The Deal Compass – Inversions

Several U.S. companies have completed an inversion transaction to potentially reduce their tax rate and ensure that earnings arising from future growth outside the U.S. remain outside the U.S. tax system.

In June of 2014, another inversion transaction, QLT Inc.’s acquisition of Auxilium Pharmaceuticals, Inc., was announced. In addition, the following inversion transactions are a partial list of those announced in 2013 and 2014:

• Chiquita (through its acquisition of Fyffes)
• Forest Laboratories (through its acquisition of Actavis)
• Endo Health Solutions (through its acquisition of Paladin Labs)
• Perrigo Company (through its acquisition of Élan Corporation)
• Actavis (through its acquisition of Warner Chilcott)

In addition to tax considerations, a number of other issues must be considered when determining whether an inversion transaction is warranted. The decision to undertake an inversion transaction is likely to have consequences on the governance and operations of the underlying corporate group. Below is a brief overview of some of the key non-tax issues that should be considered.

Corporate Governance and Takeover Defense – In analyzing the risks and benefits of an inversion transaction, the company needs to consider the corporate governance regime and corporate law generally of the jurisdiction in which the new foreign parent company will be organized.

While some jurisdictions, such as Canada, have adopted corporate law regimes that are conceptually consistent with U.S. corporate law, the laws of other foreign jurisdictions may be significantly different and may even expose the underlying corporate group to significant risks. The new foreign parent company will be subject to different rules with respect to residency requirements and fiduciary duties of officers and directors, executive compensation arrangements, reporting obligations, voting standards for the election and removal of directors, shareholders’ ability to call meetings and propose resolutions, shareholder derivative suits, transactions requiring shareholder approval and the ability to pay and the mechanics for paying dividends and distributions. Further, in a number of European jurisdictions, an advisory vote must be undertaken with respect to director compensation. Management and the board should seek competent local counsel and not assume that the company’s standard governance procedures are permitted under the laws of the new jurisdiction.

Additionally, many jurisdictions either lack or have underdeveloped takeover defenses compared to the U.S. In Ireland, a popular jurisdiction for inversion transactions, as of July 2014, the courts have not yet considered the validity of shareholder rights plans or “poison pills.” Canada has restrictions on maintaining a poison pill even in the context of a hostile bid. In the United Kingdom, many typical U.S.-style takeover defenses, such as staggered boards, are not permitted. Smaller companies may find that the takeover measures they relied upon prior to the inversion are unavailable when dealing with a larger competitor or activist. Further, traditional break-up fees are not recognized in all jurisdictions, and in Ireland, for example, break-up fees are capped at one percent and must be approved beforehand by an Irish statutory body, the Irish Takeover Panel.

SEC Requirements – In addition to the typical shareholder solicitation and approval requirements necessary to satisfy SEC and corporate governance requirements, key considerations from an SEC perspective include: (i) the requirement to receive “No-Action” relief from the SEC permitting the new parent company to succeed the inverted company as an SEC reporting company; (ii) confirmation that the new parent company shares issued in the inversion transaction will be deemed registered under Section 12(b) of the Exchange Act; and (iii) confirmation from the SEC that the public reporting history of the company will satisfy requirements for Form S-3 and Rule 144 eligibility for the new parent company.

Listing Requirements and Financial Reporting – The ability to directly list the securities of a new parent company on the NYSE or NASDAQ without having to list on a foreign exchange or dually list on a foreign exchange and a U.S. exchange is also relevant when determining the potential jurisdiction of the new parent company. One example of this in practice is Irish companies, which are not required to list or dually list on the Irish exchange or another European stock exchange in order to list on the NYSE or NASDAQ, which is one reason why Ireland has been a favorable jurisdiction for the recent wave of inversion transactions. Similarly, in the QLT-Auxilium transaction, the parent company will be a Canadian company and QLT is expected to delist its shares from the Toronto Stock Exchange following the merger, and Auxilium shares will continue to trade on the NASDAQ. Another consideration is financial accounting requirements for companies that intend to be U.S.- listed companies. In some jurisdictions, a company may be required to apply the International Financial Reporting Standards (IFRS) as opposed to U.S. GAAP for financial reporting. Therefore, jurisdictions with an acceptable accounting regime and particularly those that permit a company to report their financials only using U.S. GAAP would be advantageous for companies that plan to solely list their securities in the United States as this reduces compliance costs and administrative burdens.

Employee Considerations – Labor and employment issues may also arise from the new jurisdiction of the parent company. If employees of the new parent company become domiciled in certain European jurisdictions, they can potentially become subject to more stringent regulatory regimes applicable to employees in Europe. In addition, it may be necessary to renegotiate existing collective bargaining agreements, and European works council issues may also arise in connection with inversion transactions.

Change of Control Issues – Another issue to consider in the typical inversion transaction structure is that “change of control” clauses in contracts, leases, licenses or permits may be triggered, which may create a requirement to provide notice or obtain third-party consent in connection with the transaction.

Access to Capital and Impact on Share Price – A company may have greater access to capital or receive debt financing on more favorable terms depending on the jurisdiction of the new parent company. This issue is likely not as significant in the current debt markets but historically the domicile of a borrower and other companies in the organizational structure have impacted the availability and pricing of debt financing. Another consideration that may arise over time is whether there is shareholder hesitancy to invest in companies with a non-U.S. parent company or if stock prices will be suppressed because of a non-U.S. parent company. On the other side of the coin, a company may have additional access to foreign investors in the new jurisdiction.

Public Policy and Political Issues – As many companies are learning, there is tremendous public policy and political pressure on U.S. companies not to undergo an inversion transaction as this has the potential to result in decreased U.S. tax revenue. In addition, when determining potential inversion jurisdictions, a company must consider the economic and political stability of such jurisdiction.

Over the past few months, there have been several proposals from members of Congress and from the Obama administration to change U.S. tax laws in ways that would discourage inversions by reducing or eliminating the tax advantages sought to be achieved thereby. Some of these proposals would apply retroactively, affecting deals that have already been announced or even closed. The level of public attention to the current wave of inversions has been escalating over the past few weeks, and for this reason some are beginning to believe it is more likely than once thought that the law in this area will be changed soon. Because of this proposed legislation, several current deals feature “no change of law” conditions that would allow the parties to terminate their combination in the event of such a change in law.

Litigation and Governing Law Considerations – Although all M&A transactions run the risk of potential shareholder litigation, shareholder claims have been brought in inversion transactions under the theory that the nature of an inversion transaction has resulted in harm to the shareholders of a company. A well-established body of law and level of comfort with a legal landscape is also an important consideration when determining a potential jurisdiction. It is also worth noting that certain jurisdictions do not enjoy the same benefit of the “attorney-client privilege” as we do here in the U.S.

In summary, the potential legislation involving the current anti-inversion rules requires quick but thoughtful analysis of all issues related to a potential inversion transaction, including those set forth in this alert. Although U.S. companies may reap tax benefits by engaging in inversion transactions, these transactions should not be driven solely by tax considerations. Companies and management should carefully weigh all issues before engaging in an inversion transaction.

In addition to the recent QLT Inc.-Auxilium Pharmaceuticals, Inc. inversion transaction discussed above, below is a list of public deals and private deals that were publicly disclosed with a transaction value over $350 million that were announced in the month of June: