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Morris Trust

Basic Principles

  • A "Morris Trust" or "reverse Morris Trust" transaction is an M&A technique for a company to effectuate a sale of a division or divisions to a Buyer without incurring any corporate tax in the transaction
  • In a Morris Trust, all assets other than those being acquired are spun off into a new public company, with the remaining assets being merged with the Buyer. In a reverse Morris Trust ("RMT"), the assets to be acquired are spun off and promptly merged with the Buyer
  • The reverse Morris Trust format is currently much more common than the Morris Trust format as it typically provides the most direct means to effectuate the transaction
  • The reverse Morris Trust and Morris Trust structures can also be executed as split-offs as well as spin-offs
  • The March 2007 Weyerhaeuser/Domtar transaction is the first reverse Morris Trust executed as a split-off; structure can be attractive as a means to ensure that shares are placed in the right hands
  • Key structuring issues:
    • 50% Requirement: Shareholders of Seller must receive over 50% of the vote and value of the surviving entity in the merger (the "50% Test"). For purposes of this requirement, shares in the pro forma company owned by the Seller shareholders by virtue of equity positions in the Buyer are generally counted under the Shareholder Overlap rules.
    • Equity Financing: Dilution of Seller shareholders by planned post-transaction equity issuances by the surviving entity will be counted for purposes of the "50% Test". Equity issuances within a 2-year period of the transaction may be treated as "planned" for this purpose
    • Monetization Possible: The debt/equity and debt/debt swap techniques described under Monetizing Spin-Offs are equally available to Seller here and have been utilized in numerous such transactions ruled upon by the IRS. However, such strategies will reduce the percentage of the merged entity owned by historic Seller shareholders, putting pressure on the 50% Test (see Heinz/Del Monte)
    • Post-Merger M&A: Under the revised Morris Trust rules, as long as the Seller and potentially the Buyer have not had significant M&A discussions with a Target for the 2 years preceding the spin, the combined entity can commence M&A dialogue with respect to the Target promptly after the closing of the Morris Trust transactions. If such discussions have occurred, a 6-month or 1-year wait may be required. A similar analysis applies to M&A dialogue by the Seller, although the Seller will have greater "cushion" on the 50% Test due to the absence of any change in shareholder base in the transaction
    • Corporate Governance: Notwithstanding the 50% requirement, the Buyer in a Morris Trust acquisition can retain effective control over the Board of Directors and senior management of the surviving entity (see P&G/J.M. Smucker and Mariner/Forest Oil)
    • Precedent transactions: FairPoint/Verizon, Alltel/Valor, Weyerhaeuser/Domtar, Forest Oil/Mariner, Heinz/Del Monte, JIF/J.M. Smucker, AT&T Broadband/Comcast

Corporate Governance

  • The principal tax requirement is that the Seller shareholders receive greater than 50% of the vote and value of the pro forma company, as per Section 355(e)
  • In the RMT context, the IRS has not typically required that this greater-than-50% vote be reflected in any initial or future composition of the Board or Management of the pro forma Company, as long as (i) the Board is elected through normal shareholder voting going forward, and (ii) the normal powers of the Board over major corporate decisions are respected going forward
  • As the chart below shows, in several recent deals the Board and senior management of the Buyer have dominated the governance of the pro forma company on a going-forward basis (although there is also precedent where the Seller has predominated)
  • Based on these precedents, the Buyer should have significant flexibility from a tax perspective to have the Board and senior management of its choice, notwithstanding the Section 355(e) requirements around shareholder ownership
  • Any mechanisms put into place which could mitigate the impact of the Seller shareholder voting rights (unusually long Board terms, limits on ability of Board to control major corporate decisions, appoint senior management, etc.) will, however, be carefully scrutinized by the IRS
  • In some deals (e.g. AT&T Broadband/Comcast), the Buyer shareholders have obtained the right to a special class vote over major corporate transactions
    • Such mechanisms would be permissible for tax purposes if they are limited to transactions which would normally come to a shareholder vote (e.g. large-scale M&A, amendments of the charter, etc.)
    • While such provisions do give Buyer greater control going forward, they do also imply having two classes of public securities

Exhibit A – Corporate Governance

Parties   Date of Announcement   Board Composition   Senior Management Composition
Verizon (seller)
FairPoint (buyer)
Jan 16, 2007 3 - FairPoint
6 - Verizon
From FairPoint
Domtar (buyer)
Weyerhaeuser (seller)
Aug 23, 2006 7 - Weyerhaeuser
6 - Domtar
Mixed
Alltel (seller)
Valor (buyer)
Dec 9, 2005 8 - Alltel
1 - Valor
From Alltel
Forest Oil (seller)
Mariner (buyer)
Sep 12, 2005 6 - Mariner
1 - Forest Oil
From Mariner
JIF (seller)
Smuckers (buyer)
Jun 1, 2002 All Smuckers From Smuckers

Transaction Structure - RMT

Step 1 Transaction Steps
reverse Morris Trust step 1
  • P signs a contract to sell S to Buyer
  • Closing condition to acquisition that P spin-off S
Step 2 Transaction Steps
reverse Morris Trust step 2
  • P spins off S, which merges with Buyer
  • If monetizing spin-off technology utilized, S dropped into NewCo to facilitate debt/equity, debt/debt swap

Transaction Structure - RMT with Debt-for-Debt Exchange

Step 1 - Formation of NewCo
reverse Morris Trust step 1
  • ParentCo contributes assets and debt up to its tax basis in the wanted assets to a NewCo in exchange for NewCo equity and notes
Step 2 - Debt-for-Debt Exchange
reverse Morris Trust step 2
  • Investment Bank buys ParentCo debt in open market
  • ParentCo delivers NewCo Notes to Investment Bank in exchange for ParentCo debt in a debt-for-debt swap; Investment Bank sells NewCo Notes to investors
Step 3 - NewCo Merges with InvestorCo
reverse Morris Trust step 3  

Transaction Structure - Morris Trust

Step 1 Transaction Steps
Morris Trust step 1
  • P enters into contract to sell S2 to Buyer
  • Closing condition that P first spin off S1
Step 2 Transaction Steps
Morris Trust step 2
  • P spins off S1 and then merges with Buyer
  • If monetizing spin-off technology to be utilized, P drops S1 into NewCo to facilitate debt/equity, debt/debt swaps

Exhibit B – Advantages & Disadvantages

Advantages   Disadvantages
  • Permanently tax-free disposition of business
  • Significant monetization possible through debt/equity, debt/debt swaps
  • Shareholders get benefits of synergies of merger and, potentially, a control premium
  • Buyer can retain effective control of Board of Directors and senior management of surviving entity, notwithstanding Section 355 requirements
  • Monetization limited by market capacity and Section 355 limitations
  • Limited universe of merger partners due to Section 355 requirement
  • Post-transaction equity issuance may be limited under Section 355
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