The information presented is only of a general nature, intended simply as background material, is current only as of the latest revision date, October 15, 2007, omits many details and special rules and cannot be regarded as legal or tax advice.

Internal Revenue Code §§ 354 and 356

Target Shareholders

No gain or loss is recognized on the receipt of Acquiring or Parent stock (depending on the form of the reorganization), other than nonqualified preferred stock, in exchange for Target stock.

Gain, but not loss, is recognized to the extent any other property, e.g., cash or Acquiring or Parent indebtedness or nonqualified preferred stock (unless exchanged for Target nonqualified preferred stock), is received.

Any recognized gain is recharacterized as ordinary income if the distribution of such other property has the effect of distribution of a dividend.

A right to receive contingent or escrowed stock is regarded as stock, and not other property, if the IRS specified conditions are satisfied.

Gain recognized with respect to the receipt of indebtedness may in some circumstances be reportable under the installment sale method.

The basis of Acquiring or Parent stock received by a Target shareholder is generally equal to such shareholder's basis in the surrendered Target stock. Any other property received will ordinarily have a fair market value basis.

Target Securityholders

It is often unclear whether a particular Target debt instrument constitutes a security under the reorganization provisions. Generally, debt having a term of less than five years is not a security, while debt having a term in excess of ten years is.

Gain, but not loss, is recognized to Target securityholders upon receipt of Acquiring or Parent securities (depending on the form of reorganization) equal to the fair market value of the amount by which the principal amount of securities received exceeds the principal amount of the Target securities.

Under the original issue discount rules, "adjusted issue price" is used in place of principal amount.

Prior law providing, in essence, that no original issue discount could be created upon issuance of debt in a reorganization, has been repealed. The Acquiring or Parent debt issued to the former Target securityholders can have original issue discount, even where the Target debt did not (e.g., where the newly issued debt initially trades publicly at a discount or where none of the debt is publicly traded and the newly issued debt bears interest at a rate less than the applicable federal rate).

The basis of Acquiring or Parent securities received tax-free in the reorganization will generally equal the basis of the Target securities. Any other property, including the excess principal amount (or excess adjusted issue price) of any Acquiring or Parent securities, will ordinarily have a fair market value basis.

Target Optionholders and Warrantholders

Employees and other service providers.

Nonstatutory options do not result in any transfer of property when granted; accordingly, the "exchange" of nonstatutory Target options for nonstatutory Acquiring or Parent options is not a taxable event.

Incentive stock options ("ISOs").

It is usually important that any assumption of Target ISOs or substitution of Acquiring or Parent ISOs for Target ISOs not be considered the grant of a new option, as a newly granted ISO would need to be repriced at the underlying stock's then fair market value.

Typical adjustment formulae based on the exchange ratio in the reorganization will ordinarily satisfy the requirement that the ISO holder not obtain an increase in the aggregate "spread" in the holder's ISOs.

Under regulations adopted in January of 1998, non-service related options and warrants are treated as "securities" with no principal amount. Thus, other holders of options and warrants (e.g., prior purchasers of debt-warrant investment units) will recognize no gain or loss upon exchange of Target options or warrants for Acquiring or Parent options, warrants or stock. In addition, holders of Target stock can receive a combination of Acquiring or Parent options, warrants or stock.

© 2007