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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

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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.

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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.

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—High risk operations—Low risk operations—IP assets—Owned real estate

Shareholders

Company

Simple Company Structure Simple Company Structure

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Common Firewall StructureCommon Firewall Structure

Shareholders

HoldCo

OpCo. #1 OpCo. #2 IPCo.Real Estate

Co.

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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).

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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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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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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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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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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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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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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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Subsidiaries vs. Sister Companies Subsidiaries vs. Sister Companies

• Consolidated tax election?• Combined filing?

Tax Filing Considerations:

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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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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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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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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.

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Thank You

Garth StevensSnell & Wilmer

602-382-6313gstevens@swlaw.com

Joshua P. HayesEide Bailly

602.264.8663 jhayes@eidebailly.com