The Best Part of Breaking Up Is Folgers’s Tax-Free Spinoff

Despite running into a potential deal-breaker, Folgers parent Proctor & Gamble successfully uses a reverse Morris Trust transaction in its latest pact with Smucker.

Procter & Gamble (P&G) and J.M. Smucker Co. will be using (for the second time in the past six years) a “reverse Morris Trust” transaction. In this case, the stock of Folgers will be distributed by P&G to its shareholders in exchange for a portion of their P&G stock. The exchange ratio is expected to include a premium to induce P&G shareholders to tender their P&G shares.1

Immediately after the distribution is completed, and as part of the overall plan, a subsidiary of Smuckers will be merged with and into Folgers. In the merger, the former shareholders of Folgers will exchange their Folgers stock for voting common stock in Smucker. At that point, Folgers will become a wholly-owned subsidiary of Smucker.

The shareholders of Folgers who exchange their stock for Smucker shares will emerge with some 53 percent of the voting power and value of Smucker outstanding stock. Accordingly, the shareholders of Smucker will see their interest in that company fall from 100 percent to approximately 47 percent.

This division of ownership is necessary to insure that the distribution by P&G of Folgers’s stock will be tax-free to P&G. Under Section 355(e) — the so-called “anti-Morris Trust” rule — a distribution is taxable at the distributing corporation level if the distribution is part of a plan (or series of related transactions) in which the following is true: One or more persons acquire stock representing a 50 percent or greater interest in either the distributing corporation (P&G), the controlled corporation (Folgers), or any successor company (Smucker).

Here, because the Folgers shareholders will be acquiring a majority of the stock of Folgers’s successor (Smucker), there will be no acquisition by one or more persons (the former shareholders of Smucker) of an amount of stock sufficient to cause the transaction to run afoul of the anti-Morris Trust rule. In fact, the deal would not have been proposed had P&G not been confident that its distribution would not be ensnared by the anti-Morris Trust rule.

Surrendering voting rightsTo insure that the present shareholders of Smucker are not unduly deprived of voting privileges, the stock to be issued in the merger embodies an unusual feature. That is, each share to be issued (by Smucker to the former shareholders of Folgers) will entitle the holder to 10 votes per share on each of several matters enumerated in Smucker’s charter and by-laws. These matters pertain to major corporate transactions, such as liquidations, mergers, etc. Each such share is entitled to only one vote with respect to the election of Smucker’s board of directors.

However, upon a change in beneficial ownership of such shares, the holder is entitled to one vote with respect to the enumerated matters until the holder has held the share for four additional years. Therefore, because some amount of the Smucker stock to be issued in the merger will be given to “short-term holders” (such hedge funds) — who will dispose of the stock with alacrity — it may be that the former shareholders of Smucker will wind up with a majority of the voting rights with respect to the enumerated matters, once the Smucker stock is “fully distributed.” Does this likelihood impact the application of the anti-Morris Trust rule?


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