Teledyne to Acquire FLIR in Tax-Free Reorganization

By Stuart E. Leblang, Michael J. Kliegman,  and Amy S. Elliott

On January 4, diversified manufacturer of digital imaging equipment Teledyne Technologies Incorporated (NYSE:  TDY) (Teledyne) and thermal imaging equipment developer and manufacturer FLIR Systems, Inc. (NASDAQ:  FLIR) (FLIR) announced that they had entered into an agreement pursuant to which Teledyne will acquire 100 percent of FLIR in exchange for per- share consideration of $28 in cash and 0.0718 shares of Teledyne common stock. ¹ 

Based on Teledyne’s 5-day volume weighted average price as of the December 31 trading day close, the per-share value of the stock consideration is $28, or half of the implied $56 per-share total purchase price. ² Based on FLIR’s public float of approximately 131 million shares of common stock (its sole class of stock), ³ the transaction values FLIR at $7.3 billion.

The transaction, which is expected to close in the middle of 2021, will be effected by two statutory mergers.  To facilitate the mergers, Teledyne will form both a direct wholly owned corporate subsidiary (Merger Sub I) and a direct wholly owned Delaware limited liability company (Merger Sub II). ⁴ 

In the first merger, Merger Sub I will merge with and into FLIR, with FLIR surviving as a wholly owned subsidiary of Teledyne.  Immediately following the first merger, FLIR will merge with and into Merger Sub II, with Merger Sub II surviving as a wholly owned subsidiary of Teledyne.  The first merger, a reverse subsidiary merger, will effect Teledyne’s direct acquisition of FLIR and will cause the FLIR shares held by the current FLIR shareholders to be converted into the right to receive the merger consideration. ⁵ 

While a reverse subsidiary merger is a common form used in many transactions that qualify as tax-free reorganizations, a reverse subsidiary merger will not so qualify unless the former shareholders of the target corporation exchange an amount of target stock constituting control (as defined for tax purposes) solely in exchange for voting stock of the acquiring corporation. ⁶ As the merger consideration is described above, the current FLIR shareholders will not exchange control of FLIR solely for Teledyne voting stock.  As a result, the first merger, alone, would not qualify as a tax-free reorganization.

The second merger—of FLIR with and into Merger Sub II pursuant to an integrated plan that includes the first merger—should allow the two mergers together to qualify as a single forward merger.  The combined effect of the two mergers will be as if there had been a single transaction treated for U.S. tax purposes as a forward merger of FLIR into Merger Sub II in exchange for the merger consideration. ⁷ 

As an LLC with a single member (Teledyne), Merger Sub II could be treated for U.S. tax purposes as either a disregarded entity (the default status) or, if a tax election is made, a regarded corporation.  The Merger Agreement does not directly address the status of Merger Sub II as regarded or disregarded for tax purposes.  However, the Merger Agreement indicates that the intended tax treatment of the transaction is that FLIR will be treated as merging directly with and into Teledyne, making clear that Merger Sub II will have the default status of disregarded entity. ⁸ We note that, if Teledyne were to cause Merger Sub II to elect to be treated as a corporation, the transaction would be treated as a forward triangular merger and thereby qualify as a reorganization. ⁹ 

The parties to the transaction have covenanted to not take any actions that would prevent the transaction from qualifying as a reorganization. ¹⁰ Further, the transaction is subject to a closing condition that requires receipt of an opinion of tax counsel that the transaction will qualify for tax-free reorganization treatment. ¹¹ Interestingly, there is a provision in the agreement stating that if there were to be a determination ¹² that the two mergers together did not qualify as a reorganization, then the parties agree to instead take the position that the first merger— standing alone—was a “qualified stock purchase within the meaning of Section 338 of the Code and [the second merger] qualified as a liquidation described in Section 332 of the Code. ¹³ This is based on a principle well accepted by the IRS that although back-to-back mergers such as these are integrated if the result would qualify as a reorganization, they will be regarded separately if the result of integration would be disqualification from reorganization treatment.  As such, the first merger would be treated as a taxable stock sale to the FLIR shareholders, but neither merger would result in corporate-level tax. ¹⁴ We see no reason why the transaction should not qualify as a reorganization and think that the lawyers inserted this provision only out of an abundance of caution.

Although the forward merger provisions do not prescribe any minimum amount of stock, such a reorganization must also satisfy the requirement that continuity of shareholder interest be maintained.  Generally, as long as the qualifying stock consideration in the transaction is at least 40 percent of the total consideration, this requirement should be satisfied.  As noted above, approximately 50 percent of the consideration will be Teledyne stock, so the combined mergers should qualify comfortably satisfy the requirement. ¹⁵ 

Although the mergers should qualify as a tax-free reorganization, the U.S. shareholders of FLIR will recognize some amount of taxable gain (but not loss), because they will receive, in addition to Teledyne shares, non-stock consideration (so-called boot).  The gain to be recognized by each FLIR shareholder will be equal the value of the total merger consideration received by the shareholder minus that shareholder’s tax basis in its shares, but limited to the amount of the cash (boot). ¹⁶ Under Section 356, the gain could be treated as a dividend to any FLIR shareholder if the receipt of the cash consideration to that shareholder “has the effect of the distribution of a dividend.” ¹⁷ 

Dividend treatment is determined under the so-called Clark test ¹⁸ by (i) treating the shareholder as if it first received solely stock in the acquiring corporation and then received the cash amount in a post-merger redemption, and (ii) applying the Section 302 redemption tests to determine whether or not the shareholder experienced a sufficient reduction in its percentage interest in the company to meet one of the tests under the redemption rules.  The “safe harbor” under those rules generally requires a greater-than-20-percent reduction in the shareholder’s percentage interest. ¹⁹ 

Given that cash should constitute approximately 50 percent of the merger consideration (well over 20 percent), the FLIR shareholders should generally be able to satisfy the safe harbor.  However, if the boot is treated as a dividend, with respect to any foreign investors, it could be subject to U.S. withholding tax of 30 percent, subject to reduction under an applicable tax treaty.  As always, it will ultimately be up to the prime broker to determine how to implement the tax rule.

^{[1] Joint Press Release, Teledyne to Acquire FLIR Systems, Cash and Stock Transaction Valued at Approximately $8.0 Billion (Jan. 4, 2021) (https://www.sec.gov/Archives/edgar/data/354908/000119312521000295/d106277dex991.htm).}

^{[2] Id.}

^{[3] FLIR, Quarterly Report (Form 10-Q) (Oct. 30, 2020) (https://www.sec.gov/ix?doc=/Archives/edgar/data/354908/000035490820000096/flir-09302020x10q.htm); As of Oct. 23, 2020, there were 131,144,505 shares of the FLIR common stock outstanding and 131,144,505 x 56 = about $7.344 billion.}

^{[4] See Agreement and Plan of Merger by and among Teledyne, Merger Sub I, Merger Sub II and FLIR dated as of Jan 4, 2021 (Merger Agreement) (https://www.sec.gov/Archives/edgar/data/1094285/000119312521002733/d105076dex21.htm).}

^{[5] Id.}

^{[6] IRC §368(a)(2)(E); In the case of FLIR, “control” will generally require obtaining at least 80% of the voting power of all the voting shares of a corporation (IRC §368(c)).}

^{[7] See Rev. Rul. 2001‐46, 2001‐42 IRB 321.}

^{[8] Merger Agreement §5.17(a); see Treas. Reg. §1.368-2(b).}

^{[9] IRC §368 (a)(2)(D).}

^{[10] Merger Agreement §5.17(b).}

^{[11] Merger Agreement §6.3(d).}

^{[12] “Determination” is a term of art, defined by IRC §1313 to various conclusions to a tax controversy, in which, in this context, the IRS would be challenging qualification of the transaction as a reorganization.}

^{[13] Merger Agreement §5.17(d).}

^{[14] See Rev. Rul. 2008-25.}

^{[15] Treas. Reg. §1.368‐1(e).}

^{[16] IRC §356(a)(1).}

^{[17] IRC §356(a)(2).}

^{[18] Clark v. Comm’r, 489 U.S. 726 (1989).}

^{[19] IRC §302(b)(2).}