July 25, 1997
Extended Family Care Corporation, Inc.
Xxx Xxx Xxxxxxx Xxxx
Xxxxx 000
Xxxxx Xxxxx, XX 00000
Star Multi Care Services, Inc.
00 Xxxx Xxxxxxx Xxxx
Xxxxxxxxxx Xxxxxxx, XX 00000
Re: AGREEMENT AND PLAN OF MERGER AMONG STAR MULTI CARE
SERVICES, INC., EFCC ACQUISITION CORP. AND EXTENDED FAMILY
CARE CORPORATION, INC. DATED AS OF JANUARY 3, 1997
-----------------------------------------------------------
Ladies and Gentlemen:
We have acted as counsel to the shareholders of Extended Family Care
Corporation, Inc., a New York corporation ("EFCC"), in connection with the
proposed merger (the "Star Merger") of EFCC with and into EFCC Acquisition
Corp., a New York corporation ("Merger Sub") and wholly-owned subsidiary of Star
Multi Care Services, Inc., a New York corporation ("Star"), pursuant to the
Agreement and Plan of Merger Dated as of January 3, 1997 (the "Merger
Agreement"), among Star, Merger Sub and EFCC.
In so acting, we have participated in the preparation of the Merger
Agreement and the preparation and filing with the Securities and Exchange
Commission of a Joint Proxy Statement of EFCC and Star and Prospectus of Star
relating to the proposed Star Merger and to the shares of common stock, par
value $.001 per share, of Star to be issued to EFCC shareholders in the Star
Merger pursuant to the Merger Agreement (the "Proxy Statement").
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 2
As required by Section 6.1(f) of the Merger Agreement, you have
requested that we render the opinion set forth below. In rendering such opinion,
we have made inquiry as to the underlying facts which we consider to be relevant
to the conclusions set forth in this opinion. We have also examined and relied
upon the accuracy as of the date hereof and as of the date of the closing of the
Star Merger of the representations and warranties as to factual matters set
forth in the documents referred to above and the letters of representation,
dated as of the date hereof, that EFCC and Star have provided to us, copies of
which are attached hereto (the "Letters of Representation"). Our opinion is
expressly predicated on the continuing validity of the Letters of
Representation. We have no reason to believe that these representations and
facts are not true, but have not attempted to verify them independently and
expressly disclaim an opinion as to their validity and accuracy.
For purposes of this opinion, we have also reviewed such documents
and materials as in our judgment are necessary or appropriate to enable us to
render the opinions set forth below. We have not, however, undertaken any
independent investigation of any factual matter set forth in any of the
foregoing. In our examination, we have assumed the genuineness of all
signatures, the capacity of each party executing a document to execute such
document, the authenticity of all documents submitted to us as originals and the
conformity to original documents of all documents submitted to us as certified
or photostatic copies. Capitalized terms used but not specifically defined
herein shall have the meanings as defined in the Merger Agreement.
This discussion is based on the provisions of the Internal Revenue
Code of 1986, as amended (the "Code"), final, temporary and proposed Treasury
regulations promulgated thereunder (the "Regulations") and administrative and
judicial interpretations thereof, all as in effect as of the date hereof and all
of which are subject to change (possibly on a retroactive basis). Moreover, it
is not possible to know whether any such changes will be made or court decisions
or interpretations will be issued, or the effect, if any, that such changes or
court decisions will have on our opinion. Any such change may adversely affect
our conclusions. No ruling from the Internal Revenue Service (the "IRS") has
been or will be sought on any of the issues discussed below, and there can be no
assurance that the IRS will not take a contrary view as to the federal income
tax consequences discussed below.
This opinion does not address all of the federal income tax
consequences that may be applicable to any particular holder subject to special
treatment under United States federal income tax
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 3
law or to any particular holder in light of such holder's particular facts and
circumstances. Certain holders may be subject to special and/or different rules
not discussed below. In addition, this opinion does not address any aspect of
state, local or foreign taxation.
This opinion is limited solely to the federal law of the United
States as in effect on the date hereof and the relevant facts that exist as of
the date hereof. No assurance can be given that the law or facts will not
change, and we have not undertaken to advise you or any other person with
respect to any event subsequent to the date hereof.
We are delivering this opinion to you, the Board of Directors and
shareholders and, without our prior written consent, no other persons are
entitled to rely on this opinion. We hereby consent to the filing of this
opinion as an exhibit to the Joint Proxy Statement and to the use of our name
under the captions "The Merger-Certain Federal Income Tax Consequences" and
"Legal Matters" in the Joint Proxy Statement. In giving such consent, we do not
thereby concede that we are within the category of persons whose consent is
required under Section 7 of the Securities Act of 1933 or the Rules and
Regulations of the Securities and Exchange Commission thereunder.
FACTS
EFCC is a New York public holding corporation with 32,000,225 shares
of common stock issued and outstanding. Xxxx Holding Corp. ("Xxxx") owns
12,749,658 (39.84%) of such shares, Arbor Home Healthcare Holdings, LLC
("Arbor") owns 13,000,000 (40.63%) of such shares and public shareholders own
6,250,568 (19.53%). Arbor acquired its shares for $1,300,000 on August 21, 1996
and October 31, 1996 through the exercise of options granted on October 31,
1995.
Star is a New York corporation with 4,212,387 shares of common stock
issued and outstanding.
On January 21, 1997, when EFCC had minimal current earnings and
profits, EFCC distributed to all of its shareholders with respect to their
shares $750,000 of cash in the aggregate (the "EFCC Dividend"). Such
distribution reduced the EFCC shareholders' basis in their EFCC shares, but not
below zero. EFCC's only remaining assets are approximately $160,000 in cash,
$150,000 in other current assets, 83% of the stock of TPC Home Care Services,
Inc., a New York corporation ("TPC") and $610,000 in intercompany debt from TPC.
The other 17% of TPC is owned by many different shareholders.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 4
On December 6, 1996, TPC sold the assets, subject to liabilities, of
its Jersey City, New Jersey division in a fully taxable transaction to Public
Services, Inc. ("Buyer") for $175,000, evidenced by a promissory note, plus an
amount equal to 12% of the gross revenues of Buyer in excess of $90,000 per
month for a 24 month period. Buyer is owned l00% by Xxxx Xxxxxx, who is the
husband of a shareholder of Xxxx, the voting trustee of Xxxx' shares in EFCC and
owner of 25,000 shares of EFCC, but does not otherwise own any direct or
indirect interest in TPC and is unrelated to all of the other shareholders of
TPC and EFCC.
In order to effect desired operating efficiencies in the corporate
structure of EFCC by simplifying the current two-tiered structure, which no
longer serves any business purpose and entails a substantial cost to maintain
due to dual financial reporting, disclosure and administrative burdens, and to
make it more attractive to Star or any other potential purchaser if the Star
Merger does not occur, subsequent to the sale of TPC's Jersey City division,
subsequent to the EFCC Dividend and prior to the Star Merger, TPC will merge
into EFCC pursuant to the Business Corporation Law of the State of New York,
with EFCC as the surviving entity (the "TPC Merger"). The shareholders of TPC
(other than EFCC) will receive solely 6,554,264 EFCC shares in the TPC Merger,
which represents 17% of all outstanding EFCC shares after such issuance.
Merger Sub is a New York corporation formed on December 31, 1996 for
the sole purpose of effecting the Star Merger. Merger Sub is a wholly owned
subsidiary of Star.
Star and EFCC believe that a combination of their respective
businesses will enable both companies to grow and operate more efficiently. Star
has in place a management infrastructure and can merge the former TPC business
operations with minimal incremental cost. By eliminating the operating and
overhead costs of EFCC, profitability can be greatly enhanced. Such enhanced
profitability will be shared by Star's shareholders, including the former EFCC
shareholders. To achieve this purpose, Star has agreed to acquire all of the
outstanding capital stock of EFCC as more fully described below.
Following the TPC Merger, EFCC will merge with and into Merger Sub
(i.e., the Star Merger). Pursuant to the Star Merger, EFCC's shareholders
(including the former TPC minority shareholders) will receive $2,400,000 in cash
(plus cash payments to dissenting shareholders, if any) and $4,850,000 in Star
common stock (less the amount that would have been paid to dissenting
shareholders, if any), as determined on the third business clay prior to the
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 5
Effective Time, using the average of the closing sales price of a share of Star
common stock as reported on the NASDAQ National Market during the 120 trading
days immediately preceding the date of determination (such amounts to be
adjusted in the event of payments to dissenting shareholders in the TPC Merger).
Other than cash payments to dissenting shareholders, such proceeds will be
allocated among the non-dissenting shareholders pro rata in proportion to their
relative stock ownership.
In connection with the Star Merger, EFCC and Star will enter into a
Consulting Agreement pursuant to which Star will render to EFCC consulting and
advisory services in connection with the management, operation and supervision
of EFCC. The term of the consulting Agreement shall end on the earlier of (i)
one year from the signing of the Star Merger Agreement, (ii) the Effective Time
or (iii) the termination of the Star Merger Agreement. In consideration for the
consulting services to be rendered by Star, EFCC will pay Star $25,000 per
month, payable (a) $15,000 in arrears on the last day of each month and (b) the
remaining $10,000 on the earlier to occur of (x) the Closing Date and (y) the
termination of the Star Merger Agreement.
Alternatively, solely at Star's option, Merger Sub will be merged
with and into EFCC and EFCC's shareholders will receive solely cash in the
amount of $7,250,000 in exchange for their EFCC stock (the "All Cash Option")
(such amount to be adjusted in the event of payments to dissenting shareholders
in the TPC Merger).
REPRESENTATIONS
In connection with the proposed transaction, the following
representations are being made by EFCC, Xxxx and/or Star to us, as set forth in
the Letters of Representation:
Provided that the All Cash Option is not exercised:
(a) The Star Merger will be effected in accordance with the
Merger Agreement and pursuant to New York State law.
(b) No stock of the Merger Sub will be issued to any
shareholder of EFCC in the Star Merger.
(c) As of the Effective Time, to the best of the knowledge of
the management of EFCC, there are no shareholders of EFCC, other than Xxxx and
Arbor, who own 5% or more of the stock of EFCC.
(d) To the best of the knowledge of the management of EFCC,
Xxxx acquired their EFCC stock before the formulation of any plan
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 6
in connection with the Star Merger and not in contemplation of Merger Sub's
subsequent acquisition of the outstanding capital stock of EFCC.
(e) As of the Effective Time, Xxxx does not have a binding
commitment or preconceived plan or arrangement for disposing of any of their
Star stock received in the Star Merger.
(f) As of the Effective Time, to the best of the knowledge of
the management of EFCC, none of the shareholders of EFCC have a binding
commitment or preconceived plan or arrangement for disposing of any of their
Star stock received in the Star Merger.
(g) EFCC will transfer to Merger Sub and Merger Sub will
acquire at least 90 percent of the fair market value of EFCC's net assets and at
least 70 percent of the fair market value of EFCC's gross assets held
immediately prior to the Star Merger, including, but not limited to, the assets
formerly held by TPC (which includes the consideration received by TPC upon the
sale of its Jersey City division) and the amount of cash distributed in the EFCC
Dividend. For purposes of this representation, amounts paid by EFCC to
dissenters, amounts paid by EFCC to shareholders who receive cash in lieu of
fractional shares, amounts used by EFCC to pay reorganization expenses and all
redemptions and distributions (except for regular, normal dividends) made by
EFCC will be included as assets of EFCC immediately prior to the Star Merger.
(h) Prior to the Star Merger, Star will be in control of
Merger Sub within the meaning of Section 368(c) of the Code.
(i) Merger Sub has no plan or intention to issue additional
shares of its stock that would result in Star losing control of Merger Sub
within the meaning of Section 368(c) of the Code.
(j) As of the Effective Time, EFCC will not, in anticipation
of or as a part of the plan for the combination of EFCC and Merger Sub have (i)
redeemed any of the EFCC stock or (ii) effected any distributions with respect
to any of its stock, except for normal dividends and except for the EFCC
Dividend.
(k) As of the Effective Time, Star or any corporation
affiliated with Star (i) will not be under any obligation and will not have
entered into any agreement or understanding to redeem or repurchase any of its
stock issued in the Star Merger or to make any extraordinary distributions in
respect of the Star common stock and (ii) will have no plan or intention to
reacquire any of its stock issued in the Star Merger.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 7
(l) As of the Effective Time, there will be no plan or
intention on the part of Star or any corporation affiliated with Star to
liquidate Merger Sub, to merge Merger Sub into another corporation, to sell or
otherwise dispose of the stock of Merger Sub or to cause Merger Sub to sell or
otherwise dispose of any of the assets acquired from EFCC (including the assets
that EFCC received from TPC), except for dispositions to be made in the ordinary
course of business or transfers described in Section 368(a)(2)(C) of the Code.
(m) Following the Star Merger, Merger Sub will continue the
"historic business" of TPC or use a "significant portion" of TPC'S "historic
business assets" in a business (as such terms are defined in Treasury Regulation
Section 1.368-1(d)(2)), to the extent they have been acquired by Merger Sub in
the Star Merger.
(n) Star and the shareholders of EFCC will pay (or will have
paid) their respective expenses, if any, incurred in connection with the Star
Merger and will not pay any of the expenses of the other in connection with the
Star Merger. Star will pay or assume only those expenses of EFCC that are solely
and directly related to the Star Merger in accordance with the guidelines
established in Rev. Rul. 73-54, 1973-1 C.B. 187.
(o) As of the Effective Time, there will be no intercorporate
indebtedness existing between Star and EFCC or between Merger Sub and EFCC that
was issued, acquired or will be settled at a discount.
(p) As of the Effective Time, Star and Merger Sub will not be
investment companies as defined in Section 368(a)(2)(F)(iii) and (iv) of the
Code.
(q) At the Effective Time, the fair market value of the assets
of EFCC (including the assets received from TPC) will exceed the sum of its
liabilities, plus the amount of liabilities, if any, to which the assets are
subject. Such liabilities were incurred by in the EFCC or TPC in the ordinary
course of business and are associated with the business of EFCC or TPC.
(r) As of the Effective Time, EFCC will not be under the
jurisdiction of a court in a title 11 or similar case within the meaning of
Section 368(a)(3)(A) of the Code.
(s) The payment of cash in lieu of fractional shares of Star
common stock is solely for the purpose of avoiding the expense and inconvenience
to Star of issuing fractional shares and does not represent separately
bargained-for consideration. The total cash
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 8
consideration that will be paid in the Star Merger to the EFCC shareholders
instead of issuing fractional shares of Star stock will not exceed one percent
of the total consideration that will be issued in the Star Merger to the EFCC
shareholders in exchange for their shares of EFCC stock. The fractional share
interests of each EFCC shareholder will be aggregated, and no EFCC shareholder
will receive cash in an amount greater to or greater than the value of one full
share of Star stock.
(t) The consideration to be received by the shareholders of
EFCC in the Star Merger is a result of arm's-length bargaining. None of the
compensation received by any shareholder-employees of EFCC will be separate
consideration for, or allocable to, any of their shares of EFCC stock; none of
the shares of Star stock received by any shareholder-employees of FFCC will be
separate consideration for, or allocable to, any employment agreement; and the
compensation paid to any shareholder-employee will be for services actually
rendered and will be commensurate with amounts paid to third parties bargaining
at arm's-length for similar services.
(u) None of the representations or warranties made by EFCC,
Xxxx and, to the knowledge of the officers of Star and Merger Sub, none of the
representations or warranties made by Star or Merger Sub, herein or in any
Schedule hereto or in any other documents furnished pursuant to any of the
transactions described herein contain any untrue statement of fact or omit to
state any fact necessary in order to make the statements and opinions contained
herein or therein, including our Xxxxxxx, Lippe, Goldstein, Wolf & Xxxxxxxxx
P.C. opinions, true and not misleading.
CONCLUSION
Subject to the foregoing and to the qualifications and limitations
set forth herein, we are of the following opinion that, more likely than not:
Provided that the All Cash Option is not exercised, and assuming that
the Star Merger is consummated strictly in accordance with the Merger Agreement
and as described in the Joint Proxy Statement:
1. On the basis of our conclusion set forth below in the
Discussion section of this opinion letter that the shareholders of EFCC should
be deemed to have received and retained a sufficient amount of stock in Star to
satisfy the continuity of interest requirement, and assuming that EFCC is merged
into Merger Sub pursuant to New York State law, the Star Merger will be treated
for
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 9
United States federal income tax purposes as a reorganization within the
meaning of Section 368(a) of the Code.
2. Star, Merger Sub and EFCC will each be a party to the
reorganization within the meaning of Section 368(b) of the Code.
3. No gain or loss will be recognized by EFCC shareholders as
a result of the exchange of EFCC common stock solely for Star common stock
pursuant to the Star Merger, except that gain, if any, (but not loss) will be
recognized on the receipt of cash, other than cash received in lieu of
fractional shares, and gain or loss, if any, will be recognized in connection
with the receipt of cash in lieu of fractional shares. The payment of cash in
lieu of fractional share interests of Star common stock will be treated as if
each fractional share was distributed as part of the exchange and then redeemed
by Star. Pursuant to Section 302 (a) of the Code, these cash payments will be
treated as having been received as distributions in full payment in exchange for
such Star common stock. Any gain or loss recognized upon such exchange (as
determined under Code Section 1001 and subject to the limitations of Code
Section 267) will be capital gain or loss provided the shares would constitute a
capital asset in the hands of the exchanging stockholder.
4. Each shareholder of EFCC who elects to dissent from the
Star Merger and receive cash in exchange for his shares of EFCC common stock
will be treated as receiving such payment in complete redemption of his shares
of EFCC, provided such shareholder does not actually or constructively own any
EFCC common stock after the exchange under the provisions and limitations of
Code Section 302.
5. The tax basis of the Star common stock received by EFCC
common stockholders will be the same as the basis of the EFCC common stock
surrendered in exchange therefor, decreased by the amount of basis allocated to
the fractional shares that are hypothetically received by the stockholder and
redeemed for cash, and decreased by any money received in the exchange (other
than cash received in lieu of fractional shares) and increased by any gain
recognized on the exchange.
6. The holding period of the Star common stock received by
the EFCC common stockholders will include the period during which the EFCC
common stock surrendered in exchange therefor was held, provided that the EFCC
common stock is held as a capital asset in the hands of the EFCC stockholders at
the Effective Time.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 10
7. No gain or loss will be recognized by EFCC on the transfer
of all of its assets to Merger Sub pursuant to the plan of reorganization.
8. No gain or loss will be recognized by Star or Merger Sub
pursuant to the Star Merger.
9. The tax basis of EFCC's assets in the hands of Merger Sub
will be the same as the basis of those assets in the hands of EFCC immediately
prior to the Star Merger. The tax basis of EFCC's assets in the hands of Merger
Sub will not be increased by any cash paid to dissenters or cash paid in lieu of
fractional shares.
10. The holding period of the assets of EFCC in the hands of
Merger Sub will include the period during which such assets were held by EFCC.
We express no opinion other than as stated above, and any such
opinion is not intended to imply or be an opinion on any other matter. This
opinion represents only counsel's best legal judgment as to the likely outcome
of an issue if properly presented to a court (and assuming the court determines
all facts to be consistent with the facts stated in counsel's Is opinion) .
However, the opinion has no binding effect or official status of any kind, and
the conclusions stated herein are not free from doubt. The IRS or a court may
disagree with any or all of our conclusions and, accordingly, there can be no
assurance that the IRS will not successfully contest this opinion in the courts
or otherwise.
DISCUSSION
1. GENERAL
Section 354 (a) (1) of the Code addresses the effects of corporate
reorganizations on shareholders, providing in general that no gain or loss shall
be recognized if stock or securities in a corporation a party to a
reorganization are, in pursuance of the plan of reorganization, exchanged solely
for stock or securities in such corporation or in another corporation a party to
the reorganization.
For purposes of Code Section 354, the term "Reorganization" is
defined in Code Section 368(a). Code Section 368(a)(1)(A) states that the term
reorganization includes a statutory merger or consolidation. Regulation Section
1.368-2(b)(1) states that in order for a transaction to qualify as a
reorganization under Code
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 11
Section 368(a)(1)(A), the transaction must be a merger or consolidation effected
pursuant to the corporation laws of the United States, a State, territory or the
District of Columbia.
The Regulations under Code Section 368 require as a part of a
reorganization a continuity of the business enterprise under the modified
corporate form, a bona fide business purpose for the reorganization and a
"continuity of interest" therein on the part of those persons who, directly or
indirectly, were owners of the enterprise prior to the reorganization.
Regulation Section 1.368-l(d)(2) states that the continuity of business
enterprise requirement is met if the acquiring corporation either continues the
acquired corporation's historic business or uses a significant portion of the
acquired corporation's business assets in the operation of a trade or business.
Regulation section 1.368-2(g) indicates that in addition to coming
within the scope of the specific language of Code Section 368 (a) , a
reorganization must also be "undertaken for reasons germane to the continuance
of the business of a corporation a party to the reorganization." If the
transaction or series of transactions has no business or corporate purpose, then
the plan is not a reorganization pursuant to Code Section 368(a). Regulation
section 1.368-1(c).
The continuity of interest requirement mandates that the historic
shareholders of the acquired corporation must acquire a definite and substantial
interest in the continuing corporation, and stock must represent a material part
of the consideration transferred. The Supreme Court, in XXXXXX CO. X. XXXXXXXXX,
000 X.X. 000 (1935), held that equity equal to 38% of the entire consideration
constituted a definite and substantial interest in the purchasing corporation.
The percentage relates to the proportion of the equity consideration received by
the target shareholders in the aggregate to the total consideration paid by the
acquiror for target's assets or stock. An historic shareholder is a person who
owned the target corporation's stock before the acquisition of target commenced
and who purchased such target corporation stock before the formulation of the
transaction not in contemplation of the acquiring corporation' s subsequent
acquisition of the target. It is not necessary that all historic shareholders of
the acquired corporation have a proprietary interest in the surviving
corporation after the acquisition. The IRS has announced that it considers a 50
percent continuity-of-equity interest by
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 12
value to be sufficient(1). Nevertheless, pursuant to the XXXXXX case, a 40
percent continuity of interest by value on the part of the former historic
shareholders of the target should be sufficient.
In addition to meeting the continuity of interest requirement
immediately after the reorganization, the former shareholders of the acquired
corporation must retain their interest in the acquiring corporation for some
unspecified time after the reorganization. The courts have ruled that the
tax-free nature of the reorganization may be retroactively invalidated if the
continuity of interest is not maintained either because, at the time of the
reorganization, the shareholders intended to dispose of the proprietary interest
soon after the reorganization(2) or because a shareholder disposes of stock
immediately following the reorganization in accordance with a pre-existing
commitment to sell.(3)
In Rev. Rul. 66-23, 1966-1 C.B. 67, the IRS held that the target
shareholders must not have a preconceived plan or arrangement for disposing of
their acquiring corporation stock; if such plan or arrangement exists, any
post-reorganization dispositions of the stock of the acquiring corporation may
be stepped together with the initial receipt of such stock in the
reorganization. The consequence of applying step transaction principles(4) to
the subsequent stock disposition is to treat the selling shareholder as having
received the sales proceeds on the date of the reorganization for purposes of
testing continuity of interest. Nevertheless, target shareholders are free to
dispose of their acquiring corporation stock at any time following the
reorganization, as long as the disposition results from circumstances existing
after the reorganization and not from a
--------
1 Rev. Proc. 77-37, 1977-2 C.B. 568. This is merely a guideline established
by the IRS for purposes of obtaining a private letter ruling, and is not a
requirement of substantive law.
2 XXXXXXXX'X RESTAURANTS OF ILLINOIS, INC. V. COMMISSIONER, 688 F.2d 520 (7th
Cir. 1982).
3 AMERICAN WIRE FABRICS CORP. V. COMMISSIONER, 16 T.C. 607 (1951).
4 See infra notes 11-13 and accompanying text.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 13
preexisting plan.(5) During the period of ownership of the acquiring corporation
stock, the target shareholders must have unrestricted rights of ownership for an
unspecified period of time sufficient to warrant the conclusion that such
ownership is definite and substantial.(6)
For purposes of Code Section 354, the term "party to a
reorganization" is defined in Code Section 366(b), which provides that the term
"party to a reorganization" includes both corporations in the case of a
reorganization resulting from the acquisition by one corporation of stock or
properties of another. In the case of a reorganization qualifying under Code
Section 368 (a) (1) (A) by reason of Code Section 368 (a) (2) (D) , the term
"party to a reorganization" includes the corporation which is in control of the
acquiring corporation.
Code Section 356 (a) (1) provides that if Code Section 354 would
apply to an exchange but for the fact that the property received in the exchange
consists not only of property permitted to be received under Code Section 354
without the recognition of gain but also of other property or money then the
gain, if any, to the recipient shall be recognized but not in excess of the sum
of money and the fair market value of such other property. Code Section 356(c)
states that no loss from the exchange may be recognized by the shareholder.
--------
5 Rev. Rul. 66-23. See also XXXXXX V. COMMISSIONER, 88 T.C. 1415 (1987) ;
ESTATE OF XXXXXXXXX X. COMMISSIONER, 57 T.C.M. (CCH) 1231 (1989). Under
Proposed Regulation Section 1.368-1(e), the IRS states that stock
dispositions of the acquiring corporation by a former target shareholder
generally are not considered for determining continuity of interest.
However, under the Proposed Regulations, if the acquiring corporation or a
related party purchases the acquiring corporation stock shortly after the
reorganization, the facts and circumstances may indicate that the
transaction should be recast to treat the acquiring corporation as
furnishing cash in the reorganization and not satisfying the continuity of
interest requirement. Proposed regulations do not become law until adopted
as final regulations, and generally are applied prospectively once adopted.
Therefore, Proposed Regulation Section 1.368-1(e) is inapplicable to this
transaction. See also infra note 23 and accompanying text.
6 Id.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 14
The IRS, in Rev. Rul. 74-515, 1974-2 C.B. 118 and Rev. Rul. 74-516,
1974-2 C.B. 121, treated the distribution of cash as part of a reorganization
and in a transaction subject to Code Section 356 (including cash payments made
to dissenting shareholders of the acquired corporation) by applying the
redemption principles under Code Section 302. Code Section 302 provides, in
part, that a redemption will be treated as a distribution in part or full
payment in exchange for stock if it can meet the tests of that section. The
Supreme Court in XXXXX X. COMMISSIONER. , 469 U.S. 726 (1989), applied the tests
of Code Section 302 by viewing the exchange involving cash or other property as
a "hypothetical post-reorganization redemption." The Court viewed the exchange
as first an exchange of solely stock of the acquiring corporation for the
acquired company stock, followed by an exchange by the shareholder of the newly
acquired stock for cash from the acquiring corporation. The Code Section 302
tests are applied to the second hypothetical exchange.
One of the tests of Code Section 302 provides that where there is a
complete redemption of all of a shareholder's stock in a corporation (after
consideration of the constructive ownership rules of Code Section 302(c)) , the
redemption payment is treated as made entirely in exchange for the shareholder's
stock in the corporation. Code Section 302(b)(3). The constructive ownership
rules of Code Section 302(c) are generally contained in Code Section 318 and
provide that an individual or entity is treated as owning the stock owned by
certain other related individuals and entities. Where there is a complete
termination of the shareholder's interest, the constructive ownership rules may
be waived if certain conditions are met.
In Rev. Rul. 66-365, 1966-2 C.B. 116, the IRS announced that in a
transaction qualifying as a reorganization under Section 368(a)(1)(A) of the
Code where a cash payment is made by the acquiring corporation in lieu of
fractional shares and is not separately bargained for, such cash payment will be
treated under Section 302 of the Code as in redemption of fractional share
interests. Therefore, each shareholder's redemption will be treated as a
distribution in full payment in exchange for his or her fractional share
interest under Section 302(a) of the Code and accorded capital gain or loss
treatment provided the redemption is not essentially equivalent to a dividend
and that the fractional shares redeemed constitute a capital asset in the hands
of the holder as discussed below. In Rev. Proc. 77-41, 1977-2 C.B. 574, the IRS
stated that "a ruling will usually be issued under Section 202(a) of the Code
that cash to be distributed to shareholders in lieu of fractional share
interests arising in corporate reorganizations will be treated as having been
received in part or
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 15
in full payment in exchange for the stock redeemed if the cash distribution is
undertaken solely for the purpose of saving the corporation the expense and
inconvenience of issuing and transferring of fractional shares, and is not
separately bargained-for consideration."
Under Code Section 358(a)(1) , in the case of an exchange to which
Code Section 354 or Code Section 356 applies, the basis of property which is
permitted to be received under such sections without the recognition of gain or
loss shall be the same as that of the property exchanged, decreased by the
amount of any money received by the recipient and the amount of loss recognized
by the recipient as a result of the exchange and increased by the amount which
was treated as a dividend and the amount of other gain recognized by the
recipient as a result of the transaction.
As described above, where cash is received in lieu of fractional
shares, the substance of the transaction is that of a hypothetical receipt of
the fractional shares and then a redemption of such shares. Therefore, the basis
that is to be allocated to the stock of the acquiring corporation received must
be allocated to the shares retained and the fractional shares hypothetically
received. The gain or loss attributable to the receipt of cash in lieu of
fractional shares is measured by comparing the cash received with the basis
allocated to the Factional shares that are hypothetically received, and such
gain or loss is recognized as discussed earlier pursuant to Rev. Rul. 66-365.
Code Section 361 (a) states that, as a general rule, no gain or loss
is to be recognized by a corporation if such corporation is a party to a
reorganization and exchanges property, in pursuance of the plan or
reorganization, solely for stock or securities in another corporation a party to
the reorganization. Code Section 361(b) states that if Code Section 361(a) would
apply to an exchange but for the fact that the property received in the exchange
consists not only of stock or securities afforded nonrecognition treatment under
Code Section 361(a), but also of other property or money, then provided the
corporation receiving such other property or money distributes it in pursuance
of the plan of reorganization, no gain to the corporation shall be recognized
from the exchange. Code Section 361(c) states that as a general rule no gain or
loss shall be recognized by a corporation a party to a reorganization on the
distribution to its shareholders of any stock in another corporation which is a
party to the reorganization if such stock was received by the distributing
corporation in the exchange.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 16
Code Section 1032(a) states that no gain or loss shall be recognized
to a corporation on the receipt of money or other property in exchange for such
corporation's stock, including treasury stock.
Code Section 362(a) states that the basis of property received by the
acquiring corporation in a reorganization is the same as it would be in the
hands of the transferor of the assets, increased by any gain recognized by the
transferor. The transferors for purposes of the preceding sentence in the
instant case is TPC and EFCC.
Code Section 1221 defines a capital asset as property held by the
taxpayer which is not inventory or other property held by the taxpayer primarily
for sale to customers in the ordinary course of a trade or business, property
used in the taxpayer's trade or business subject to the allowance for
depreciation under Code Section 167, a copyright, literary, musical or artistic
composition, a letter or memorandum, or similar property created by the personal
ef forts of the taxpayer, accounts or notes receivable acquired in the ordinary
course of a trade or business f or services rendered or from the sale of
inventory or other property held by the taxpayer primarily f or sale to
customers in the ordinary course of business, or a publication of the United
States Government which is received from the United States Government or any
agency thereof other than by purchase at the price at which it is offered for
sale to the public.
Code Section 1223(1) states that in determining the period f or which
a taxpayer has held property received in an exchange, there shall be included
the period for which he or she held the property exchanged if the property has,
for the purpose of determining gain or loss from a sale or exchange, the same
basis as the property exchanged and the property exchanged was a capital asset
as defined in Code Section 1221 as of the date of the exchange. Code Section
1223(2) states that for determining the period for which the taxpayer has held
property however acquired there shall be included the period for which such
property was held by another person if the property has the same basis in whole
or in part in his hands as it would have had in the hands of such other person.
2. STAR MERGER
(a) General
Code Section 368(a)(2)(D) provides that the acquisition by one
corporation, in exchange for stock of a corporation which is in control of the
acquiring corporation, of substantially all of the
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 17
properties of another corporation shall not disqualify a transaction under Code
Section 368(a) if no stock of the acquiring corporation is used in the
transaction and such transaction would have qualified under Code Section
368(a)(1)(A) had the merger been into the controlling corporation. Regulations
permit the acquiring corporation or its parent or both to pay some cash, subject
to the continuity of interest requirement discussed above.
Accordingly, an acquisition by Merger Sub in exchange for stock of
Star should qualify as a Code Section 368(a)(1)(A) reorganization via Code
Section 368(a)(2)(D) if (1) substantially all of the properties of EFCC are
acquired by Merger Sub; (2) EFCC is merged into Merger Sub pursuant to state
law; (3) the Star Merger would have qualified under Code Section 368(a)(1)(A)
had it been effected directly into Star; and (4) no stock of the Merger Sub is
used in the Star Merger.
(b) The "Substantially All" Requirement
The "substantially all" requirement has not been statutorily defined.
The determination of "substantially all" is based upon all the facts and
circumstances of each transaction. The IRS's advance ruling guidelines, Rev.
Proc. 77-37, 1977-2 C.B. 568,(7) provide that the "substantially all"
requirement will be met if at least 90% of the fair market value of the net
assets and at least 70% of the fair market value of the gross assets of the
acquired corporation immediately before the merger are transferred to the
acquiring corporation. All payments to dissenters and all redemptions and
distributions (except for regular, normal distributions) made by the corporation
immediately preceding the transfer and which are part of the plan of
reorganization will be considered as assets held by the corporation immediately
prior to the transfer. In addition, where a corporate division effected prior to
and in contemplation of the reorganization removes assets from target, the
reorganization may be taxable on the ground that the acquiror has not acquired
substantially all of target's "historic" assets.(8)
Unlike a spin-off of unwanted assets, a sale of a portion of target's
assets prior to the reorganization does not deplete the aggregate amount of
target's assets -- it only changes the makeup of those assets. That is, the
assets sold are replaced with the
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7 SEE ALSO Rev. Proc. 86-42, 1986-2 C.B. 722.
8 SEE HELVERING V. ELKHORN COAL CO., 95 F.2d 732 (4th Cir. 1938), CERT.
DENIED, 000 X.X. 000 (1938).
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 18
consideration received on the sale, whether it is cash, notes or other assets.
Provided the sale of assets does not destroy continuity of business enterprise,
the nature and amount of the assets sold should have no bearing on the
qualification of the reorganization so long as the sale proceeds remain with the
target's other assets and are not distributed to the shareholders.
In Rev. Rul. 88-48, 1988-1 C.B. 117, target sold one of its two
significant lines of business (constituting 50% of its historic business assets)
for cash and then transferred its other line of business together with the cash
proceeds to acquiror in exchange for acquiror voting stock in a Code Section
366(a)(1)(C) reorganization. The IRS held that because the cash proceeds were
not retained by target or its shareholders but were transferred to acquiror, the
transaction was not divisive in nature. Also, because the sale of the historic
business assets was to "unrelated purchasers," the former target shareholders
retained no direct or indirect interest in those assets. The term "unrelated
purchaser" was not defined or specified. Under those circumstances, the IRS
ruled, the "substantially all" requirement was met.
In the instant case, the sale of TPC's Jersey City, New Jersey
division was to a person who should be treated as an unrelated purchaser for
purposes of the "substantially all" requirement for full and adequate
consideration in a fully taxable transaction. Such consideration was
subsequently transferred to EFCC in the TPC/EFCC merger and will then be
transferred to Merger Sub in the Star Merger of EFCC with and into Merger Sub.
Thus, such sale should not impact the "substantially all" requirement. Based on
the above analysis and on the representation in the Letters of Representation
that EFCC will transfer to Merger Sub and Merger Sub will acquire at least 90
percent of the fair market value of EFCC's net assets and at least 70 percent of
the fair market value of EFCC's gross assets held immediately prior to the Star
Merger, including, but not limited to, the assets formerly held by TPC, the
"substantially all" requirement should be met with respect to the properties of
EFCC acquired by Merger Sub in the Star Merger.
(c) Continuity of Business Enterprise
Based on representations included in the Letters of Representation
that following the Star Merger, Merger Sub will continue the historic business
of TPC or use a significant portion of TPC's historic business assets in a
business (as such terms are defined in Treasury Regulation Section 1.3 68-1
(d)(2)) , the continuity of business enterprise requirement should be met with
respect to the assets and business operations of TPC, EFCC and Merger Sub.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 19
(d) Business Purpose
In general, Star and EFCC believe that a combination of their
respective businesses will enable both companies to grow and operate more
efficiently. Based on these reasons, the Star Merger should meet the business
purpose requirement.
(e) Continuity of Interest
(1) Arbor Options
For purposes of the Star Merger, continuity of interest must exist in
the "historic shareholders" of EFCC. The exercise of Arbor's options in
contemplation of the Star Merger raises two continuity of interest issues: (1)
does the EFCC stock issued upon exercise of the Arbor options count as
outstanding EFCC stock in applying the continuity of interest test and (2) if
the EFCC stock does count, is Arbor considered to be an historic EFCC
shareholder?
In General Counsel Memoranda ("GCM") 36040 and 36041 (Oct. 8, 1974),
as part of a plan of reorganization, the holders of target warrants and
convertible target debt converted these instruments into target stock and then,
along with the other target shareholders, exchanged their target stock for
acquiror stock in the reorganization. At issue was whether the step-transaction
doctrine should apply to treat the transactions as though the target warrants
and target convertible debt were exchanged directly for acquiror stock. The IRS
concluded that the step-transaction doctrine should not apply because to do so
would ignore the right inherent in the warrants and debentures that allows the
holder thereof to acquire an equity interest in target. Thus, the IRS honored
the form of the transactions and preserved tax-free reorganization treatment for
the warrant holders and convertible debenture holders.
It is unclear whether the IRS would apply the same rationale for
purposes of measuring continuity of interest.(9) On the one
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9 See Priv. Let. Rul. 9008028 (Nov. 21, 1989) (the target shares acquired on
exercise of the options are not excluded from the 50% continuity
representation); BUT SEE Priv. Let. Rul. 9105028 (Nov. 6, 1990) (the target
shares acquired on exercise of the options are excluded from the 50%
continuity representation). Private Letter Rulings may not be relied upon
or otherwise cited as precedent. However, we believe it is appropriate to
refer to them in order to demonstrate an administrative position
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 20
hand, the holdings in GCM 36040 and 36041 imply that the IRS might conclude that
the newly issued EFCC shares count in applying the continuity of interest test.
A representation obtained by the IRS from a taxpayer in a 1993 private letter
ruling also suggests this result.(10) On the other hand, taxpayer
representations in two other private letter rulings indicate that the IRS might
ignore the newly issued EFCC shares in applying the continuity of interest
test.(11)
If the IRS in fact counts the newly issued EFCC shares in measuring
continuity, does Arbor qualify as an historic EFCC shareholder? This issue could
be resolved in three ways:
(i) Arbor automatically could be treated as a non-historic
EFCC shareholders, i.e., as bad continuity.
(ii) Arbor automatically could be treated as an historic EFCC
shareholders, i.e., as good continuity.
(iii) The determination of whether Arbor is an historic EFCC
shareholder could be based on whether it was an historic holder of the options,
i.e., whether it acquired the options in contemplation of the Star Merger.
Some commentators favor approach (iii),(12) although there is no
authority directly on point. The risk that the IRS will disagree and analyze
Arbor's stock ownership in EFCC under approach (i), i.e., the least favorable
approach, exists. In the absence of a private letter ruling from the IRS,
prudence dictates that Arbor be treated as a non-historic shareholder of EFCC
for purposes of calculating the EFCC shareholders' continuity of interest in the
merged entity. Thus, the other historic EFCC shareholders must hold, with the
requisite intent and for the requisite period, Star stock equal to at least 40%
of the fair market value of all of the EFCC shares outstanding immediately prior
to the Star Merger (including the shares received by Arbor pursuant to the
exercise of its options) to satisfy the continuity of interest test.
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previously taken by the Service.
10 Priv. Let. Rul. 9324021 (Mar. 19, 1993) (representation c).
11 SEE Priv. Let. Rul. 9105028 (Nov. 6, 1990) (representation b),
supplemented by Priv. Let. Rul. 9132068 (Apr. 19, 1991) (representation b);
Priv. Let. Rul. 9136027 (June 11, 1991) (representation c).
12 Xxxxxx X. Xxxxxxxx and Tack X. Xxxxx, Mergers, Acquisitions, and Buyouts,
ss 610.3.2 (Jan. 1996).
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 21
(2) Pre-Merger Dividend
We believe that the $750,000 of cash distributed by EFCC to all of
its shareholders with respect to their shares prior to the Star Merger should
not be taken into account for purposes of the continuity of interest test. In
Private Letter Ruling 9041064 (July 19, 1990), three corporations paid
significant dividends to their shareholders immediately prior to merging into an
acquiring corporation and as part of the same plan. The IRS ruled that the
mergers qualified as tax-free Code Section 368(a)(1)(A) reorganizations. We
believe the salient point is that the $750,000 dividend did not come from Star
or the Merger Sub. There is no justification for the IRS to conclude that this
cash should be deemed to have come from Star or the Merger Sub, especially since
the cash is proceeds from the exercise of Arbor's options, and not from a
disposition or liquidation of operating assets or equity interests.(13)
Nevertheless it is possible that the IRS may assert that the $750,000
distribution paid by EFCC must be taken into account in applying the continuity
of interest test, which could cause continuity of interest to fall below an
acceptable level to preserve tax-free reorganization treatment.
(3) Less than 5% Shareholders
As a practical matter, in the case of a widely held and publicly
traded target corporation, it is difficult to determine which of the target
corporation's public shareholders have held their target stock long enough to
become historic target shareholders and whether such target corporation's less
than 5% public shareholders intended at the time of the reorganization to retain
their acquiring corporation stock and whether and for how long they in fact
retain such stock following the reorganization. The IRS seems to have recognized
this reality and for purposes of issuing private rulings has focused only on
target shareholders owning at least 5% of the outstanding target stock as well
as target insiders. See Rev. Proc. 77-37, section 7, added by Rev. Proc. 86-42.
The Tax Court seems to agree. In the SEAGRAM CORP. V. COMMISSIONER, 104 T.C. 75
(1995), the Tax Court stated, "[a] requirement that the identity of the acquired
corporation's shareholders be tracked to assume a sufficient number of
'historic' shareholders to satisfy some arbitrary minimal percentage receiving
the acquiring corporation's stock would be completely unrealistic."
--------
13 See XXXXXX INDUSTRIES INC. V. COMMISSIONER, 89 T.C. 1086 (1987), ACQ. IN
RESULT, 1988-2 C.B. 1; TSN LIQUIDATING CORP. V. U.S., 624 F.2d 1328 (5th
Cir. 1980). Accord UNIROYAL INC. V. COMMISSIONER, 65 T.C.M. 2690 (1993).
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 22
104 T.C. at 103. Thus, since we believe EFCC should be considered to be widely
held for these purposes, noninsiders who own less than 5% of the outstanding
EFCC stock and who exchange their EFCC stock for Star stock in the Star Merger
generally should be counted toward satisfying the continuity of interest
requirement.
(4) Prior Merger of TPC Into EFCC
As discussed above, a tax-free transaction in which a target
corporation's stock is transferred to new shareholders followed by a subsequent
tax-free reorganization of the target corporation into another corporation
should be respected if such initial transaction has independent significance and
a business purpose.(14) The issue addressed is whether the subsequent merger
affects the qualification of the original reorganization, but implicit in this
analysis is the notion that the new target corporation shareholders may supply
the necessary continuity of interest to qualify the subsequent merger as a
tax-free transaction even though the original reorganization and the subsequent
merger occur pursuant to an overall plan.
In several private letter rulings, the IRS has held that a merger of
a parent corporation into another corporation preceded by an upstream merger or
liquidation of a wholly-owned subsidiary into the target parent corporation
qualified as tax-free reorganization under Code Section 368 (a).(15) Although we
are unaware of any direct case law authority supporting this proposition, we
believe the conclusion is consistent with the policies underlying the
reorganization provisions of Code Section 368 et. seq. since the shareholders in
the TPC Merger principally changed the form of their ownership but retained the
requisite proprietary interest. Therefore, subsequent to their exchange of TPC
stock for EFCC stock pursuant to the TPC Merger and based on the representations
in the Letters of Representation, the former shareholders of TPC should be
treated as historic shareholders of EFCC for purposes of satisfying the Star
Merger's continuity of interest requirement. In addition, based on the
representations in the Letters of Representation and the discussion above, Xxxx
and the public shareholders are historic shareholders of EFCC.
--------
14 See supra notes 11-13 and accompanying text.
15 See Priv. Let. Rul. 8713033 (Dec. 29, 1986); Priv. Let. Rul. 8425081 (Mar.
21, 1984) ; Priv. Let. Rul. 8032114 (May, 1980); Priv. Let. Rul. 8024137
(Mar. 20, 1980).
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 23
(5) Post-Reorganization Continuity of Interest
Based on the representations in the Letters of Representation that as
of the Effective Time, Xxxx, the shareholders of Xxxx and any other shareholder
of EFCC, including the former shareholders of TPC, will not have a binding
commitment or preconceived plan or arrangement for disposing of any of their
Star common stock received in the Star Merger, the former EFCC shareholders will
satisfy the continuity of interest requirement that they retain their interest
in Star for some unspecified time after the reorganization.(16)
(6) Value of Star Common Stock
The IRS position in connection with determining whether at least
50%(17) by value of the target corporation's outstanding stock is exchanged for
the acquiring corporation's stock in the reorganization is that the value of the
target corporation stock is determined "as of the effective time of the
reorganization."(18) Nevertheless, assuming that the fair market value of the
outstanding EFCC stock at the Effective Time is determined by reference to the
exchange value of the EFCC stock in terms of Star stock and cash, and assuming
that the parties to the Star Merger make a good faith and reasonable effort to
achieve a consideration mix consisting of at least 40% Star stock, the use of a
value as determined on the third business day prior to the Effective Time, using
the average of the closing sales price of a share of Star common stock as
reported on the NASDAQ National Market during the 120 trading days immediately
preceding the date of determination should be sufficient for purposes of
determining whether the 40% continuity of interest requirement is met in the
Star Merger if, solely as a result of market fluctuations between the date that
the
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16 See supra notes 3-6 and accompanying text.
17 As discussed above at note 1 and accompanying text, the IRS has announced
that it considers a 50 percent continuity-of-equity interest by value to be
sufficient. Rev. Proc. 77-37. Nevertheless, pursuant to the XXXXXX case and
as discussed above, a 40 percent continuity of interest by value on the
part of the former historic shareholders of the target should be
sufficient.
18 Id.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 24
Merger Agreement is signed and the Effective Time, the consideration paid to the
EFCC historic shareholders turns out to be less than 40% Star stock.(19)
This formula was devised by the parties in an attempt to minimize the
impact on the business arrangement of temporary market fluctuations of Star
stock. In addition, since (1) there was an unusually protracted time period
between the parties agreement in concept and an actual contract and closing, (2)
the shareholders of EFCC had locked in their investment during the 120 days
since the principal economic terms of the transaction were in place, (3) Star
assumed the management of EFCC and the profits therefrom were largely payable to
Star in the form of consulting fees so that the EFCC shareholders could share in
those profits during such period only through this pricing mechanism and (4) the
principal reason for not closing the Star Merger immediately was the need to
secure approvals of governmental authorities, the adjustment mechanism merely
reflects the fact that the economic merger of EFCC and Star does not occur
solely on the closing date, but rather will occur incrementally over time so
that a valuation as of the closing date is less likely to accurately reflect the
true value of the continuity of interest of the EFCC shareholders. However,
there is no authority that addresses whether an average trading price may be
used and there is a risk that this issue could be resolved unfavorably. If the
price of the Star stock declines prior to the Effective Time, the risk that the
Star Merger will be treated as a taxable transaction by the IRS becomes greater.
Immediately prior to the Effective Time, the historic shareholders of
EFCC (i.e., Xxxx, the former TPC minority shareholders and the other public
shareholders of EFCC, assuming Arbor is not an historic shareholder of EFCC)
will own 66.8% of the stock of EFCC. For purposes of calculating continuity of
interest, the value of the stock consideration paid by Star ($4,400,000) to the
EFCC shareholders in the Star Merger will equal 60.69% of the total
consideration paid by Star ($7,250,000) in the Star Merger. Thus, 40.54% of the
total consideration paid by Star to the historic shareholders of EFCC will
consist of Star stock.
Based on the representations in the Letters of Representation, and
assuming that (1) EFCC's shareholders receive Star common stock with a value of
at least $4,607,5O6(20) as determined on the third business day prior to the
Effective Time, using the average of the
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19 SEE Rev. Rul. 81-190, 1981-2 C.B. 84.
20 See infra note 28.
Extended Family Care Corporation, Inc.
Star Multi Care Services, Inc.
July 24, 1997
Page 25
closing sales price of a share of Star common stock as reported on the NASDAQ
National Market during the 120 treading days immediately preceding the date of
determination and that (2) all shareholders receive, at a maximum, aggregate
cash in the amount of $2,714,998,(21) which amount includes total cash paid to
dissenting shareholders, it is our opinion that, although not free from doubt,
the continuity of interest requirement should be met with respect to the Star
Merger.
Very truly yours,
Xxxxxxx, Lippe, Goldstein, Wolf
& Xxxxxxxxx, P.C.
By:
Xxxxxxx X. Xxxxxxxxxx
--------
21 These numbers are based on certain assumptions as to possible payments to
dissenting shareholders. If the value of the stock received by the EFCC
shareholders is less than $4,607,506 and/or the amount of cash received is
greater than $2,714,998, the continuity of interest test will be below 40%
and, therefore, tax-free reorganization treatment may be jeopardized.
