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Federal Register / Vol. 70, No.

179 / Friday, September 16, 2005 / Rules and Regulations 54631

extension in delaying the anticipated DEPARTMENT OF THE TREASURY first date there is a binding contract to
benefits of the rule, in our judgment a effect the potential reorganization (the
limited extension of the compliance Internal Revenue Service signing date rule). Under the proposed
date is, on balance, appropriate. Our regulations, consideration is fixed in a
judgment is based on the 26 CFR Part 1 contract if the contract states the
representations made by the SIA, the [TD 9225] number of shares of the issuing
ACLI, and the FSI (whose members are corporation and the amount of money,
RIN 1545–BD53 if any, to be exchanged for the
required to comply with the rule and
thus are in a position to assess the level proprietary interests in the target
Corporate Reorganizations; Guidance corporation. The signing date rule is
of difficulty and time involved in their on the Measurement of Continuity of based on the principle that, in cases in
complying with the rule) and our Interest which a binding contract provides for
experience in overseeing the industry. fixed consideration, the target
We are not, however, persuaded that a AGENCY: Internal Revenue Service (IRS),
Treasury. corporation shareholders generally can
delay of up to an additional six months be viewed as being subject to the
is necessary given that we already ACTION: Final regulation.
economic fortunes of the issuing
afforded broker-dealers approximately a SUMMARY: This document contains final corporation as of the signing date.
six-month compliance period, and that regulations that provide guidance No public hearing regarding the
these provisions will provide investors regarding the satisfaction of the proposed regulations was requested or
with important protections.5 continuity of interest requirement for held. However, several written and
Accordingly, the Commission believes it corporate reorganizations. The final electronic comments regarding the
is appropriate to extend the compliance regulations affect corporations and their notice of proposed rulemaking were
date for rule 202(a)(11)–1(b)(2) and shareholders. received. After consideration of the
(b)(3) until January 31, 2006. The rule’s DATES: Effective Date: These regulations
comments, the proposed regulations are
effective date of April 15, 2005 remains are effective September 16, 2005. adopted as revised by this Treasury
unchanged. decision.
FOR FURTHER INFORMATION CONTACT:
The Commission for good cause finds Jeffrey B. Fienberg, at (202) 622–7770 Explanation of Provisions
that, for the reasons cited above, (not a toll free number). These final regulations retain the
including the brief length of the SUPPLEMENTARY INFORMATION: general framework of the proposed
extension we are granting, notice and regulations but make several
Background
solicitation of comment regarding the modifications in response to the
extension of the compliance date for The Internal Revenue Code of 1986 comments received. The following
rule 202(a)(11)–1(b)(2) and (b)(3) are (Code) provides for general sections describe the most significant
impracticable, unnecessary, or contrary nonrecognition treatment for comments and the extent to which they
to the public interest.6 In this regard, the reorganizations described in section 368 have been incorporated into these final
Commission notes that broker-dealers of the Code. In addition to complying regulations.
need to be informed as soon as possible with the statutory and certain other
requirements, to qualify as a A. Fixed Consideration
of the extension and its length in order
reorganization, a transaction generally As stated above, the proposed
to plan and adjust their implementation regulations require that the
must satisfy the continuity of interest
processes accordingly. (COI) requirement. COI requires that, in consideration in a contract be fixed in
Dated: September 12, 2005. substance, a substantial part of the value order for the signing date rule to apply.
By the Commission. of the proprietary interests in the target One commentator identified a number
Jonathan G. Katz, corporation be preserved in the of contractual arrangements that do not
reorganization. provide for fixed consideration within
Secretary.
On August 10, 2004, the IRS and the meaning of the proposed
[FR Doc. 05–18384 Filed 9–15–05; 8:45 am] Treasury Department published a notice regulations, but, nevertheless, are
BILLING CODE 8010–01–P of proposed rulemaking (REG–129706– arrangements in which the
04) in the Federal Register (69 FR consideration should be treated as fixed
48429) (hereinafter the proposed and, therefore, eligible for the signing
regulations) identifying certain date rule. In particular, the commentator
5 JCM asserts that providing the requested relief circumstances in which the identified a number of circumstances in
will exacerbate and extend investor confusion with determination of whether a proprietary which, rather than stating the number of
respect to fee-based accounts. We disagree. Broker- interest in the target corporation is shares and money to be exchanged for
dealers already are required to comply with the preserved would be made by reference target corporation shares, a contract may
specific disclosure provisions of rule 202(a)(11)–
to the value of the issuing corporation’s provide that a certain percentage of
1(a)(1)(ii).
6 See section 553(b)(3)(B) of the Administrative
stock on the day before there is an target corporation shares will be
Procedure Act (5 U.S.C. 553(b)(3)(B)) (‘‘APA’’) (an agreement to effect the potential exchanged for stock of the issuing
agency may dispense with prior notice and reorganization. In particular, in cases in corporation. One such circumstance is
comment when it finds, for good cause, that notice which the consideration to be tendered where a merger agreement permits the
and comment are ‘‘impracticable, unnecessary, or to the target corporation’s shareholders target corporation some flexibility in
contrary to the public interest). The change to the is fixed in a binding contract and issuing its shares between the signing
compliance date is effective upon publication in the includes only stock of the issuing date and effective date of the potential
Federal Register, which is less than 30 days after
corporation and money, the issuing reorganization. Such an issuance may
publication. The APA allows effective dates less
than 30 days after publication in the Federal corporation stock to be exchanged for occur, for example, upon the exercise of
Register for ‘‘a substantive rule which grants or the proprietary interests in the target employee stock options. As a result, the
recognizes an exemption or relieves a restriction.’’ corporation would be valued as of the total number of outstanding target
See section 553(d)(1) of the APA. end of the last business day before the corporation shares at the effective time

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54632 Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations

of the merger and, therefore, the total issuing corporation is the only type of there is a binding contract to effect the
number of shares of the acquiring consideration that is subject to a potential reorganization. One comment
corporation to be issued in the merger, contingency, the delivery of any of the requested clarification of the meaning of
may not be known when the merger contingent consideration to the target as of the end of the last business day.
agreement is signed. corporation shareholders will enhance That comment suggested that an average
In addition, a contract may permit the the preservation of the target of the high and low trade price on that
target corporation shareholders to elect corporation’s shareholders’ proprietary day should be an acceptable value for
to receive stock (the number of shares of interests. Therefore, these final this purpose. Alternatively, the
which may be determined pursuant to a regulations provide for a limited comment suggested that if a single trade
collar) and/or money or other property exception to the general rule that an were to determine the value of the
in respect of target corporation stock, arrangement that provides for issuing corporation stock, the closing
but provide that a particular percentage contingent consideration will not be one price of the issuing corporation stock on
of target corporation shares will be to which the signing date rule applies. the relevant market should be used. The
exchanged for stock of the issuing The exception applies to cases in which comment further described an approach
corporation and a particular percentage the contingent consideration consists for identifying the relevant stock
of target corporation stock will be solely of stock of the issuing corporation market.
exchanged for money. In these cases, if and the execution of the potential In response to these comments, these
either the stock or the cash reorganization would have resulted in final regulations remove the
consideration is oversubscribed, the preservation of a substantial part of requirement that the consideration be
adjustments are made to the the value of the target corporation valued as of the end of the last business
consideration to be tendered in respect shareholders’ proprietary interests in day before the first date that there is a
of the target corporation shares such the target corporation if none of the binding contract. Instead, they provide
that the specified percentage of target contingent consideration were delivered general guidance that the consideration
corporation shares is, in fact, exchanged to the target corporation shareholders. to be exchanged for target corporation
for stock of the issuing corporation. The IRS and Treasury Department shares pursuant to a contract must be
The IRS and Treasury Department continue to study whether other valued the day before such contract is
agree that a contract that provides for arrangements involving contingent a binding contract.
either the percentage of the number of consideration should be within the
shares of each class of target corporation 2. New Issuances
scope of the signing date rule. Among
stock, or the percentage by value of the these arrangements are cases in which The IRS and Treasury Department
target corporation shares, to be the contingent consideration consists recognize that the application of the
exchanged for issuing corporation stock not only of issuing corporation stock but requirement that the consideration to be
should be treated as providing for fixed also of money or other property and exchanged for proprietary interests in
consideration, as long as the target cases in which the issuing corporation the target corporation be valued on the
corporation shares to be exchanged for stock to be issued in respect of target last business day before the first date
issuing corporation stock and the target corporation stock is determined there is a binding contract to effect the
corporation shares to be exchanged for potential reorganization may be unclear
pursuant to a collar.
consideration other than issuing in cases in which the consideration does
corporation stock each represents an C. Nature of Consideration not exist prior to the effective date of the
economically reasonable exchange. Just As described above, under the reorganization. For example, suppose
as in cases in which the contract states proposed regulations, the signing date that, in the potential reorganization, the
the number of shares of the issuing rule applies only when the issuing corporation will issue a new
corporation and the amount of money, consideration to be provided in respect class of its stock in exchange for the
if any, to be exchanged for the of target corporation shares includes shares of the target corporation. The
proprietary interests in the target only stock of the issuing corporation question has arisen as to how to value
corporation, in these cases, the target and money. One commentator suggested those to be issued shares under the
corporation shareholders generally can that the signing date rule should be signing date rule, given that they do not
be viewed as being subject to the expanded to apply to transactions in exist on the last business day before the
economic fortunes of the issuing which the non-stock consideration first date that there is a binding contract
corporation as of the signing date. includes property other than money. to effect the potential reorganization.
Accordingly, these final regulations Under these final regulations, the Thus, these final regulations clarify that
include an expanded set of signing date rule may apply in such this new class of stock will be deemed
circumstances in which a contract will cases. Therefore, under these final to have been issued on the last business
be treated as providing for fixed regulations, the signing date rule may day before the first date there is a
consideration. apply, for example, in cases in which binding contract to effect the potential
B. Contingent Consideration proprietary interests in the target reorganization for purposes of applying
The fact that a contract provides for corporation are exchanged for stock and the signing date rule.
contingent consideration will generally securities of the issuing corporation.
E. Escrowed Stock
prevent a contract from being treated as D. Valuation
providing for fixed consideration. One 1. Pre-Closing Covenants
commentator suggested that a contract 1. The ‘‘As of the End of the Last The proposed regulations provide that
should not be treated as failing to Business Day’’ Rule placing part of the stock issued or
provide for fixed consideration solely The proposed regulations require that, money paid into escrow to secure
because it provides for contingent if the signing date rule applies, the customary target representations and
consideration that can only increase the consideration to be tendered in respect warranties will not prevent the
proportion of issuing corporation stock of the target corporation shares consideration in a contract from being
to cash to be exchanged for target surrendered be valued as of the end of fixed. One comment suggested that this
corporation shares. Where stock of the the last business day before the first date rule should be expanded to include

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Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 54633

consideration placed in escrow to 3. Rev. Proc. 84–42 is not amended at issuing corporation to be received by the
secure target’s performance of this time. target shareholders. The IRS and
customary pre-closing covenants (rather Treasury Department agree that, because
F. Anti-Dilution Provisions
than representations and warranties). such a modification only enhances the
That commentator stated that there is no One comment suggested that preservation of the target corporation’s
reason to distinguish between consideration in a contract should not shareholders’ proprietary interests, it is
customary pre-closing covenants, on the be treated as fixed unless the contract not appropriate to value the
one hand, and customary includes a customary anti-dilution consideration to be provided to the
representations and warranties, on the provision. The commentator posited an target corporation shareholders as of the
other hand. The IRS and Treasury example in which the absence of an day before the date of the modification
Department agree. Accordingly, these anti-dilution clause and the occurrence rather than as of the day before the date
final regulations extend the rule related of a stock split with respect to the stock of the original contract, at least in cases
to escrows to include consideration of the issuing corporation prior to the in which the transaction would have
placed in escrow to secure target’s effective date of a potential satisfied the COI requirement under the
performance of customary pre-closing reorganization results in the value of the signing date rule if there had been no
covenants. consideration received in respect of the modification. Therefore, these final
target corporation shares being regulations provide that a modification
2. Effect of Escrowed Consideration on substantially different from its value on that has the sole effect of providing for
Satisfaction of COI the day before the first date there is a the issuance of additional shares of
Some commentators have indicated binding contract. issuing corporation stock to the target
that certain examples in the proposed The IRS and Treasury Department do corporation shareholders will not be
regulations suggest that escrowed stock, not believe that the absence of a treated as a modification if the
even if it is forfeited to the issuing customary anti-dilution provision execution of the potential reorganization
corporation, is treated as preserving the should necessarily preclude the would have resulted in the preservation
target shareholders’ proprietary interests application of the signing date rule as of a substantial part of the value of the
in the target corporation. The IRS and dilution may not, in fact, occur. target corporation shareholders’
Treasury Department believe that However, the IRS and Treasury proprietary interest in the target
escrowed consideration that is forfeited Department are concerned that corporation if there had been no
should not be taken into account in application of the signing date rule is modification. In such cases, the
determining whether the COI not appropriate if the contract does not determination of whether a proprietary
requirement is satisfied. This contain an anti-dilution clause relating interest in the target corporation has
conclusion reflects the view that the to the stock of the issuing corporation been preserved is made by reference to
forfeiture of escrowed consideration is and the issuing corporation alters its the value of the consideration as of the
in substance a purchase price capital structure between the first date last business day before the first date the
adjustment. Accordingly, the examples there is an otherwise binding contract to contract was binding, not the last
in these final regulations reflect that effect the potential reorganization and business day before the modification.
forfeited stock is not treated as the effective date of the potential The IRS and Treasury Department
preserving the target corporation reorganization in a manner that continue to consider whether this
shareholders’ proprietary interests in materially alters the economic exception should be extended to certain
the target corporation and forfeited non- arrangement of the parties to the cases in which the modification results
stock consideration is not treated as binding contract. Accordingly, these in not only additional shares of the
counting against the preservation of the final regulations provide that, in such issuing corporation to be issued to target
target corporation’s shareholders’ cases, the consideration will not be corporation shareholders, but also
proprietary interest in the target treated as fixed. additional money or other property to
corporation. The IRS and Treasury be transferred to target corporation
Department continue to consider the G. Contract Modifications
shareholders.
effect on COI of escrowed consideration The proposed regulations require that
and contingent consideration. if a term of a binding contract that H. Application of Principle Illustrated
relates to the amount or type of by Examples
3. Revenue Procedure 84–42 consideration the target shareholders One commentator asked whether the
One commentator requested will receive in a potential reorganization principle that the COI requirement is
clarification regarding the impact of the is modified before the closing date of satisfied where 40 percent of the target
proposed regulations on Revenue the potential reorganization, and the corporation stock is exchanged for stock
Procedure 84–42 (1984–1 C.B. 521). Rev. contract as modified is a binding in the issuing corporation that is
Proc. 84–42 includes certain operating contract, then the date of the illustrated in the examples of the
rules of the IRS regarding the issuance modification shall be treated as the first proposed regulations (which relate to
of letter rulings, including the date there is a binding contract. Thus, the application of the signing date rule)
circumstances in which the placing of such a modification requires that the also applies in cases in which the
stock in escrow will not prevent the IRS stock of the issuing corporation be signing date rule does not apply. The
from issuing a private letter ruling. The valued as of the end of the last business IRS and Treasury Department believe
IRS and Treasury Department continue day before the date of the modification that this principle is equally applicable
to review the existing revenue in order to determine whether the to cases in which the signing date rule
procedures relating to reorganizations in transaction satisfies the COI does not apply as it is to cases in which
light of the numerous regulatory requirement. the signing date rule does apply.
changes since the publication of these One commentator suggested that a
procedures and the policy against contract should not be treated as being I. Restricted Stock
issuing rulings in the reorganization modified for this purpose if the The IRS and Treasury Department are
area unless there is a significant issue, modification has the sole effect of continuing to consider the appropriate
which is reflected in Rev. Proc. 2005– increasing the number of shares of the treatment of restricted stock in the

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54634 Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations

determination of whether the COI language ‘‘(e)(4)’’ wherever it appears, corporation pursuant to a contract to
requirement is satisfied. and add the language ‘‘(e)(5)’’ in its effect the potential reorganization shall
place. be valued on the last business day
Special Analyses
■ 6. In newly designated paragraphs before the first date such contract is a
It has been determined that this (e)(3) through (e)(8), remove the binding contract, if such contract
Treasury decision is not a significant language ‘‘(e)(3)’’ wherever it appears, provides for fixed consideration.
regulatory action as defined in and add the language ‘‘(e)(4)’’ in its (ii) Binding contract—(A) In general.
Executive Order 12866. Therefore, a place. A binding contract is an instrument
regulatory assessment is not required. It ■ 7. In newly designated paragraphs enforceable under applicable law
also has been determined that section (e)(3) through (e)(8), remove the against the parties to the instrument.
553(b) of the Administrative Procedure language ‘‘(e)(2)’’ wherever it appears, The presence of a condition outside the
Act (5 U.S.C. chapter 5) does not apply and add the language ‘‘(e)(3)’’ in its control of the parties (including, for
to these regulations and, because these place. example, regulatory agency approval)
regulations do not impose a collection ■ 8. In newly designated paragraph shall not prevent an instrument from
of information on small entities, the (e)(4)(ii)(B), remove the language being a binding contract. Further, the
Regulatory Flexibility Act (5 U.S.C. ‘‘(e)(3)(i)(A)’’ wherever it appears, and fact that insubstantial terms remain to
chapter 6) does not apply. Therefore, a add the language ‘‘(e)(4)(i)(A)’’ in its be negotiated by the parties to the
Regulatory Flexibility Analysis is not place. contract, or that customary conditions
required. Pursuant to section 7805(f) of ■ 9. In newly designated paragraph remain to be satisfied, shall not prevent
the Code, the proposed regulations (e)(7), Example 1, remove the language an instrument from being a binding
preceding these regulations were ‘‘(e)(1) and (2)’’ whenever it appears, contract.
submitted to the Chief Counsel for and add the language ‘‘(e)(1) and (3)’’ in (B) Modifications—(1) In general. If a
Advocacy of the Small Business its place. term of a binding contract that relates to
Administration for comment on their ■ 10. In newly designated paragraph the amount or type of the consideration
impact on small business. (e)(7), Example 2, make the following the target shareholders will receive in a
revisions: potential reorganization is modified
Drafting Information
■ A. Remove the language ‘‘(e)(3)(i)(B)’’ before the closing date of the potential
The principal author of these wherever it appears, and add the reorganization, and the contract as
regulations is Christopher M. Bass of the language (e)(4)(i)(B)’’ in its place. modified is a binding contract, the date
Office of the Associate Chief Counsel ■ B. Remove the language ‘‘(e)(3)(i)(A) of the modification shall be treated as
(Corporate). However, other personnel and (ii)(B)’’ wherever it appears, and the first date there is a binding contract.
from the IRS and Treasury Department add the language ‘‘(e)(4)(i)(A) and (2) Exception. Notwithstanding
participated in their development. (ii)(B)’’ in its place. paragraph (e)(2)(ii)(B)(1) of this section,
List of Subjects in 26 CFR Part 1 ■ 11. In newly designated paragraph a modification of a term that relates to
(e)(7), Example 3, where the language the amount or type of consideration the
Income taxes, Reporting and target shareholders will receive in a
recordkeeping requirements. ‘‘(e)(1) and (2)’’ wherever it appears, and
add the language ‘‘(e)(1) and (3)’’ in its potential reorganization will not be
Adoption of Amendments to the place. treated as a modification for purposes of
Regulations ■ 12. In newly designated paragraph that provision if—
(e)(7), Example 4, paragraph (iii), (i) That modification has the sole
■Accordingly, 26 CFR part 1 is effect of providing for the issuance of
amended as follows: remove the language ‘‘(e)(3)(i)(A) and
(B)’’ wherever it appears, and add the additional shares of issuing corporation
language ‘‘(e)(4)(i)(A) and (B)’’ in its stock to the target corporation
PART 1—INCOME TAXES
place. shareholders; and
■ Paragraph 1. The authority citation ■ 13. In newly designated paragraph
(ii) The execution of the potential
for part 1 continues to read, in part, as (e)(7), Example 6, remove the language reorganization would have resulted in
follows: ‘‘(e)(3)(i)(A) and (B)’’ wherever it the preservation of a substantial part of
Authority: 26 U.S.C. 7805 * * * appears, and add the language the value of the target corporation
‘‘(e)(4)(i)(A) and (B)’’ in its place. shareholders’ proprietary interest in the
■ Par. 2. Section 1.368–1 is amended as
■ 14. In newly designated paragraph target corporation if there had been no
follows:
■ 1. Paragraph (e)(1)(i) is amended as (e)(7), Example 8, remove the language modification.
‘‘(e)(3)(i)(A)’’ wherever it appears, and (C) Tender offers. For purposes of this
follows:
■ A. Removing the language ‘‘(e)(3)’’ add the language ‘‘(e)(4)(i)(A)’’ in its paragraph (e)(2), a tender offer that is
and adding in its place ‘‘(e)(4)’’ place. subject to section 14(d) of the Securities
wherever it appears. ■ 15. Revising newly designated
and Exchange Act of 1934 [15 U.S.C.
■ B. Removing the language paragraph (e)(8). 78n(d)(1)] and Regulation 14D (17 CFR
‘‘(e)(3)(i)(A)’’ and adding ‘‘(e)(4)(i)(A)’’ The addition and revision read as 240.14d–1 through 240.14d–101) and is
in its place. follows: not pursuant to a binding contract, is
■ 2. Redesignating paragraphs (e)(2) treated as a binding contract made on
through (e)(7) as (e)(3) through (e)(8), § 1.368–1 Purpose and scope of exception the date of its announcement,
respectively. of reorganization exchanges. notwithstanding that it may be modified
■ 3. Adding a new paragraph (e)(2). * * * * * by the offeror or that it is not
■ 4. In newly designated paragraphs (e) * * * enforceable against the offerees. If a
(e)(3) through (e)(8), remove the (2) Measuring continuity of interest— modification (not pursuant to a binding
language ‘‘(e)(6)’’ wherever it appears, (i) In general. In determining whether a contract) of such a tender offer is subject
and add the language ‘‘(e)(7)’’ in its proprietary interest in the target to the provisions of Regulation 14d–6(c)
place. corporation is preserved, the (17 CFR 240.14d–6(c)) and relates to the
■ 5. In newly designated paragraphs consideration to be exchanged for the amount or type of the consideration
(e)(3) through (e)(8), remove the proprietary interests in the target received in the tender offer, then the

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Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 54635

date of the modification shall be treated the proprietary interests in the target a provision that provides for contingent
as the first date there is a binding corporation; or consideration, if—
contract. (ii) The minimum percentage of the (i) The contingent consideration
(iii) Fixed consideration—(A) In number of shares of each class of consists solely of stock of the issuing
general. A contract provides for fixed proprietary interests in the target corporation; and
consideration if it provides— corporation, or the minimum percentage (ii) The execution of the potential
(1) The number of shares of each class (by value) of the proprietary interests in reorganization would have resulted in
of stock of the issuing corporation, the the target corporation, to be exchanged the preservation of a substantial part of
amount of money, and the other for stock of the issuing corporation, the value of the target corporation
property (identified either by value or provided that the proprietary interests shareholders’ proprietary interests in
by specific description), if any, to be in the target corporation to be the target corporation if none of the
exchanged for all of the proprietary exchanged for stock of the issuing contingent consideration were delivered
interests in the target corporation; corporation and the proprietary interests to the target corporation shareholders.
(2) The number of shares of each class in the target corporation to be (2) Exception for escrows. For
of stock of the issuing corporation, the exchanged for consideration other than purposes of paragraph (e)(2)(iii)(C)(1) of
stock of the issuing corporation each this section, contingent consideration
amount of money, and the other
represents an economically reasonable does not include consideration paid in
property (identified either by value or
exchange as of the last business day escrow to secure target’s performance of
by specific description), if any, to be
before the first date there is a binding customary pre-closing covenants or
exchanged for each proprietary interest
contract to effect the potential customary target representations and
in the target corporation;
reorganization. warranties.
(3) The percentage of the number of (D) Escrows. Placing part of the
(2) Special rules. (i) In the case of a
shares of each class of proprietary consideration to be exchanged for
shareholder election described in
interests in the target corporation, or the proprietary interests in the target
paragraph (e)(2)(iii)(B)(1)(i) of this
percentage (by value) of the proprietary corporation in escrow to secure target’s
section, the determination of whether a
interests in the target corporation, to be performance of customary pre-closing
proprietary interest in the target
exchanged for stock of the issuing covenants or customary target
corporation is preserved shall be made
corporation, provided that the representations and warranties will not
by assuming the issuance by the issuing
proprietary interests in the target prevent a contract from being treated as
corporation of the minimum number of
corporation to be exchanged for stock of shares of each class of stock of the providing for fixed consideration.
the issuing corporation and the issuing corporation and the maximum (E) Anti-dilution clauses. The
proprietary interests in the target amount of money and other property presence of a customary anti-dilution
corporation to be exchanged for allowable under the contract and clause will not prevent a contract from
consideration other than stock of the without regard to the number of shares being treated as providing for fixed
issuing corporation each represents an of each class of stock of the issuing consideration. However, the absence of
economically reasonable exchange as of corporation and the amount of money such a clause will prevent a contract
the last business day before the first date and other property actually exchanged from being treated as providing for fixed
there is a binding contract to effect the thereafter for proprietary interests in the consideration if the issuing corporation
potential reorganization; or target corporation. alters its capital structure between the
(4) The percentage of each proprietary (ii) In the case of a shareholder first date there is an otherwise binding
interest in the target corporation to be election described in paragraph contract to effect the potential
exchanged for stock of the issuing (e)(2)(iii)(B)(1)(ii) of this section, the reorganization and the effective date of
corporation, provided that the portion of determination of whether a proprietary the potential reorganization in a manner
each proprietary interest in the target interest in the target corporation is that materially alters the economic
corporation to be exchanged for stock of preserved shall be made by assuming arrangement of the parties to the
the issuing corporation and the portion the issuance of issuing corporation stock binding contract.
of each proprietary interest in the target in exchange for the minimum (F) Dissenters’ rights. The possibility
corporation to be exchanged for percentage of the number of shares of that some shareholders may exercise
consideration other than stock of the each class of proprietary interests in the dissenters’ rights and receive
issuing corporation each represents an target corporation, or the minimum consideration other than that provided
economically reasonable exchange as of percentage (by value) of proprietary for in the binding contract will not
the last business day before the first date interests in the target corporation, as the prevent the contract from being treated
there is a binding contract to effect the case may be, to be exchanged for stock as providing for fixed consideration.
potential reorganization. of the issuing corporation allowable (G) Fractional shares. The fact that
(B) Shareholder elections—(1) In under the contract and without regard to money may be paid in lieu of issuing
general. A contract that is not described the percentage of the number of shares fractional shares will not prevent a
in paragraph (e)(2)(iii)(A) of this section of each class of proprietary interests in contract from being treated as providing
and pursuant to which a target the target corporation, or the percentage for fixed consideration.
corporation shareholder has an election (by value) of proprietary interests in the (iv) Valuation of new issuances. For
to receive stock and/or money and other target corporation, actually exchanged purposes of applying paragraph (e)(2)(i)
property in respect of target corporation for stock of the issuing corporation. of this section, any class of stock,
stock is treated as providing for fixed (C) Contingent consideration—(1) In securities, or indebtedness that the
consideration if the contract provides— general. In general, the fact that a issuing corporation issues to the target
(i) The minimum number of shares of contract provides for contingent corporation shareholders pursuant to
each class of stock of the issuing consideration will prevent a contract the potential reorganization and that
corporation and the maximum amount from being treated as providing for fixed does not exist before the first date there
of money and other property (identified consideration. However, a contract will is a binding contract to effect the
either by value or by specific not fail to be treated as providing for potential reorganization is deemed to
description) to be exchanged for all of fixed consideration solely as a result of have been issued on the last business

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54636 Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations

day before the first date there is a provides for the number of shares of P and P stock on March 31 of Year 1. Because, for
binding contract to effect the potential the amount of money to be exchanged for all continuity of interest purposes, the T stock
reorganization. of the proprietary interests in T, under is exchanged for $25 of P stock and $75 of
(v) Examples. For purposes of the paragraph (e)(2) of this section, there is a cash, the transaction does not preserve a
binding contract providing for fixed substantial part of the value of the
examples in this paragraph (e)(2)(v), P is consideration as of January 3 of Year 1. proprietary interest in T. Therefore, the
the issuing corporation, T is the target Therefore, whether the transaction satisfies transaction does not satisfy the continuity of
corporation, S is a wholly owned the continuity of interest requirement is interest requirement.
subsidiary of P, all corporations have determined by reference to the value of the Example 5. Modification of binding
only one class of stock outstanding, A P stock on January 2 of Year 1. Because, for contract disregarded—continuity preserved.
is an individual, no transactions other continuity of interest purposes, the T stock The facts are the same as in Example 4
than those described occur, and the is exchanged for $32 of P stock and $48 of except that, pursuant to the modified
transactions are not otherwise subject to cash, the transaction preserves a substantial contract, which is a binding contract, the T
part of the value of the proprietary interest shareholders will receive 60 P shares (an
recharacterization. The following in T. Therefore, the transaction satisfies the additional 20 shares as compared to the
examples illustrate the application of continuity of interest requirement. original contract) and $60 of cash in
this paragraph (e)(2): Example 3. Redemption of stock received exchange for all of the outstanding T stock.
Example 1. Application of signing date pursuant to binding contract. The facts are In addition, on March 31 of Year 1, the value
rule. On January 3 of Year 1, P and T sign the same as in Example 1 except that A owns of the P stock is $.40 per share. Under
a binding contract pursuant to which T will 50 percent of the outstanding stock of T paragraph (e)(2) of this section, although
be merged with and into P on June 1 of Year immediately prior to the merger and receives there was a binding contract providing for
1. Pursuant to the contract, the T 10 P shares and $30 in the merger and an fixed consideration as of January 3 of Year 1,
shareholders will receive 40 P shares and $60 additional 10 P shares upon the release of the terms of that contract relating to the
of cash in exchange for all of the outstanding stock placed in escrow. In connection with consideration to be provided to the target
stock of T. Twenty of the P shares, however, the merger, A and S agree that, immediately shareholders were modified on April 1 of
will be placed in escrow to secure customary after the merger, S will purchase any P shares Year 1. Nonetheless, the modification has the
target representations and warranties. The P that A acquires in the merger for $1 per sole effect of providing for the issuance of
stock is listed on an established market. On share. Shortly after the merger, S purchases additional P shares to the T shareholders. In
January 2 of Year 1, the value of the P stock A’s P shares for $20. Because the contract addition, the execution of the terms of the
is $1 per share. On June 1 of Year 1, T merges provides for the number of shares of P and contract without regard to the modification
with and into P pursuant to the terms of the the amount of money to be exchanged for all would have resulted in the preservation of a
contract. On that date, the value of the P of the proprietary interests in T, under substantial part of the value of the T
stock is $.25 per share. None of the stock paragraph (e)(2) of this section, there is a shareholders’ proprietary interest in T
placed in escrow is returned to P. Because binding contract providing for fixed because, for continuity of interest purposes,
the contract provides for the number of consideration as of January 3 of Year 1. the T stock would have been exchanged for
shares of P and the amount of money to be Therefore, whether the transaction satisfies $40 of P stock and $60 of cash. Therefore, the
exchanged for all of the proprietary interests the continuity of interest requirement is modification is not treated as a modification
in T, under paragraph (e)(2) of this section, determined by reference to the value of the under paragraph (e)(2) of this section.
there is a binding contract providing for fixed P stock on January 2 of Year 1. In addition, Accordingly, whether the transaction
consideration as of January 3 of Year 1. S is a person related to P under paragraph satisfies the continuity of interest
Therefore, whether the transaction satisfies (e)(4)(i)(A) of this section. Accordingly, A is requirement is determined by reference to the
the continuity of interest requirement is treated as exchanging his T shares for $50. value of the P stock on January 2 of Year 1.
determined by reference to the value of the Because, for continuity of interest purposes, Despite the modification, the transaction
P stock on January 2 of Year 1. Because, for the T stock is exchanged for $20 of P stock continues to satisfy the continuity of interest
continuity of interest purposes, the T stock and $80 of cash, the transaction does not requirement.
is exchanged for $40 of P stock and $60 of preserve a substantial part of the value of the Example 6. New issuance. The facts are the
cash, the transaction preserves a substantial proprietary interest in T. Therefore, the same as in Example 1, except that, in lieu of
part of the value of the proprietary interest transaction does not satisfy the continuity of the $60 of cash, the T shareholders will
in T. Therefore, the transaction satisfies the interest requirement. receive a new class of P securities that will
continuity of interest requirement. Example 4. Modification of binding be publicly traded. In the aggregate, the
Example 2. Treatment of forfeited contract—continuity not preserved. The facts securities will have a stated principal amount
escrowed stock. (i) The facts are the same as are the same as in Example 1 except that on of $60 and bear interest at the average LIBOR
in Example 1 except that T’s breach of a April 1 of Year 1, the parties modify their (London Interbank Offered Rates) during the
representation results in the escrowed contract. Pursuant to the modified contract, 10 days prior to the potential reorganization.
consideration being returned to P. Because which is a binding contract, the T If the T shareholders had been issued the P
the contract provides for the number of shareholders will receive 50 P shares (an securities on January 2 of Year 1, the P
shares of P and the amount of money to be additional 10 shares) and $75 of cash (an securities would have had a value of $60
exchanged for all of the proprietary interests additional $15 of cash) in exchange for all of (determined by reference to the value of
in T, under paragraph (e)(2) of this section, the outstanding T stock. On March 31 of Year comparable publicly traded securities).
there is a binding contract providing for fixed 1, the value of the P stock is $.50 per share. Whether the transaction satisfies the
consideration as of January 3 of Year 1. Under paragraph (e)(2) of this section, continuity of interest requirement is
Therefore, whether the transaction satisfies although there was a binding contract determined by reference to the value of the
the continuity of interest requirement is providing for fixed consideration as of P stock and the P securities to be issued to
determined by reference to the value of the January 3 of Year 1, terms of that contract the T shareholders on January 2 of Year 1.
P stock on January 2 of Year 1. Because, for relating to the consideration to be provided Under paragraph (e)(2)(iv) of this section, for
continuity of interest purposes, the T stock to the target shareholders were modified on purposes of valuing the new P securities,
is exchanged for $20 of P stock and $60 of April 1 of Year 1. Because the modified they will be treated as having been issued on
cash, the transaction does not preserve a contract provides for the number of P shares January 2 of Year 1. Because, for continuity
substantial part of the value of the and the amount of money to be exchanged for of interest purposes, the T stock is exchanged
proprietary interest in T. Therefore, the all of the proprietary interests in T, under for $40 of P stock and $60 of other property,
transaction does not satisfy the continuity of paragraph (e)(2) of this section, the modified the transaction preserves a substantial part of
interest requirement. contract is a binding contract providing for the value of the proprietary interest in T.
(ii) The facts are the same as in Example fixed consideration as of April 1 of Year 1. Therefore, the transaction satisfies the
2 (i) except that the consideration placed in Therefore, whether the transaction satisfies continuity of interest requirement.
escrow consists solely of eight of the P shares the continuity of interest requirement is Example 7. Economically unreasonable
and $12 of the cash. Because the contract determined by reference to the value of the exchange. On January 3 of Year 1, P and T

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Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 54637

sign a binding contract pursuant to which T P and the other requirements of paragraph DEPARTMENT OF HOMELAND
will be merged with and into P on June 2 of (e)(2)(iii)(A)(3) of this section are satisfied, SECURITY
Year 1. At that time, A is T’s sole there is a binding contract providing for fixed
shareholder. Pursuant to the contract, 60 consideration as of January 3 of Year 1. Coast Guard
percent of the T stock will be exchanged for Therefore, whether the transaction satisfies
$80 of cash and 40 percent of the T stock will
the continuity of interest requirement is 33 CFR Part 117
be exchanged for 20 shares of P stock. As of
January 2, 20 shares of P stock have a value determined by reference to the value of the
[CGD05–05–112]
of $20, representing only 20 percent of the P stock on January 2 of Year 1. Because, for
value of the total consideration to be received continuity of interest purposes, the T stock RIN 1625–AA–09
by the T shareholders. Because the is exchanged for $50 of P stock and $50 of
percentage of proprietary interests in the cash, the transaction preserves a substantial Drawbridge Operation Regulations;
target corporation to be exchanged for stock part of the value of the proprietary interest James River, VA
of the issuing corporation and the proprietary in T. Therefore, the transaction satisfies the
interests in the target corporation to be AGENCY: Coast Guard, DHS.
continuity of interest requirement.
exchanged for money do not each represent ACTION: Notice of temporary deviation
an economically reasonable exchange as of * * * * * from regulations.
the last business day before the first date (8) Effective date. Paragraphs (e)(1)
there is a binding contract to effect the SUMMARY: The Commander, Fifth Coast
and (e)(3) through (e)(7) of this section
potential reorganization, under paragraph Guard District, has approved a
(e)(2)(iii)(A)(3) of this section, the contract is apply to transactions occurring after temporary deviation from the
not treated as a binding contract that January 28, 1998, except that they do regulations governing the operation of
provides for fixed consideration. not apply to any transaction occurring the James River Bridge, mile 5.0, across
Example 8. Absence of anti-dilution pursuant to a written agreement which the James River between Isle of Wight
clause. On January 3 of Year 1, P and T sign is binding on January 28, 1998, and at and Newport News, Virginia. This
a binding contract pursuant to which T will all times thereafter. Paragraph (e)(1)(ii)
be merged with and into P on June 1 of Year
deviation allows the drawbridge to
1. Pursuant to the contract, the T
of this section, however, applies to remain closed-to-navigation on two 3-
shareholders will receive 40 P shares and $60 transactions occurring after August 30, day closure periods from 7 a.m. on
of cash in exchange for all of the outstanding 2000, unless the transaction occurs October 14 through 5 p.m. October 17,
stock of T. The contract does not contain a pursuant to a written agreement that is 2005, and from 7 a.m. on November 18
customary anti-dilution provision. The P (subject to customary conditions) through 5 p.m. November 21, 2005, to
stock is listed on an established market. On binding on that date and at all times facilitate mechanical repairs.
January 2 of Year 1, the value of the P stock
thereafter. Taxpayers who entered into a DATES: This deviation is effective from
is $1 per share. On April 10 of Year 1, P
issues its stock to effect a stock split; each binding agreement on or after January 7 a.m. on October 14, 2005, until 5 p.m.
shareholder of P receives an additional share 28, 1998, and before August 30, 2000, on November 21, 2005.
of P for each P share that it holds. On April may request a private letter ruling ADDRESSES: Materials referred to in this
11 of Year 1, the value of the P stock is $.50 permitting them to apply the final document are available for inspection or
per share. Because P altered its capital regulation to their transaction. A private copying at Commander (obr), Fifth Coast
structure between January 3 and June 1 of letter ruling will not be issued unless Guard District, Federal Building, 1st
Year 1 in a manner that materially alters the Floor, 431 Crawford Street, Portsmouth,
economic arrangement of the parties, under
the taxpayer establishes to the
satisfaction of the IRS that there is not VA 23704–5004 between 8 a.m. and 4
paragraph (e)(2)(iii)(E) of this section, the
contract is not treated as a binding contract a significant risk of different parties to p.m., Monday through Friday, except
that provides for fixed consideration. the transaction taking inconsistent Federal holidays. The telephone number
Example 9. Shareholder election with a positions, for Federal tax purposes, with is (757) 398–6222. Commander (obr),
proration mechanism. On January 3 of Year respect to the applicability of the final Fifth Coast Guard District maintains the
1, P and T sign a binding contract pursuant
regulations to the transaction. Paragraph public docket for this temporary
to which T will be merged with and into P deviation.
on June 1 of Year 1. Pursuant to the contract, (e)(2) of this section applies to
at the shareholders’ election, each share of T transactions occurring pursuant to FOR FURTHER INFORMATION CONTACT: Bill
will be exchanged for cash of $1 or, binding contracts entered into after H. Brazier, Bridge Management
alternatively, P stock that has a value of $1, September 16, 2005. Specialist, Fifth Coast Guard District, at
if the value of each share of P stock is at least (757) 398–6422.
$.80 and no more than $1.20 on the effective Mark E. Matthews, SUPPLEMENTARY INFORMATION: The James
date of the potential reorganization; 1.25 Deputy Commissioner for Services and River Bridge, a vertical-lift drawbridge,
shares of P stock, if the value of each share Enforcement. has a vertical clearance in the closed
of P stock is less than $.80 on the effective
date of the potential reorganization; or .83
Approved: September 6, 2005. position to vessels of 60 feet and 145
shares of P stock, if the value of each share Eric Solomon, feet in the full open position, at mean
of P stock is more than $1.20 on the effective Acting Deputy Assistant Secretary of the high water.
date of the potential reorganization. In Treasury (Tax Policy). Electrical Motor Services Industrial,
addition, the contract provides for a Inc. (EMS), is the contractor engaged to
[FR Doc. 05–18263 Filed 9–15–05; 8:45 am]
proration mechanism to ensure that 50 perform these repairs for the Virginia
percent of the T shares will be exchanged for BILLING CODE 4830–01–P
Department of Transportation (VDOT),
cash and 50 percent of the T shares will be the bridge owner. EMS, on behalf of
exchanged for P stock. On January 2 of Year VDOT, requested a temporary deviation
1, T has 100 shares outstanding. The P stock from the operating regulations for the
is listed on an established market. On
January 2 of Year 1, the value of the P stock
James River Bridge, set out in 33 CFR
is $1 per share. Because the contract provides 117.5, that requires the bridge to open
for the percentage of the number of shares of promptly and fully for the passage of
each class of proprietary interests in T, and vessels when a request to open is given.
the percentage (by value) of the proprietary EMS requested the temporary
interests in T, to be exchanged for stock of deviation to close the James River

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