Xerox Corp., to the surprise of many observers, announced an agreement on September 28 to acquire Affiliated Computer Services (ACS) in exchange for a combination of cash and Xerox stock. The deal is conditioned on securing an opinion of counsel that it will qualify as a reorganization, which would render the deal tax-free by Internal Revenue Service standards. We have every expectation that this opinion will be rather easily secured.
The merger agreement provides that ACS will be merged with and into a newly created subsidiary of Xerox, Boulder Acquisition Corp. (BAC). In the merger, each share of ACS Class A common stock will be converted into the right to receive 4.935 shares of Xerox common stock and $18.60 per share in cash.
Moreover, each share of ACS Class B common stock (held entirely by one shareholder and entitled to “enhanced” voting rights vis à vis the Class A common stock) will be converted into the following: (1) 4.935 shares of Xerox common stock, (2) $18.60 in cash, and (3) a number of shares of Xerox convertible preferred stock. That number is equal to the “preferred exchange ratio,” which is, in turn, the quotient of 300,000 and the number of shares of Class B common stock outstanding as of the “effective time.”
Forward Triangular Merger
The transaction, therefore, will take the form of a “forward triangular merger” — a merger in which the acquiring corporation (BAC) is a controlled subsidiary of the entity (Xerox) whose stock is issued in the transaction.
“The postannouncement declines in the price of Xerox’s stock should not impact the transaction’s satisfaction of the continuity of interest test.” — Robert Willens
A forward triangular merger qualifies as an “A” reorganization by reason of the tax code1 if, as here, the acquiring corporation is a first-tier subsidiary of the issuing corporation. To qualify as a first-tier subsidiary, several criteria must be met. They are as follows: no stock of the acquiring subsidiary can be used in the transaction to compensate the shareholders of the target, “substantially all” of the properties of the target must be obtained by the acquiring corporation, and the transaction “would have qualified” as an “A” reorganization had the merger been a “two-party” merger, in which the target was merged with and into the controlling corporation.
Note that the “would have qualified” test refers only to the general requirements for a reorganization, such as business purpose, continuity of interest, and continuity of business enterprise. Therefore, for purposes of the “would have qualified” test, it is not relevant whether a merger (of the target with and into the controlling corporation) could have been effected pursuant to state or federal corporate law.2
Clearly, the Xerox deal satisfies these general reorganization requirements. The majority of the consideration to be paid by Xerox consists of its stock. As a result, it seems apparent that a substantial part of the value of the proprietary interests in ACS will be preserved in the transaction. Accordingly, the transaction will exhibit the requisite continuity of interest.
Further, because the instant transaction provides for “fixed consideration,” the determination of whether the continuity of interest test is met should be made as of the announcement date, not as of the effective time. Thus, postannouncement declines in the price of Xerox’s stock (and in the relative proportion of the merger consideration that consists of Xerox stock) should not impact the transaction’s satisfaction of the continuity of interest test.
In addition, since Xerox will be continuing ACS’s historic business, the continuity of business enterprise test should be easily met. Finally, it goes without saying that this transaction will be carried out for several compelling corporate business purposes.
In the end, we have no doubt that counsel easily will be able to render its opinion, as it must for the deal to proceed to fruition, that the merger of Xerox and ACS will qualify as a reorganization within the meaning of the IRS Code.
Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
2See Reg. Sec. 1.368-2(b)(2)