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Minimizing Risk Through Company Restructuring Garth D. Stevens, Snell & Wilmer L.L.P.
Joshua P. Hayes, Eide Bailly LLP
2 ©2010 Snell & Wilmer L.L.P.
Objectives of Reorganization Objectives of Reorganization
1. Protect specific classes of assets (e.g., real estate, IP)
2. Create firewalls between different businesses
3. Insulate higher risk business from lower risk business
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Limited Liability and Piercing the Corporate Veil
4 ©2010 Snell & Wilmer L.L.P.
Limited Liability Limited Liability
• A fundamental tenet of corporation and LLC formation:
• Ordinarily, a company’s shareholders will not be liable for the company’s debts or other liabilities beyond the shareholders’ equity investment in the company.
5 ©2010 Snell & Wilmer L.L.P.
Piercing the Corporate Veil Piercing the Corporate Veil
Potential triggers:◦ Fraud◦ Deliberate efforts to hinder creditors◦ Recklessly undercapitalizing / underinsuring the
company.◦ Failing to observe legal formalities that give the
company independent legal status.
6 ©2010 Snell & Wilmer L.L.P.
—High risk operations—Low risk operations—IP assets—Owned real estate
Shareholders
Company
Simple Company Structure Simple Company Structure
7 ©2010 Snell & Wilmer L.L.P.
Common Firewall StructureCommon Firewall Structure
Shareholders
HoldCo
OpCo. #1 OpCo. #2 IPCo.Real Estate
Co.
8 ©2010 Snell & Wilmer L.L.P.
Three-Step Process Three-Step Process
• First – Factual analysis and planning; preliminary steps.
• Second – Complete the Reorganization (one time event).
• Third – Observe corporate & business formalities (ongoing).
9 ©2010 Snell & Wilmer L.L.P.
Factual Analysis & Planning; Factual Analysis & Planning; Preliminary Steps Preliminary Steps
• Determine appropriate tax structure. • Identify contractual restrictions (e.g., bank
loan documents; shareholder agreements).
• Identify permit and licensing issues, including transferability.
• Identify notices/registrations that will need to be made (e.g., IP transfers; notices to customers).
• Obtain applicable shareholder/director approvals.
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©2010 Snell & Wilmer L.L.P.
Tax Analysis and Considerations Tax Analysis and Considerations
• Tax considerations – e.g., preservation of NOLs and tax credits.
• Valid business purpose.• Shareholders receive stock in exchange
for stock.• Investment position is equivalent after
transaction is complete.
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©2010 Snell & Wilmer L.L.P.
How Do We Get There? How Do We Get There?
1. Form new HoldCo.2. Shareholders of current
OpCo assign their shares of OpCo to new HoldCo (Code § 351)
3. In exchange, HoldCo issues shares to OpCo shareholders
4. The result – Shareholders now hold the same % ownership of HoldCo and HoldCo owns OpCo
Step One – Formation of New Parent Holding Company
Shareholders
HoldCo
OpCo.
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©2010 Snell & Wilmer L.L.P.
Shareholders
How Do We Get There?How Do We Get There?
1. HoldCo forms new OpCo subsidiaries.
2. Each OpCo subsidiary issues shares to HoldCo
3. S-election for new HoldCo; Q-Sub elections for subsidiaries (watch timing)
Step Two – Formation of New Subsidiaries
HoldCo.
OpCo.OpCo. IPCo.
Real Estate
Co.
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©2010 Snell & Wilmer L.L.P.
Shareholders
How Do We Get There?How Do We Get There?
1. Original OpCo. makes a dividend/distribution of assets to HoldCo. (Code § 368)
2. HoldCo then contributes the assets to another OpCo subsidiary.
3. OpCo’s then enter into cross agreements on arm’s length terms.
Step Three – Transfer of Assets
HoldCo.
OpCo. OpCo. IPCo.Real
Estate Co.
ASSETS
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©2010 Snell & Wilmer L.L.P.
The End Result The End Result
Shareholders
HoldCo
OpCo. #1 OpCo. #2 IPCo.Real
Estate Co.
Building Lease
IP Licenses
Admin Services Agreements
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©2010 Snell & Wilmer L.L.P.
Subsidiaries vs. Sister Companies Subsidiaries vs. Sister Companies
Parent Co.
OpCo.
IPCo.Real Estate
Co.
HoldCo
OpCo. IPCo.Real
Estate Co.
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©2010 Snell & Wilmer L.L.P.
Subsidiaries vs. Sister Companies Subsidiaries vs. Sister Companies
• Consolidated tax election?• Combined filing?
Tax Filing Considerations:
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©2010 Snell & Wilmer L.L.P.
Preserving Limited Liability Preserving Limited Liability
TWO KEYS:
1. Maintenance of independent existence and operation.
2. REASONABLE capitalization and/or insurance for each company.
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©2010 Snell & Wilmer L.L.P.
Independent Existence Independent Existence
• Think of (and treat) each company as if it was truly independent of each other company.
• If you don’t treat each company as a separate legal entity, there is a good chance that a court won’t either.
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©2010 Snell & Wilmer L.L.P.
Maintaining The Firewalls Maintaining The Firewalls
• Avoid co-mingling funds; each company with its own bank account.
• Document inter-company transactions should be documented with written agreements on arm’s length terms.
• Intercompany loans should be under written, interest-bearing notes or loan agreements (not just GL entry).
• Each company should follow proper corporate formalities.
• Where appropriate, each company should have its own employees.
• If possible, avoid cross guaranties and cross-default terms in contracts.
• If possible, physical segregation of businesses.
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©2010 Snell & Wilmer L.L.P.
Capitalization and Insurance Capitalization and Insurance
• The best way to avoid a creditor’s attempt to “pierce the veil” is to give the creditor no need to do so.
• Take a REASONABLE approach to capitalizing and/or insuring each company.