251(g) Reorganizations

Delaware Section 251(g) Styled Reorganization – Eliminating Debt and Avoiding Skeletons in the Closet with the Reverse Merger
(CAUTION – practitioners who fail to employ this strategy may be liable for consequential losses sustained!)

An essential yet underutilized strategy for corporate cleanups, especially preceding any reverse merger is the reorganization pursuant to Section 251(g) of the Delaware General Corporation Law.

The Delaware Section 251(g) reorganization eliminates liabilities and potential liabilities from the new public company corporate structure. The Securities and Exchange Commission has ruled on multiple occasions, in no action letters that the newly formed company, without the baggage, is the successor issuer and the predecessor issuer is the subsidiary.

Securities Counselors, Inc. is well-versed in these matters. This Delaware Section 251(g) transaction should be mandatory for any reverse merger transaction, to avoid the horror stories which we have all heard, not to mention the prospects for malpractice for not using this strategy. We need to rid the new company going public of the potential exposures to the issuer’s liabilities and potential liabilities.

Steps to Achieve the Delaware Section 251(g) Styled Reorganization

A reorganization pursuant to Section 251(g) of the Delaware General Corporation Law, or its financial equivalent in an alternative jurisdiction, involving a reorganization of three entities, two of which would be newly created and leaving the company, recognized by the SEC as the successor issuer and leaving the predecessor issuer as a subsidiary, with all historical debts, as well as assets, in a subsidiary, with the parent company being the surviving public entity. This reorganization pursuant to Section 251(g) of the DGCL (Delaware General Corporation Law) – eliminates debt in the public entity, being the successor issuer, as Section 251(g) expressly provides for the newly formed holding company/successor issuer to become the public entity, without a vote of the stockholders of the constituent corporations. The predecessor issuer becoming a direct, wholly-owned subsidiary of a new public holding company, with all debts residing therein and no longer affecting the public entity.

These are the steps to achieve the tax-free (under section 368(a)(1) of the Internal Revenue Code) merger/reorganization, conforming to Section 251(g) of the Delaware General Corporation Law as a shell cleanup tool – eliminating corporate debt and potential debt.

  • First, the public company, say Predecessor Corporation, re-domiciles, for example, to Delaware or Colorado, being the jurisdictions of choice, depending upon the circumstances and based on budgetary concerns vis-à-vis the objectives (Delaware being the Cadillac, having the benefit of in common law precedent, but costing an additional approximately $4000 in filing fees).
  • Then there are two new companies which must be formed, in order to conform to the rules as outlined in Delaware Section 251(g) of the corporate statute, as follows: First, the existing public company Predecessor Corporation forms, as it subsidiary, a new company which ultimately becomes the holding company and, consequently, the successor issuer/new public company or (which we typically refer to as “Hold-Co”). Then Hold-Co, as its first course of business, forms a new company, as it subsidiary, which we typically refer to as “Merger Sub”.
  • Then there are two separate agreements that occur, a Merger Agreement and a Share Exchange Agreement, as follows: The result of the Merger Agreement is that Hold-Co survives and Merger Sub does not.The results of the Share Exchange Agreement is that all outstanding shares of common stock and preferred stock of the Predecessor Corporation are automatically converted into identical shares of common stock or preferred stock, as applicable, of Hold Co, on a one-for-one basis, and the Predecessor’s existing stockholders and other equity holders become stockholders and equity holders, as applicable, of Hold Co in the same amounts and percentages as they were in the Predecessor prior to the Reorganization.The stock transfer agent would actually issue new shares to the shareholders (although it could be in book entry form, for ease of administration and cost reduction).

As a result of these transactions, Hold-Co becomes the parent company and Predecessor Corporation becomes its wholly-owned subsidiary (which the SEC refers to as a “totally held” subsidiary), with its assets and liabilities locked in that wholly-owned subsidiary.This series of transactions, collectively, constitute a reorganization pursuant to a reorganization under the applicable provisions of Section 368(a)(1)(B) of the IRS Code of 1986, as amended and conforming to the provisions of Section 251(g) of the Delaware Corporate Act. (The Secretary of State’s Office publishes the agreements and related resolutions on its website.)The final step is that the Predecessor Corporation changes its name to Predecessor Services (typically that name ascribe to Merger Sub) and the newly formed Hold Co (as the successor issuer) changes its name to that previously held by the Predecessor Corporation. In Delaware, the “combination” of the participants in the 251(g)-styled reorganization provides for the share exchange, automatically, in other jurisdictions the documents must expressly provide for this result. [1] We also can orchestrate a similar reorganization under the statutes of other states, which may be more suitable under certain circumstances, while having a similar effect, and under some circumstances, even an enhanced set of consequences.

Randall S. Goulding 847-948-5431

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