Berbano, Kevin Joseph Mergers & Acquisitions

Gallardo, Christian Andrew November 15, 2018

Gonzales, Trixie
Manalang, Alyanna Marie T.
Sabaupan, Liezel Angelique

EXECUTIVE SUMMARY OF THE DUE DILIGENCE ON:

AAA, BBB, and CCC Corporation

There are three corporations involved in this transaction. AAA Corporation is a family-owned
corporation engaged in the business of warehousing. AAA was incorporated two years ago, but owns vast
tracts of land in the Bulacan area. The owners of AAA Corporation also owns and manages CCC
Corporation. It is recently incorporated and has not started operations as of yet.

BBB Corporation, incorporated one year ago, is engaged in the business of cold storage
warehousing. The owners of BBB Corporation are also engaged in the business of retailing and own
several retail stores throughout the country, and are the majority owner of a bank, to which the lands of
AAA Corporation are mortgaged to.

Goal of the Transaction

BBB Corporation, our client, seeks to expand its cold storage warehousing business by acquiring
the lands currently owned by AAA and CCC Corporation. The suggested transaction is a merger, wherein
AAA Corporation and CCC Corporation would be absorbed by BBB, the surviving corporation. After the
merger, the goal is to have the present owners of BBB Corporation own 51% of the stocks, while the
family owners of AAA and CCC Corporation to own 49% of the stocks. AAA and CCC Corporation also
want to expand their business and acquire other parcels of land, whether pre- or post-merger.

Deal Breakers, Red Flags, and Possible Risks

A. Financial Statements Review

Since AAA Corporation is only recently incorporated, they mostly have operation expenses.
Transfer Certificate Titles (TCTs) of their assets are also encumbered by mortgage. The mortgage, if still
present upon merger, would be assumed by BBB Corporation. Furthermore, it must be noted that the
properties are located in Bulacan and Laguna. As compared to the fair market values of real properties
located in Manila, the fair market values of the real properties located in Bulacan and Laguna are much
lower. Taking this into consideration, BBB would be prejudiced as its real properties are located in the
Metropolitan Manila.
 AAA corporation has not yet also disclosed whether or not it has pending litigation or labor
issues. This fact alone also raises a red flag. At this point in time, they should have already disclosed such
facts even in passing.

AAA corporation is also more susceptible to litigation because it is heavily burdened with
encumbrances on its properties. Default of payments may lead to foreclosure and when this happens,
AAA corporation will be left with no properties which leaves BBB corporation at a disadvantage.

CCC Corporation, on the other hand, just received its certificate of incorporation last September.
This means that it is a start-up business without capacity to earn profits yet. Also, being a start-up
business, it has yet to recover its expenses in incorporation and registration fees. This places BBB
Corporation at prejudice as it will definitely use its resources to recover the aforementioned expenses
upon merging with both AAA and BBB.

B. Management and Operations Review

AAA and CCC Corporation are owned and managed by the same family. Hence, there may be
minimal risks as to the reliability of records and the control measures in their corporation, and the family
owners are likely to be aware of what is happening to the rest of the company.
However, it must also be noted that one of the core competencies of a family business is its
cultural distinctiveness. While it does not clearly appear on the books, family culture and history and
continued leadership and influence can be both an asset and a liability depending on how it can be
utilized. A sudden change in ownership, or the involvement of “outsiders” in how a family business is
being run, can create a huge impact in the family business. Hence, a well-defined strategy to understand
the unique culture of the firm, taking into consideration the relationship of the family members with each
other as well as the beliefs, discipline and values that make up structures of an organization, must be
formulated.

C. Legal Liability Review

General Banking Law

Since BBB Corporation owners are also majority owner of the bank, to which AAA Corporation
mortgaged their land, there may be possible issue under the General Banking Law. According to Article
36 of the law:

“SECTION 36. Restriction on Bank Exposure to Directors, Officers, Stockholders and

Their Related Interests.

No director or officer of any bank shall, directly or indirectly, for himself or as the
representative or agent of others, borrow from such bank nor shall he become a
guarantor, indorser or surety for loans from such bank to others, or in any manner be an
obligor or incur any contractual liability to the bank except with the written approval of
the majority of all the directors of the bank, excluding the director concerned: Provided,
 That such written approval shall not be required for loans, other credit accommodations
and advances granted to officers under a fringe benefit plan approved by the Bangko
Sentral. The required approval shall be entered upon the records of the bank and a copy
of such entry shall be transmitted forthwith to the appropriate supervising and examining
department of the Bangko Sentral.

Dealings of a bank with any of its directors, officers or stockholders and their related
interests shall be upon terms not less favorable to the bank than those offered to others.

After due notice to the board of directors of the bank, the office of any bank director or
officer who violates the provisions of this Section may be declared vacant and the
director or officer shall be subject to the penal provisions of the New Central Bank Act.
The Monetary Board may regulate the amount of loans, credit accommodations and
guarantees that may be extended, directly or indirectly, by a bank to its directors,
officers, stockholders and their related interests, as well as investments of such bank in
enterprises owned or controlled by said directors, officers, stockholders and their related
interests. However, the outstanding loans, credit accommodations and guarantees which
a bank may extend to each of its stockholders, directors, or officers and their related
interests, shall be limited to an amount equivalent to their respective unencumbered
deposits and book value of their paid-in capital contribution in the bank: Provided,
however, That loans, credit accommodations and guarantees secured by assets
considered as non-risk by the Monetary Board shall be excluded from such limit:
Provided, further, That loans, credit accommodations and advances to officers in the
form of fringe benefits granted in accordance with rules as may be prescribed by the
Monetary Board shall not be subject to the individual limit.

The Monetary Board shall define the term "related interests."

The limit on loans, credit accommodations and guarantees prescribed herein shall not
apply to loans, credit accommodations and guarantees extended by a cooperative bank to
its cooperative shareholders. (83a)”

Tax Implications

The tax implications of the foregoing transaction will depend on what type of acquisition the
parties ultimately agree upon. The different types of taxes which a particular transaction will attract are as
follows:

I. Asset-only Acquisition

BBB Corporation may opt to acquire only the lands owned by AAA Corporation since these are
the assets essential for its goal of expanding its cold storage warehousing business. If that were the case,
the following taxes will have to be paid by the parties before the title to land could be validly transferred
to BBB Corporation: Capital Gains Tax, Real Property Tax, Documentary Stamp Tax.
 Capital Gains Tax is currently levied at 6% on the gain presumed to have been realized on the
sale of lands and/or buildings, as provided for in Section 27(D)(5) the NIRC, as amended. The transaction
will also attract the payment of Documentary Stamp Taxes, as provided by the for in Section 196 of the
NIRC, as amended, which levies said tax on deeds of sale and conveyances of real property. Lastly
payment of Real Property Tax is mandated under Section 209(b) of the Local Government Code before
the Registrar of Deeds can validly register the land in the purchaser’s name.

It is also worth noting that an asset-only transaction can attract the application of the Bulk Sales
Law. Section 2 of the Bulk Sales Law provides that such law shall apply when the transaction consists of
the sale of all or substantially all of the business conducted by the vendor. Since AAA Corporation is
engaged in the business of warehousing, the sale of the lands it uses in its business may constitute a
substantial portion of its assets.

II. Equity Acquisition

BBB Corporation can also opt to acquire the shares of stock of AAA Corporation and CCC
Corporation so that it can indirectly own the assets of the latter corporations. An equity transaction can
attract the payment of Capital Gains Tax or Stock Transaction Tax. Section 27(D)(2) of the NIRC, as
amended by TRAIN, provides that the Capital Gains Tax shall be levied at 15% on the net capital gains
realized from the sale of the shares of stock not listed and traded through the local stock exchange. If the
shares of stock are listed and traded through the local stock exchange, Section 127(A) of the NIRC, as
amended by TRAIN, requires the payment of the Stock Transaction Tax which is currently levied at sex-
tenths of one percent (6/10 of 1%) of the gross selling price or the gross value in money of the shares of
stock sold.

III. Merger or Consolidation

If BBB Corporation were to enter into a merger with AAA Corporation and CCC Corporation,
then such transaction will be considered a tax-free exchange pursuant to Section 40(C)(2) of the NIRC, as
amended, to wit:

“(2) Exception. - No gain or loss shall be recognized if in pursuance of a plan of merger or

consolidation -
(a) A corporation, which is a party to a merger or consolidation, exchanges property
solely for stock in a corporation, which is a party to the merger or consolidation; or
(b) A shareholder exchanges stock in a corporation, which is a party to the merger or
consolidation, solely for the stock of another corporation also a party to the merger or
consolidation; or
(c) A security holder of a corporation, which is a party to the merger or consolidation,
exchanges his securities in such corporation, solely for stock or securities in such
corporation, a party to the merger or consolidation.
No gain or loss shall also be recognized if property is transferred to a corporation by a person in
exchange for stock or unit of participation in such a corporation of which as a result of such
 exchange said person, alone or together with others, not exceeding four (4) persons, gains control
of said corporation: Provided, That stocks issued for services shall not be considered as issued in
return for property.”

Thus, in Commissioner of Internal Revenue v. Rufino, the Supreme Court ruled that if a merger
was undertaken for a bona fide business purpose, and not merely for the purpose of escaping the burden
of taxation, the exchange of properties involved therein shall not be subject to capital gains tax. In BBB
Corporation’s case, the purpose of the parties in entering into the transaction is to expand its business;
hence, the same is for a bona fide business purpose and not merely for the purpose of evading taxation.

It has been also held by the Supreme Court in CIR v. La Tondena Distillers, Inc. that the transfer
of real property to a surviving corporation pursuant to a merger is not subject to Documentary Stamp Tax.

The Philippine Competition Act

The Philippine Competition Act, designed to prevent anti-competitive mergers and acquisitions,
empowers the Philippine Competition Commission to review mergers and acquisitions based on factors
deemed relevant by the Commission. Section 20 of the Philippine Competition Act provides for the
prohibited mergers and acquisitions, to wit:

“Section 20. Prohibited. Mergers and Acquisitions. – Merger or acquisition agreements that
substantially prevent, restrict or lessen competition in the relevant market or in the market for
goods or services as may be determined by the Commission shall be prohibited.”

Thus, the parties to this particular transaction should notify The Philippine Competition
Commission so that the latter may determine whether such agreement is prohibited under Section 20 and
does not qualify for exemption under Section 21 of the Philippine Competition Act. Compliance with this
particular law is paramount since a violation thereof could warrant the penalties of imprisonment and a
fine up to the amount of two hundred fifty million pesos.
 INITIAL MODE OF ACQUISITION: MERGER

Company 1 Company 2 Company 3

ASSETS Owns real properties Owns warehouse and No operations yet

(e.g. lands and cold storage and
building) retail business

LIABILITIES Titles: mortgaged to

the bank which is
owned by the
Company 2 owner

High in debt

OWNERSHIP Family-owned (Same Family-owned (Same

owner as company 3) owner as Company
1)

STATUS Absorbed Surviving Corporation Absorbed

Corporation Corporation

TIME OF Incorporated 2 years Incorporated a year Incorporated recently

INCORPORATION ago ago

NOT YET Litigations and What type of goods?

DETERMINED employee issues

GOALS:
1. NEW CORP: 51% owned by Company 2; 49% owned by Companies 1&3
2. Companies 1 & 3 want to acquire more lands in the north

POSSIBLE ISSUES:
1. Acquiring of land:
a. better if pre or post merger?
b. Tax implication if pre or post merger?
2. What type of investment?
a. Cash
b. Advances
c. Deposits of future subscriptions?