Material Transaction Agreements in Spin-Offs

In connection with spin-off transactions, a number of material agreements are entered into between the parent company and spin-off company that govern their ongoing relationships following the spin-off. Such agreements may include a Separation and Distribution Agreement, Transition Services Agreement, Tax Matters Agreement, Employee Matters Agreement, Trademark License Agreement, Intellectual Property Cross-License Agreement, and Real Estate Matters Agreement.

These agreements provide and allocate various services, rights, and indemnification obligations between the parties following the spin-off. The terms of these agreements must be carefully structured in order to ensure a smooth relationship after the spin-off closes. This is particularly important for any long-term arrangements and, in the case of tax-free spin-offs, for preserving the tax-free nature of the spin-off. Careful drafting of these material agreements will also mitigate the risk of post-spin disputes arising between the parent company and spin-off company.

Separation and Distribution Agreement

The Separation and Distribution Agreement outlines the agreements between the parent company and spin-off company with respect to the principal actions required to consummate the spin-off and various aspects of their ongoing relationship after the completion of the spin-off.

The asset and liability transfer provisions of the Separation and Distribution Agreement will identify the transfers of asset and assumptions of liabilities. It will also define the excluded assets and retained liabilities. The body of the Separation and Distribution Agreement will typically include categorical descriptions of the assets and liabilities, while the schedules attached to the agreement will list the specific assets and liabilities that fall within the specified categories.

The assets are usually transferred on an “as is, where is” basis. This means that the assets are transferred in their present condition and the agreement does not make representations as to undisclosed liabilities, financial statements, or other such matters.

The Separation and Distribution will also generally include provisions to account for potential delays in the transfer of assets, liabilities, permits, or other items intended to be transferred prior to the completion of the spin-off. Such delays may be due to issues with obtaining government regulatory approvals and required third-party consents. In such circumstances, the parties are obligated to use reasonable best efforts to effectuate such transfers as soon as practicable following the spin-off. The Separation and Distribution Agreement also typically provides the parent company and spin-off company with information access rights.

Transition Services Agreement

The Transition Services Agreement stipulates that the parent company and spin-off company will provide each other with specified services for a limited period of time to facilitate a smooth transition after the spin-off. These may include services such as information technology, human resources, legal, payroll, and accounting. The transition services are generally intended to be provided for no longer than two years following the closing of the spin-off.

Services intended to be provided on a short-term basis, such as administrative and other support services, may be provided on a cost basis. Services that may need to be provided on a longer-term basis, such as operational or commercial services, should be provided with arm’s length terms and pricing.

Tax Matters Agreement

The allocation of responsibility over tax obligations and liabilities of the parent company and spin-off company following the spin-off is a particularly hot topic. The Tax Matters Agreement sets forth the respective rights and obligations of the parent company and spin-off company with respect to tax matters.

There are three approaches to the allocate of tax liabilities. The approach used depends on the type of taxes involved. The first approach allocates tax liabilities on a pre-closing and post-closing basis. In other words, the parent company is obligated to pay the specified taxes covering the timeframe prior to the spin-off closing and the spin-off company is obligated to pay the specified taxes covering the timeframe after the spin-off closes. The second approach allocates responsibility using a “line-of-business” split. Regardless of the timeframe, the parent company is responsible for paying taxes of the businesses it retains and the spin-off company is responsible for paying taxes of the spun-off businesses. The final approach is referred to as letting taxes “lie where they fall” under the law. This means that the responsibility for paying the applicable taxes should fall on the legal entity that the law imposes the tax on.

For tax-free spin-offs, the Tax Matters Agreement will contain additional provisions restricting the spin-off company from taking certain actions in the two-year period after the spin-off. For example, the spin-off company will typically not be allowed to sell a substantial portion of its assets or engage in transactions involving a change of control.

Employee Matters Agreement

An Employee Matters Agreement governs the allocation of responsibilities for employee matters and provides protections to certain current and former employees. It also sets forth the general liabilities and responsibilities with respect to employee compensation and benefits programs. In some cases, the employee matters may be addressed in the Separation and Distribution Agreement rather than in a standalone Employee Matters Agreement.

Intellectual Property Agreements

Certain specified patents, trademarks, domain names, and other rights in intellectual property may be governed and protected by arrangements in one or more intellectual property agreements between the parent company and spin-off company. Such agreements may provide for the sharing or licensing of intellectual property on either a transitional or long-term basis.

Real Estate Matters Agreement

The Real Estate Matters Agreement will govern the allocation and transfer of property between the parent company and spin-off company. It may also specify which party is responsible for paying for any necessary alterations or improvements to real estate being transferred.