3.3.4.2.1 Business combinations

Business combination is an aggregate term which can include part or all of the transactions such as mergers, consolidations and share exchanges. Its scope depends on which statute or model act we are referring to. In the RMBCA, for instance, business combination refers to mergers and share exchanges.1

A merger in the RMBCA means: One or more business corporations merge with one or more business corporations or eligible entities, pursuant to a plan of merger, or two or more business corporations or eligible entities merge into a new business corporation to be created in the merger.2

I give the description above in the form of an equation:

Company X + Company Y = Company X Company X is the surviving entity, and Company X+ Company Y= Company Z; Company Z is a new name and a new corporate identity.3

A share exchange means a corporation acquires all of the shares of one or more classes or series of shares of another corporation, or all of the interests of one or more classes or series of interests of a other entity, in exchange for shares or other securities, interests, obligations, rights to acquire shares or other securities, cash, other property, or any combination of the foregoing, pursuant to a plan of share exchange.4 The differences between mergers and share exchanges are mainly the number of shares purchased in the transaction and the legal existence of the corporations involved after the transaction. In a merger, all shares of the corporation(s) or all eligible interests of the eligible entities are merged. Consequently, at least one party to the transaction ceases to exist as the result of a merger. In a share exchange, all of one or more classes or series of shares or eligible interests are acquired. A share exchange enables all parties to the transaction to continue in existence. Continuation of the separate existence of the parties is a desirable aspect of share exchange because, given the complexity and diversified needs in business management, it may be preferable to structure a business combination without dissolving any party involved, in other words, there are situations in which corporations prefer to sell some shares to another corporation without the ceasing to exist themselves.5

In the absence of that form of share exchange, the above result can only be achieved indirectly, i.e., by a reverse triangular merger. In a triangular merger, corporation A does not directly merge with another party B, but instead, it forms a new subsidiary C, and lets C merge with another party B.6 In a reverse triangle merger, corporation A transfers shares to be acquired in the new subsidiary C and C merges into the other party to the merger, B. As a result, both parties, A and B remain, after B has acquired some of the shares which A wants to sell. In a share exchange, B can directly acquire one or more classes of shares of corporation A, which is a more straightforward way to achieve the same result. 7

In the Delaware statute, the scope of business combination is limited to mergers and consolidations.8

A merger in the Delaware statute means:

Company X + Company Y = Company X. Company X is the surviving entity.

And a consolidation is:

Company X+ Company Y= Company Z; Company Z is a new name and a new corporate identity.

We can see here that in the Delaware statute, mergers and consolidations together have the same scope as mergers in the RMBCA. Share exchanges, however, are not included in the Delaware statute. In a merger, the shareholders whose interests are eliminated from the original corporation should enjoy appraisal rights because this is a fundamental change to their investment expectations. By the same token, in a share exchange, the shareholders whose interests are to be acquired by another corporation should also be granted appraisal rights because such a transaction has the same result for them as in a merger, though a different consequence for the corporation. The scope of appraisal triggers in the Delaware statute is therefore too narrow to recommend.

In 7.21 (a) of the Principles, business combination means a merger, a consolidation, or a share exchange, basically the same as in the RMBCA, but it also explicitly includes triangle merger wherein the acquiring corporation sets up a subsidiary as a vehicle to effect the acquisition.9 A triangle merger has the advantage of protecting the parent company from risks in the transactions due to either a less committed due diligence or other causes, while having the advantage of the independent legal status of the subsidiary.

Under Section 11.04 of the RMBCA, shareholders from the corporations which do not survive the merger are entitled to the appraisal remedy which, in the pattere of Company X + Company Y = Company Z, means that shareholders from both company X and company Y have appraisal rights, and in the mode of Company X + Company Y = Company X, only shareholders in company Y can enjoy appraisal rights because company Y does not survive the merger. But there is an exception to this rule. In the aforementioned mode, Company X + Company Y = Company X, normally shareholders in company X have no rights to appraisal. But if the articles of incorporation are changed as a result of the transaction, rights home by the shares are changed or, in exchange for stakes in company Y, company X issues new shares which comprise more than 20 per cent of the voting power of the shares of company X that were outstanding immediately before the transaction, shareholders of company X are also entitled to vote on the transaction and consequently qualify for appraisal rights in this situation.10 The underlying rationale is that each of the actions mentioned above is likely to be considered a fundamental change to company X and to the shareholders in it. Accordingly, protection by means of appraisal rights should also be granted to shareholders in company X onder these circumstances. Now back to the question of triangle mergers. Suppose: company X first forms a new subsidiary financed by the issuance of more than 20 per cent of its outstanding shares, and the establishment of the subsidiary is purely for the purpose of a subsequent merger with company Y. Under the RMBCA, shareholders in company X have no appraisal rights since triangle merger is not explicitly included among the statutory triggers.11 Consequently, company X can avoid granting appraisal rights to its own shareholders by initiating a triangle merger. The inclusion of triangular mergers in the ALI Principles represents its willingness to pierce through appearance and allow substance control over form.12 The principles do not allow incentives to be created to use particular transaction techniques in order to avoid appraisal rights.13