The upcoming spinoff of AOL by Time Warner may be a harbinger of a new trend for large U.S. public companies to use warming equity markets to raise cash and unload assets. The dominant themes of a relatively slow U.S. M&A market in 2009 were the difficult credit markets and evolving deal structures involving predominantly strategic players as well as a rise in the number of distress and spin transactions. Recent examples include Bristol-Meyers Squibb saying goodbye to Mead Johnson Nutrition in a spinoff restructuring, while Las Vegas Sands carved out a $2.5 billion stake in Sands China in a Hong Kong IPO, and JBS announced plans to spin out JBS USA. Citigroup also is planning to raise $100 million in its planned spinout IPO of its Primerica Inc. life insurance unit.

Distressed companies, oversized conglomerates and strategic divestments by large companies with underperforming businesses should continue to fuel a hot spinoff/spinout market for the foreseeable future. The process of planning, structuring and implementing a spinoff is complex and typically involves a division of assets and liabilities. Experience has shown that spinners should resist the temptation to dump environmental liabilities, underfunded employee benefit plans and other liabilities into businesses they are spinning because this can present major legal issues for the spunout company and return to haunt the former parent company. As well, certain types of liabilities (such as litigation claims by employees or customers) are frequently allocated in a sharing arrangement such as a reimbursement, contribution or indemnification agreement. In some cases, however, for practical as well as for legal reasons, liabilities may be deemed to be non-transferable. An appropriate assessment of, and plan for, the spunout business's financing needs as well as a post-spin viable capital structure are key prerequisites of a successful spin transaction. Tax planning, intellectual property, transition services and regulatory compliance (including ERISA and SEC requirements) are also important factors to be taken into account in a spin transaction.

In the United States, creditors of spunoff companies frequently sue the parent or its banks for fraudulent conveyance, alleging that the parent loaded the spinoff with debt and kept all the cash or burdened the spinoff with environmental and other liabilities shortly before effecting the spinoff. Kerr-McGee's 2006 spinoff of Tronox, which led to a Chapter 11 bankruptcy filing by Tronox in January of last year, is a good textbook example of what can go wrong in a spin transaction. The official creditors committee of bankrupt Tronox has filed a suit for fraudulent conveyance against the banks that arranged its spinoff from Kerr-McGee. Filed in the U.S. bankruptcy court in Manhattan, the suit targets the banks that arranged pre-bankruptcy loans for Tronox. The lawsuit claims that the spinoff was structured so that Tronox was burdened with 70 years of the parent's environmental liabilities, hundreds of other tort claims and retiree and other legacy liabilities. The creditors committee claims that as part of the spinoff, Tronox was forced to take out $200 million in secured loans, whose proceeds were upstreamed to Kerr-McGee prior to the spinoff. In addition to seeking to recover more than $100 million from the banks, the creditors committee seeks to have the banks "equitably subordinated." If the claims of the creditors committee are successful, the banks would be repaid only after all the other creditors of Tronox in the bankruptcy proceeding are paid on their claims.

Tronox filed its own lawsuit against Kerr-McGee and its parent, Anadarko Petroleum Corporation, which acquired Kerr-McGee for about $18 billion a few months after the spinoff of Tronox. That lawsuit alleges that Tronox was spunoff only after it had been stripped of some of Kerr's best chemical assets and Kerr had taken all of the cash from the bank financing. The end result, according to the claims, is that Tronox was grossly undercapitalized and left with insufficient assets to pay its debts after it was spun by Kerr-McGee. To make matters even worse, U.S. prosecutors in Manhattan and the U.S. Environmental Protection Agency have filed civil charges against Kerr-McGee and Anadarko for fraudulently attempting to avoid hundreds of millions of dollars of environmental liabilities by dumping them into Tronox prior to the spinoff. This lawsuit undoubtedly will provide lots of ammunition for the creditors in their lawsuit against the banks as well as for Tronox's suit against its former parent and Anadarko.

All in all, the Kerr-McGee spinoff of Tronox pushed the spin envelope in several respects and quickly turned into an unmitigated disaster for all stakeholders as well as the banks. Companies that are contemplating a spin transaction would therefore be well-advised to seek competent legal counsel in the planning stages and to resist the temptation to push down accumulated liabilities on the spin company and loading it up with debt.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.