On July 1, 2015, the new Pennsylvania Entity Transaction Law (the “Act”) becomes effective. Among its innovations, the Act significantly expands the ability of entities – including corporations, limited liability companies, and partnerships organized in Pennsylvania and certain other states – to engage in statutory equity interest exchanges.
The Act provides that a Pennsylvania or foreign entity may acquire all of one or more classes or series of equity interests of a Pennsylvania entity in exchange for equity interests, securities, obligations, money, other property, or rights to acquires equity interests or securities or any combination of the foregoing, and that a Pennsylvania entity may do the same with respect to a foreign entity (if the foreign entity is chartered in a state that permits equity interest exchanges.
An interest exchange allows an acquiring entity to acquire one or more classes or series of interests of another entity and, provided that a plan of interest exchange is approved in accordance with the Act, does not require that all of the equity holders personally agree to sell their interests. It therefore provides a statutory mechanism for forcing the sale of equity interests in a target company even when some of the owners do not want to sell, thereby avoiding the “hold out” problem in connection with equity sales.
Previously, a triangular merger was required in order to force the transfer of all equity interests despite the existence of equity holders who did not want to sell. In a triangular merger, an acquiring entity formed a new subsidiary, and the acquired entity merged into the new subsidiary or the new subsidiary merged into the acquired entity. In comparison with a statutory interest exchange, such mergers, however, require the additional step of capitalizing and forming the merger subsidiary. Equity interest exchanges thus function as a more efficient alternative to triangular mergers, saving time and money while still squeezing out resistant equity holders.
Assume, for example, that a Texas limited liability company desires to acquire a Pennsylvania corporation in which not all of the shareholders want to sell their shares but (b) there is sufficient shareholder support (a simple majority) for the transaction to approve an equity interest exchange. The Texas limited liability company could acquire all of the common stock of the Pennsylvania corporation, despite its recalcitrant shareholders, in exchange for cash pursuant to a statutory exchange and thereby make the Pennsylvania corporation its wholly-owned subsidiary. Previously, to achieve the same result, the Texas limited liability company would have had to form a subsidiary and either merge into the Pennsylvania limited liability company or have the Pennsylvania limited liability company merged into it.
The Act provides an additional feature enhancing the flexibility of equity interest exchanges. Except for distinctions based upon race, sex, religion, and other “manifestly unreasonable” categories, the Act generally permits the payment or provision of different types of consideration to equity interest holders holding the same series or class of equity interests. For example, if the Pennsylvania corporation in the example described above had one class of common stock, non-management shareholders could receive cash for their common stock whereas management shareholders could receive membership interests in the Texas limited liability company in order to align their interests with the interests of the acquirer after the consummation of the transaction.
Allyson Matvey, a summer law clerk, assisted in the preparation of this article.