In its struggle to fend off a $53 billion hostile takeover bid by Canada's Valeant Pharmaceuticals, California-based Botox maker Allergan Inc. is marshaling all available defenses, including reaching out to officials in the Obama administration, but it is uncertain whether additional anti-inversion measures will help its cause.
Delaying the Day of Reckoning
Battling not only Valeant but also activist hedge fund Pershing Square Capital Management, which has entered into a formal agreement with Valeant, Allergan has adopted a poison pill defense. A takeover would require approval of the board, and Valeant and Pershing have called for a special meeting of Allergan shareholders to consider replacing a majority of the directors.
Allergan has scheduled the meeting for December 18 and has been resisting Valeant and Pershing's demands to move up the date. In an amended complaint filed September 2 in the Delaware Court of Chancery, Valeant and Pershing argued that Allergan's selection of a meeting date several months into the future was the "latest in a string of defensive measures." The court may sympathize with that argument. An August 27 order setting a trial date of October 6 expressed concern about Allergan shareholders being deprived of their right to consider the Valeant bid, noting that "Allergan may not want to have a special meeting at all."
Separately, Allergan is suing Valeant and Pershing in the U.S. District Court for the Central District of California for alleged securities laws violations committed in the collaboration on the takeover bid. Allergan filed a motion August 26 in that case for an expedited hearing and an order precluding Valeant and Pershing from voting their shares in the shareholders' special meeting.
Meanwhile, Allergan reportedly has approached the Obama administration. In a recent article about investment bankers hired by U.K. pharmaceutical giant AstraZeneca PLC -- which was then confronting a hostile takeover bid from Pfizer Inc. -- who had urged administration officials in May to clamp down on inversions, The Wall Street Journal noted cryptically that Allergan, too, has been in contact with Treasury officials (Damian Paletta, "How AstraZeneca Raised Inversion Concerns With Washington to Help Fend Off Pfizer," The Wall Street Journal, September 4, 2014).
Curiously, the article does not provide additional details about these contacts. Allergan's is by far the more intriguing story because unlike AstraZeneca, which seems to have successfully held off Pfizer, Allergan remains embroiled in a live takeover battle.
Allergan did not respond to a request for comment, but Laurie Little, senior vice president of investor relations at Valeant, told Tax Analysts, "Valeant's proposed combination with Allergan would not be considered an inversion under any existing definition."
Stretching the Meaning of Inversion
Applying the word "inversion" to a successful Valeant bid does seem to be a stretch. For example, in comparison with AstraZeneca, which was a foreign target of a potential U.S. inverter, Allergan is a U.S. corporation facing a hostile bid from a potential foreign acquirer -- Valeant. In a 2002 study prepared in connection with the enactment of IRC section 7874, the first and so far only direct congressional attack on inversions, Treasury characterized an inversion as recourse to "self-help territoriality" (Office of Tax Policy, Department of Treasury, Corporate Inversion Transactions: Tax Policy Implications 1, 29 (2002)).
Arguably, the target of a hostile bid lacks volition, and territoriality is merely thrust on it. Nevertheless, the Treasury study urged Congress to cover all acquisitions, including both friendly and hostile bids with a U.S. corporation as either the bidder or the target. Certainly, the text of section 7874 makes no distinctions between the modes of acquiring a U.S. corporation. It covers all manner of acquiring a U.S. corporation as long as the continuity of shareholding meets the prescribed thresholds.
Thus, in applying current section 7874 to a successful Valeant bid, the continuity of shareholding in the combined entity, rather than the bid's hostile nature, will matter. Valeant's offer envisages that on completion of Allergan's acquisition, former Allergan shareholders will hold no more than 44 percent of the combined entity's stock on a diluted basis.
Valeant retains an option to issue to Pershing additional shares at a 15 percent discount immediately before completing Allergan's acquisition. Even if Valeant were to exercise that option, the ownership percentage of former Allergan shareholders, which include Pershing, would remain below 50 percent of the combined entity's stock.
Eliminating Shareholding Continuity Tests
While a less than 50 percent continuity of shareholding would not trigger current section 7874, that threshold may no longer remain dispositive under some of the "reforms" being proposed. These include the Stop Corporate Inversions Act of 2014, H.R. 4679, introduced May 20 by House Ways and Means Committee ranking member Sander Levin, D-Mich., and the companion bill (S. 2360) introduced that day by Sen. Carl Levin, D-Mich.
The proposed legislation would apply in years ending after May 8, 2014, to acquisitions completed after that date. Thus, if enacted, it would cover a successful Valeant bid. In remarks at the Urban Institute on September 8, Treasury Secretary Jacob Lew endorsed the concept of new anti-inversion legislation applying retroactively "to any deal after early May of this year."
The Levin brothers' bills seem to flesh out a similar, less developed proposal contained in the administration's 2015 budget.
The bills would treat a foreign corporation as an "inverted domestic corporation" -- that is, a domestic corporation for all purposes of the tax code, even in the absence of a greater than 50 percent continuity of shareholding -- on the satisfaction of a three-pronged conjunctive test:
- the management and control of the expanded affiliated group (EAG), which includes the subject foreign corporation, occurs primarily within the United States;
- the EAG has "significant domestic business activities"; and
- the EAG does not have "substantial business activities" in the foreign corporation's country of organization.
The bills require enabling regulations to provide that the management and control prong is satisfied if "substantially all of the executive officers and senior management of the expanded affiliated group . . . are based or primarily located in the United States." The "significant domestic business activities" prong would be satisfied if the United States accounts for a minimum of 25 percent of any one of the EAG's income, assets, employee compensation, and employee headcount. The EAG would not have "substantial business activities" in the foreign corporation's country of organization if that country accounts for less than 25 percent of any one of the EAG's income, assets, employee compensation, and employee headcount.
Valeant has extensive operations in the United States; it was domiciled here until 2010 and has since continued to make large and small acquisitions of U.S. businesses, including Bausch & Lomb in 2013. Therefore, if the EAG of a combined Valeant-Allergan entity is deemed to be managed and controlled in the United States, it is conceivable, though far from clear, that the first two prongs of the conjunctive test would be satisfied. The third prong could then be determinative.
In other words, whether the combined entity is treated as a domestic corporation may very well turn on Canada accounting for at least 25 percent of each of the EAG's aggregate income, assets, employee compensation, and employee headcount.
For its part, Valeant has either ignored the administration's and the Levin bothers' proposals or concluded that their adoption would not affect the tax treatment of a combined Valeant-Allergan entity. In an SEC filing in which it acknowledged reviewing "tax reform proposals currently being debated in Congress," Valeant maintains "that even if the most aggressive proposed rule changes were enacted, Valeant would expect no material impact in the next two years and would estimate a zero to three percent increase in Valeant's effective tax rate in the longer term."
Developing Political and Popular Sentiment
In delaying the shareholders special meeting until December, Allergan is giving itself room to maneuver. Earlier, the company was said to have approached North Carolina-based Salix Pharmaceuticals Ltd. to explore a friendly merger that would have resulted in a combined entity too large for Valeant's preferences (David Benoit and Liz Hoffman, "Valeant Pushes Ahead in Allergan Fight," The Wall Street Journal, August 24, 2014).
Salix recently agreed to buy the Irish unit of Italy-based Cosmo Pharmaceuticals SpA. Acquiring Salix could therefore enable Allergan to undertake a tax inversion of its own -- and a volitional one at that. But talks with Salix appear to have gone nowhere. Instead, Allergan seems to have shifted gears and begun participating in the growing political and popular sentiment against corporate expatriations.
In late June, seven Democratic senators wrote to the Justice Department and the Federal Trade Commission, expressing concern about Valeant's hostile bid for Allergan, referring to, among other things, Valeant's own expatriation to Canada following its merger in 2010 with Biovail Corp., then the largest Canadian publicly traded pharmaceutical company.
Pointedly, the senators characterized that expatriation as an inversion, although former Biovail shareholders ended up with a majority -- 50.5 percent -- of the combined entity on completion of the transaction ("Biovail to Merge With Valeant," Dealbook, New York Times, June 21, 2010).
Allergan's reported contacts with Treasury officials appear consistent with a strategy of deploying as a takeover defense the furor over corporations "renouncing their U.S. citizenship." Delaying the special shareholders meeting until December may allow that furor to come to a head.
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