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Structuring REIT Mergers and Acquisitions:
Due Diligence, Preserving REIT Status, Tax
Concerns, Closing ConditionsAddressing Unitholder Rights in UPREITs, Coordinating Dividend Payments, Deal Protection Provisions
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THURSDAY, SEPTEMBER 19, 2019
Presenting a live 90-minute webinar with interactive Q&A
James V. Davidson, Partner, Hunton Andrews Kurth, Richmond, Va.
Kendal A. Sibley, Partner, Hunton Andrews Kurth, Richmond, Va.
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STRUCTURING REIT MERGERS AND ACQUISITIONS
Jim Davidson
Kendal Sibley
Hunton Andrews Kurth LLP
September 19, 2019
I. Introduction
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Overview
• 2012-2019 YTD: 55+ public to public mergers, 20+ going private transactions; ~$250 billion aggregate transaction value
• Consistent activity and growth since Great Recession
• While market conditions may change rapidly, expect activity to continue for the foreseeable future
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What Is Special About REIT M&A?
Tax issues
o Legal requirements
o Prevailing market practice
Maryland law
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Introduction to UPREITs
REIT
Stockholders
OperatingPartnership
GP(can be REIT)
Property Contributor LPs(OP Unitholders)
Property-holding SPVs (LLCs)
REIT owns assets directly and also through partnerships with other partners
Partnership units are not equivalent to REIT shares
May facilitate goals of contributing partners
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DownREIT
REIT
JV
Public Stockholders
JV Partners
Assets
Assets
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UPREIT Issues
• OP agreements may require unitholder consent• In UPREIT to UPREIT mergers, OP units of Acquirer OP may be received on a
tax deferred basis• However, indemnities under tax protection agreements potentially
triggered by:o Sales of unwanted assets
o Changes in financing strategies
o Loss of favorable grandfather status for existing "bottom dollar" debt guarantees
• “Continuing” partnership for tax purposes not governed by state law structure, allowing OP merger to accommodate non-income tax considerations
• In non-UPREIT to UPREIT mergers, downREIT could result or insertion of new OP could affect other tax planning
II. REIT M&A TRANSACTION STRUCTURES
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Transaction Structures: Preference for Forward Mergers
“Triangular”Direct
TargetREIT
AcquirerREIT
Merge TargetREIT
AcquirerREIT
MergerSub
Forward mergers can accommodate all cash (taxable), all stock (generally tax deferred) and mixed consideration
Although less common, a reverse merger may make third party consents easier
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Reverse Mergers
TargetREIT
AcquirerREIT
MergerSub
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UPREIT to UPREIT Merger
TargetREIT
AcquirerREIT
Merge
TargetStockholders
LimitedPartners
AcquirerOP
TargetOPMerge
LimitedPartners
In a tax deferred UPREIT to UPREIT merger, both REITs and both OPs can be combined
Stockholders become owners of the combined REIT, and LPs become partners in the combined OP
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UPREIT Going Private Transaction
TargetREIT
AcquirerEntity
Merge
TargetShareholders
TargetOP
LimitedPartners
In a go-private transaction, the Acquirer Entity may cash out existing LPs or may leave them in place as partners in a partnership that is now controlled by the private entity
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UPREIT Acquisition of C Corporation –(Two Options)
Final Structure
Target
AcquirerREIT
Either a REIT or
liquidated into OP
AcquirerOP
Transaction (New REIT)
TargetC Corp
AcquirerREIT Target
Stockholders
AcquirerOP
Transaction (Liquidate)
TargetC Corp
AcquirerREIT
TargetStockholders
AcquirerOP
If an UPREIT wants to acquire a C corporation that owns REIT qualifying assets, it can either combine the C corporation into the Acquirer REIT or maintain it as a private REIT
Either way, a purging distribution and sting tax must be considered
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UPREIT Acquisition of Private REIT
Final Structure
AcquirerREIT
AcquirerOP
TargetAssets
TargetPrivate
REIT
AcquirerREIT
TargetStockholder
Transaction
AcquirerOP
AcquirerTRS
Buyer
To get a step up in tax basis after a purchase of REIT stock, an Acquirer REIT can liquidate a Target REIT into a non-REIT entity
This may require creating a regarded partnership with a TRS
Transfer taxes/state withholding
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Asset Acquisitions
PublicREIT
AcquirerREIT
Assets
LLC
LLCInterests
Cash
100%
III. CONFIRMING REIT QUALIFICATION
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Entity versus asset deals
REIT Status of Target
o Liability for taxes related to prior years
o Requirement to purge all C corp E&P
o Taint on built-in gain assets – Section 337
o Deemed sale election if Target engaged in a spin-off in prior 10 years of merger into REIT
▪ Automatic deemed sale treatment applicable only to “distribution property”
REIT Status of Acquirer
o Affects value of consideration for Target stockholders in a stock deal
o Need to confirm that combined Acquirer/Target can satisfy REIT requirements, depending on structure
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Confirming REIT Qualification –Do You Care?
Contractual protections
o Merger/Purchase agreement
▪ Reps and warranties
Rep and warranties insurance
▪ Schedules
Exceptions to reps – often come late in the process
▪ Unqualified REIT opinion
Tax officer’s certificate – may reveal factual issues
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Confirming REIT Qualification –Agreement Protections
Diligence
o 4 years/9 years/Forever?
o Tax Returns/Tax Compliance Schedules
o Dividends – preferential dividend rule still applies for private REITs
o Does the Target have any BIG assets that will delay sale or liquidation?
o Short year – is income lumpy?
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Confirming REIT Qualification – Diligence
Options when there is a REIT qualification issue for Target
o Rep and warranty insurance
o Indemnity/escrow
o Closing agreement with the IRS (timing)
o Restructure the transaction (i.e., buy the assets)
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Confirming REIT Qualification –There’s An Issue
AcquirerREIT
$100 unrelated qualifying
assets
AcquirerOP
TargetREIT
$94 qualifying assets
$6 single bad asset
JV
other partners20%
80%
Include representations regarding qualification in agreement
5/50 test – any changes needed to ownership waivers
Short taxable year?
o Income test
o Distribution test
TRS elections for acquired TRSs
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Confirming REIT Qualification – Post-Closing
M&A agreements typically require break-up or termination fees
For REIT M&A agreements, these termination fees have historically been subject to escrow provisions to protect REIT qualification
Section 451(b) concerns
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Confirming REIT Qualification –Termination Fees
IV. UPREITS AND DOWNREITS
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As discussed, mergers can take a variety of forms with a variety of tax consequences
Mergers at the OP level can create a second layer of complications
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Merger Structures
“Continuing” Partnership
o State law form does not govern
o Answer may be surprising
o Can affect transfer tax, EIN, grandfathered status for certain guarantees
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OP-Level Mergers
Avoiding disguised sale with mixed consideration
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OP-Level Mergers
TargetREIT
AcquirerREIT
Merge
TargetShareholders
Redeem UnitsFor Cash
AcquirerOP
TargetOPMerge
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Need to address OP limited partner consent provisions
Tax protection agreements may affect timing, require consents or gross-up
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OP-Level Mergers
REIT
OP
LegacyUnitholders
Assets
LegacyOP
Assets
REIT
OP
LegacyUnitholders
Assets
LegacyOP
After Merger Simplified Structure
If Acquirer and Target do not both have an UPREIT structure, it may be desirable to create a mirror structure to facilitate mergers
Be careful of any prior tax planning and creating indirectly owned C corps
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OP-Level Mergers
Acquirer REIT
AcquirerREIT
AcquirerOP
Assets
C Corp(Former QRS)
Pre-Transaction Proposed Transaction
Target REIT
TargetOP
C Corp Qualified
REIT Subsidiary
TargetREIT
TargetOP
Assets
Merge
Merge
REIT QualificationIssue
V. DIVIDENDS
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Minimum Dividend Required
o Timing of record date, payment
Customary Dividend?
o Reduces consideration versus equivalent Target dividend
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Restrictions on Post-Signing Dividends
Purge C corporation E&P from Target restructuring
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Dividends
AcquirerREIT
AcquirerOP
TargetTRS
TargetREIT Liquidate pre-merger to
use previously distributed return of capital
TargetOP
Merge
Merge
Delay dividends from Subsidiary REITs
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Dividends
TargetREIT
AcquirerREIT
Merge
PreferredShareholders
**Tax year of subsidiary REIT does not end
SubsidiaryREIT**
VI. DEAL PROTECTION PROVISIONS
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REIT M&A deal protections align with broader M&A market
Purposes:
o Obstruct disruption of deal by another purchaser
o Provide economic compensation to Acquirer in case Target chooses not to close
o Limit divulgence of confidential information
Limitations:
o Fiduciary obligations of Target board of directors
o “Superior Proposals”
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Deal Protections: Similar to Non-REIT M&A
Typical Clauses
o Definition of “superior proposal”
o Buyer matching rights
o Fiduciary termination right
o Force-the-vote
o Changing or withdrawing board recommendation
o “Shopping”
▪ No-shop
▪ Go-shop
▪ Window-shop
o Termination fee
▪ Expense reimbursement structure
▪ Two-tiered structure
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Deal Protections: Similar to Non-REIT M&A
Frederick v. Corcoran
o Annaly partially owned CreXus and negotiated a merger agreement to purchase the remainder
o Terms of the merger agreement included 45-day go-shop period, termination fee, and stockholder vote, et al.
o Plaintiffs’ firms alleged Special Committee agreed to unreasonable deal protection measures, et al.
o Takeaways
▪ Deal protections are generally reasonable and will be balanced against potential chilling effect on alternate bids
▪ Termination fees under 3% of a transaction value are generally reasonable
▪ 45-day go-shop was reasonable
▪ Matching right was reasonable
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Deal Protections: Similar to Non-REIT M&A
VII. CLOSING CONDITIONS—PROPERTY LEVEL AND OTHER ISSUES
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Shareholder Approval Issues
o Common Stock
o Preferred Stock
Unitholder Approval Issues
o Change of Control provisions in OP agreements
o Conflicted insiders holding OP or LTIP units
o Conflicts of interest between REIT and OP
Partnership Agreement Issues
Diligence Issues
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Closing Conditions: REIT Specific Items
VIII. PREPARING FOR AND RESPONDING TO SHAREHOLDER ACTIONS
43
Like other industries, majority of transactions result in litigation
Historical trends
More recent developments
44
Shareholder Actions: Overview
State common law
Separate courts of law and equity
Business Judgment Rule (Van Gorkom)
Enhanced scrutiny
o Reasonableness and proportionality (Unocal)
o Best price (Revlon)
o Entire fairness (Weinberger)
▪ Fair dealing
▪ Fair price
o Uncertainty whether Unocal or Revlon apply to deal protections
45
Shareholder Actions: Delaware Framework
Director duties codified (MGCL 2-405)
o Act in good faith
o With the care that an ordinarily prudent person in a like position would exercise under similar circumstances
o In a manner he believes to be in the best interests of the corporation
Presume any act of a director satisfies statutory duties (MGCL 2-405(e))
No enhanced duties or scrutiny for actions relating to an acquisition or acquisition of control
No requirement to accept, recommend or respond to proposals
No requirement to act or refuse to act simply because the effect such action or inaction would have on:
o an acquisition or potential acquisition of control
o the amount or type of consideration that may be offered or paid
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Shareholder Actions: Maryland Framework
Uncertain persuasiveness of Delaware Framework
o Supportive: “Until the Court of Appeals rules otherwise, this court will continue to look to Delaware law to the extent that it is not inconsistent with Maryland law” (Frederick v. Corcoran) (See Boland Trane Associates, Inc. v. Boland)
o Combative: “A Maryland court . . . will not adopt the standards and burdens assigned the parties under Delaware corporate law . . .” (Costa Brava Partnership III, L.P. v. Telos Corp., Circuit Court for Baltimore City, Maryland)
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Shareholder Actions: Maryland Framework
Questions?
Telephone
+1 804 787 8035
+1 212 309 1255
+1 804 788 8697
HuntonAK.com
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Contact Us
Jim’s practice focuses on all aspects of capital markets, mergers andacquisitions, corporate finance, and real estate transactions, with aparticular emphasis on REITs. He represents issuers and investmentbanks in connection with public and private offerings of common andpreferred equity and senior and convertible debt securities, includinginitial public offerings, follow-on offerings, “at the market” offerings,tender offers and Rule 144A and Regulation D private placements. Hehas extensive experience representing some of the largest publicmortgage REITs, hospitality REITs, office REITs, multifamily REITs,banking institutions and mortgage lenders.
Kendal focuses on federal income tax issues related to REITs,investment funds and structured finance and securitization. Sherepresents issuers and underwriters in REIT capital marketstransactions and acquires and targets in REIT merger and acquisitions.She advises funds and joint ventures regarding tax efficient structuresusing REITs.
The presenters wish to thank Marshall Heins II and Josh Venne for their efforts on this presentation.
