreement reached in each transaction will depend on all of the facts and circumstances, as well as the relative bargaining power of the Selling and Acquiring groups. (*1)

   [The following sectins is part of

   "Definitions"]

   SECTION X. Definitions. For purposes of this Agreement:

   X.01. "Tax" or "Taxes" shall mean all federal, state, local, foreign, and other taxes, assessments or other governmental charges, including without limitation, income, estimated income, business, occupation, franchise, property, sales, employment, or withholding taxes, including interest, penalties and additions in connection therewith for which the Company and each of the Subsidiaries is or may be liable.

   X.02. "Code" shall mean the Internal Revenue Code of 1986. All citations to the Code, or the Treasury Regulations promulgated thereunder, shall include any amendments or any substitute or successor provisions thereto.

   [The following section is part of

   "Representations and Warranties of

   Seller"]

   Section XX. Tax Matters.

   XX.01. Filing of Tax Returns. Each of Seller, Company, the Subsidiaries, Parent (and any affiliated group of which Company and the Subsidiaries are now or have been members), has timely filed...