British Telecommunications Plc v  Revenue & Customs [2005] UKSPC SPC00535 (11 April 2006)

                                                                                                      SPC00535
CHARGEABLE GAINS – payment made by higher bidder to terminate existing merger agreement equal to the sum that the other party to the merger agreement would have had to pay to terminate it – whether the payment was a capital sum derived from assets – no – appeal allowed

THE SPECIAL COMMISSIONERS

BRITISH TELECOMMUNICATIONS PLC	Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMS	Respondents

Special Commissioner: 	DR JOHN F. AVERY JONES CBE

Sitting in public in London on 27 March 2006

David Goldberg QC, counsel, instructed by Debevoise & Plimpton LLP, for the Appellant

Philip Jones, counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2006

DECISION

1.	This is an appeal by British Telecommunications plc against a corporation tax assessment for the accounting period ended 31 March 1998.  The Appellant was represented by Mr David Goldberg QC and the Revenue by Mr Philip Jones.
2.	The issue in the appeal is the liability to tax as a chargeable gain of a payment of $450m made to the Appellant in the circumstances described below when the agreement for its proposed merger with MCI Communications Corporation (“MCI”) was terminated following a higher offer for MCI by Worldcom Inc (“Worldcom”).  The issue is more precisely stated in clause 6 below.
3.	There was an agreed statement of facts as follows:
(1)	The Appellant was at all material times a publicly quoted company incorporated and resident for tax purposes in the United Kingdom.  Its principal activity during the period in question was the provision of telecommunications services, both directly and through subsidiaries and associated companies.
(2)	In 1994, the Appellant acquired a 20 per cent shareholding in MCI.  MCI was at all material times a US publicly quoted company which carried on business as a provider of telecommunications services, whose principal operations were in the USA.
(3)	In 1996, the Appellant and MCI entered into negotiations relating to a merger of their operations, on the basis of which the Appellant would acquire the issued share capital of MCI which it did not already own.  On 3 November 1996, a merger agreement (the “Original Merger Agreement”) was entered into between the Appellant, MCI and Tadworth Corporation (“Tadworth”), a Delaware corporation and a wholly-owned subsidiary of the Appellant.  The Original Merger Agreement and its exhibits were subsequently amended on two occasions to reflect subsequent negotiations between the parties, by agreements dated 14 February 1997 (the “Amendment Agreement”) and 21 August 1997 (the “Amendment Agreement No.2”).  References to the “Merger Agreement” are to the Original Merger Agreement as amended by the Amendment Agreements.  
(4)	Under the Merger Agreement, it was agreed that, with effect from the “Effective Time”, MCI and Tadworth would be merged, with the result that the surviving entity, Tadworth, would acquire all the assets and liabilities of MCI and remain a wholly-owned subsidiary of the Appellant.  In exchange, MCI shareholders (other than the Appellant) would receive a consideration consisting of a combination of cash and shares in the Appellant (s 1.8 of the Merger Agreement).  As of the date of the Amendment Agreement No.2, 21 August 1997, the value to MCI shareholders of the merger with BT was approximately $30–31 per share.  The merger was conditional on the matters referred to in section 6 of the Merger Agreement, including the obtaining of regulatory clearances and shareholder approvals.  The “Effective Time” for these purposes would occur once all the conditions had been satisfied and the steps necessary to implement the merger had been implemented – see s 1.3 of the Merger Agreement.
(5)	Section 7.1 of the Merger Agreement contained provisions giving the Appellant and MCI the right, in the circumstances enumerated in paragraphs (a) to (h) of the sub-s, to terminate the Merger Agreement.  In particular s 7.1(f) provided:
“[The Merger Agreement] may be terminated at any time prior to the Effective Time, by action taken or authorized by the Board of Directors of the terminating party or parties, whether before or after the approval of the matters presented in connection with the Merger by the shareholders of MCI and by the shareholders of BT…
… (f)	By either MCI or BT, upon five Business Days’ prior notice to the other, if, as a result of a Superior Proposal received by such party from a Person other than a party to this Agreement or any of its affiliates, the Board of Directors of such party determines in good faith that their fiduciary obligations under applicable law require that such Superior Proposal be accepted; provided, however, that (i) the Board of Directors of such party shall have concluded in good faith, after considering applicable provisions of law and after giving effect to all concessions which may be offered by the other party pursuant to clause (ii) below, on the basis of advice of counsel, that such action is necessary for such Board of Directors to act in a manner consistent with its fiduciary duties under applicable laws and (iii) prior to any such termination, such party shall, and shall cause its respective financial and legal advisors to, negotiate with the other party to this Agreement to make such adjustments in the terms and conditions of this Agreement as would enable such party to proceed with the transactions contemplated hereby; provided, however, that it shall be a condition to termination by BT pursuant to this Section 7.1(f) that BT shall have made the payment of the Alternative Transaction Fee to MCI required by Section 7.2(b), and it shall be a condition to termination by MCI pursuant to this Section 7.1(f) that MCI shall have made the payment of the Alternative Transaction Fee to BT required by Section 7.2(c)”.  
(6)	A “Superior Proposal” was defined in s 5.7(a)(i) of the Merger Agreement as an “Acquisition Proposal” which “the Board of Directors of MCI or the Appellant, as the case may be, concludes in good faith (after consultation with its financial advisers) that … is reasonably capable of being completed, taking into account all legal, financial, regulatory and other aspects of the proposal, and the Person making the proposal, and would, if consummated, result in a transaction more favourable to MCI’s or the Appellant’s stockholders, as the case may be, from a financial and strategic point of view than the transaction contemplated by” the Merger Agreement.  An “Acquisition Proposal” was also defined in s 5.7(a) and included a merger with another party.  (Section 5.7(a) is set out in paragraph 10(5) below.)
(7)	Section 7.2 of the Merger Agreement addressed the consequences of termination of the Merger Agreement.  Section 7.2(a) provided that in the event of termination the Merger Agreement became void except to the extent set out in s 7.2(a), including the remaining provisions of s 7.2.
(8)	Section 7.2(c) and (e) contained further provisions relating to the termination of the Merger Agreement by MCI pursuant to s 7.1(f) of the Merger Agreement in the event that MCI received a Superior Proposal.  In such circumstances MCI was required to pay to BT, as a pre-condition to such termination, an amount equal to the sum of (a) the Alternative Transaction Fee (defined in s 7.2(b) (as amended by Amendment Agreement No.2) as the sum of $450,000,000) and (b) all of the Appellant’s expenses incurred in connection with the Merger Agreement up to $15,000,000 (see the definition of “Expenses” in s 5.10 and of the “Expense Amount” in s 7.2(b)).  Similarly, s 7.2(b) (as amended) of the Merger Agreement provided that the Appellant was obliged to pay equivalent amounts to MCI in the event that the Appellant terminated the agreement pursuant to s 7.1(f).
(9)	Following the entry into the Merger Agreement, and subsequent renegotiations of the terms of the merger between the Appellant and MCI which led to the entry into Amendment Agreement No.2, MCI received a public approach from Worldcom, another US telecommunication operator.  Worldcom’s initial offer to MCI was made on 1 October 1997 at a value of $41.50 per MCI share (considerably in excess of the $30–31 per share at which the Appellant’s exchange offer was valued).  After a period of negotiations among the various parties, Worldcom made an increased exchange offer on 9 November 1997 which valued MCI at $51 per share.  The offer was treated by MCI as a “Superior Proposal” for the purposes of the Merger Agreement as a result of which it wished to exercise its right to terminate the Merger Agreement in accordance with s 7.1(f).  MCI was therefore required to pay the Alternative Transaction Fee and reimbursement of BT’s Expenses under s 7.2(c) of the Merger Agreement as a pre-condition to exercising its termination right (s 7.2(e)).  
(10)	MCI’s right to terminate the Merger Agreement, and BT’s right to the payment of the Alternative Transaction Fee and expense reimbursement as a pre-condition to such exercise, were addressed by an agreement dated 9 November 1997 between Worldcom, the Appellant and MCI (the “Termination Agreement”).  The Termination Agreement provides (in Section 2) for the termination of Merger Agreement on 9 November 1997 and for the payment of the Alternative Transaction Fee (as defined in the Merger Agreement) of $450m and the Appellant’s Expenses (as so defined) of $15m on 12 November 1997 (see s 3(a) and the first recital to the Termination Agreement).
(11)	Worldcom’s exchange offer for MCI was embodied in a merger agreement between Worldcom, its wholly-owned subsidiary, TC Investments Corporation and MCI, entered into on 9 November 1997.
(12)	On 12 November 1997, Worldcom paid the Alternative Transaction Fee and $15m of the Appellant’s Expenses to the Appellant in accordance with Section 3(a) of the Termination Agreement.  For the purposes of its accounts for the period ending 31 March 1998, the relevant dollar amounts were converted into sterling amounts of £263,723,000 and £8,791,000 respectively.
(13)	The Appellant prepared its tax computations for its accounting period ending 31 March 1998 on the basis that the Alternative Transaction Fee and the amount reimbursed in respect of the Appellant’s Expenses are both not subject to corporation tax.
(14)	The Revenue contend that the payment of the Alternative Transaction Fee by Worldcom to the Appellant in the sterling equivalent amount of £263,723,000 is subject to corporation tax as a chargeable gain.
4.	I should record the existence of a disagreement between the parties about paragraph 3(10) above, which says that the Termination Agreement provides for the payment of the Alternative Transaction Fee.  Mr Goldberg thought he was agreeing that there was a payment in accordance with s 7.2(b) of the Merger Agreement, which provides for such a fee in the event of termination by notice by MCI following a Superior Proposal.  Mr Jones thought he was agreeing to what the Termination Agreement said, that the Alternative Transaction Fee will be paid to the Appellant by Worldcom, meaning that an amount equal to such Fee was paid.  Accordingly Mr Goldberg contends that it is not open to Mr Jones to argue that the Alternative Transaction Fee was not paid in accordance with the Merger Agreement.  I ruled that I would allow Mr Jones to argue the case as set out in his skeleton, which Mr Goldberg had answered in a second skeleton, but that I would allow Mr Goldberg to call evidence, including the possibility of having an adjournment, if he was taken by surprise.  He considered this during the short adjournment and announced that it would be too difficult to obtain any evidence after the time that had elapsed, particularly as it is common knowledge that the merged Worldcom was subsequently hit by accounting scandals, prosecution and conviction of several of its senior executives, and bankruptcy.    Mr Goldberg reserved the right to repeat this contention on any appeal.  
5.	The following further facts were agreed at the hearing:
(1)	The Worldcom revised offer was a Superior Proposal (rather than being treated as one, as stated in paragraph 3(9) above) within the meaning of the Merger Agreement;
(2)	The sequence of events was that following the revised terms of the Appellant’s offer recorded in Amendment Agreement No.2 of 21 August 1997, shareholders meetings of BT and MCI were called for December 1997.  Following Worldcom’s offer of 1 October 1997 another company, GTE, made an offer as a result of which Worldcom increased its offer on 9 November 1997.  Accordingly MCI stockholders never voted on the Appellant’s revised bid.
6.	The issue agreed between the parties is whether the Alternative Transaction Fee is a capital sum derived from assets within the meaning of s 22 of the Taxation of Chargeable Gains Act 1992, which provides:
“22 Disposal where capital sums derived from assets 
(1) Subject to sections 23 and 26(1), and to any other exceptions in this Act, there is for the purposes of this Act a disposal of assets by their owner where any capital sum is derived from assets notwithstanding that no asset is acquired by the person paying the capital sum, and this subsection applies in particular to— 
(a)   capital sums received by way of compensation for any kind of damage or injury to assets or for the loss, destruction or dissipation of assets or for any depreciation or risk of depreciation of an asset, 
(b)   capital sums received under a policy of insurance of the risk of any kind of damage or injury to, or the loss or depreciation of, assets, 
(c)   capital sums received in return for forfeiture or surrender of rights, or for refraining from exercising rights, and 
(d)   capital sums received as consideration for use or exploitation of assets. 
(2) In the case of a disposal within paragraph (a), (b), (c) or (d) of subsection (1) above, the time of the disposal shall be the time when the capital sum is received as described in that subsection. 
 (3) In this section “capital sum” means any money or money’s worth which is not excluded from the consideration taken into account in the computation of the gain.” 
7.	Mr David Goldberg contends in outline:
(1)	There is no disposal of any asset, or if there has been a disposal it is of the satisfaction of a debt by the original creditor.  
(2)	Disposal involves the transfer of an existing asset from one person to another: Powlson v Welbeck Securities Ltd (1987) 60 TC 269 at 287B to D:
“Section [1(1)] is plainly apt to cover the common case of a transfer of the beneficial title to property by one person in favour of another.”
And Kirby v Thorn EMI plc 60 TC 519 at 538E to 539H:
“Thus the basic structure of the tax is of a charge on gains accruing to a person on disposal of an asset by him.  There is no statutory definition of disposal; but, having regard to the context, what is envisaged by that expression is a transfer of an asset (ie of ownership of an asset), as widely defined, by one person to another.”
(3)	Section 22 of the Taxation of Chargeable Gains Act 1992 requires that there must be an asset and the capital sum must be derived from the asset.  Where there is a right (whether contingent or not) to receive a payment there is no sum derived from the asset.  The right to the sum and the payment of the sum are one and the same thing.  When a bud turns into a flower there is no disposal of the bud: it just becomes the flower.  The flower is not derived from the bud; they are the same thing in different states.
(4)	By way of illustration if a vendor agrees to sell his house with completion in one year in a rising market, completion of the contract in accordance with its terms would not give rise to a gain, although a sale of the benefit of the contract would do so.
(5)	Sections 122 (capital distributions in respect of shares) and 251 (debts) are necessary to create a tax charge because they relate to the receipt of something arising normally from, or inherent in, the asset.  Without them there would be no capital sum derived from assets.
(6)	The Merger Agreement did not provide for the $450m to be paid for the surrender of the Appellant’s rights; in the circumstances the only term of the contract which survived was the obligation of MCI to pay the Appellant $450m, which is a separate chose in action.  The payment is the fulfilment of rights, not the surrender of them.  It got the asset to which it was entitled.  It did not get anything from that asset.  It got the asset.  The payment was not for the termination but a consequence of the termination.
8.	Mr Philip Jones contends in outline:
(1)	MCI’s obligation to cooperate with the Appellant and use all reasonable best efforts to consummate and make effective the merger were choses in action owned by the Appellant.  A chose in action is incorporeal property within s 21(1) of the Taxation of Chargeable Gains Act 1992 and accordingly an asset.
(2)	By the Termination Agreement the Appellant surrendered its choses in action under the Merger Agreement in consideration of the $450m paid by Worldcom and this was accordingly a capital sum derived from the Appellant’s asset consisting of its choses in action under the Merger Agreement.  The case was indistinguishable from Powlson v Welbeck Securities Ltd in which to settle litigation the parties agreed that the taxpayer would relinquish its option to take part in a development in consideration of a payment of £2m.  This was held to be a capital sum derived from the option.
(3)	The payment was not made pursuant to the Merger Agreement.  MCI did not operate s 7.1(f); instead Worldcom made the payment that MCI would have had to make and the Appellant and MCI terminated the Merger Agreement by mutual consent.  Even if MCI had operated that provision the result would have been the same.  It provides for one party by paying the alternative Transaction Fee to compel the other party to surrender its rights under the agreement, which is just as much a surrender of rights as it would be if made by a subsequent termination agreement.
(4)	Continuing Mr Goldberg’s example of the sale of a house, if the vendor refused to complete and the purchaser treated it as a repudiation of the contract the damages would be a capital sum derived from the asset (the rights under the contract).  The result would be the same if the contract had provided for liquidated damages.
(5)	On Mr Goldberg’s argument that the payment was the satisfaction of a debt, there was never a debt.  In any case in Powlson v Welbeck Securities Ltd the Court of Appeal held the capital sum to have been derived from the option and not from the agreement under which it was payable.
9.	It seems to me that the difference between the parties is not so much a matter of law but of appreciation of the facts.  There is an asset, the Appellant’s bundle of rights or choses in action under the Merger Agreement, and there is the termination of that asset on payment of the Alternative Transaction Fee; the sole question is whether such capital sum is derived from that asset.  I think that it is common ground that if the reason for the payment was to give effect to a term of the Merger Agreement rather than because the Appellant gave up its rights under the agreement, the sum would not be derived from assets; and if the reason for the payment was in return for the Appellant’s giving up its rights under the agreement, the sum would be derived from the asset.  The guidance from the authorities is that that a sum paid in return for terminating an option was derived from the option in Powlson v Welbeck Securities Ltd.  Similarly in Kirby v Thorn EMI plc on the sale of three companies from the Thorn EMI group a capital sum was paid by the purchaser for the covenant by Thorn EMI not to engage in the same trades as the companies sold for five years.  This was derived from the goodwill of Thorn EMI in the trades.  Both cases illustrate a direct connection between the asset and the sum derived from giving it up or agreeing to refrain from exploiting it.  One must also look for the real (rather than the immediate) source of the capital sum (Zim Properties Ltd v Proctor (1984) 58 TC 371, 391B).  There Zim lost a sale of land when the purchaser treated the contract as repudiated because Zim could not make title to part of the land because of the negligence of its solicitors in drawing up the contract.  The reality was held to be that the damages received from suing the solicitors derived from the right to sue (p 393D), rather than the land, which Zim still owned but which had presumably had decreased in value, although the evidence of fact about this was unclear (p 392A).  Zim is therefore an example of the existence of an asset in the background which was not as a matter of reality the asset from which the capital sum was received.
10.	It is necessary to summarise the Merger Agreement in more detail.  It is a 74 page agreement governed by New York law.
(1)	Section 1 provides for the merger of MCI into Tadworth, a Delaware wholly-owned subsidiary of the Appellant, under which all the property and liabilities of MCI would become the property and liabilities of Tadworth; the MCI common stock would be cancelled in consideration of the issue of American Depositary Shares of the Appellant and cash (the amounts of which were decreased by Amendment Agreement No.2 made as of 21 August 1997); and Tadworth would issue shares of common stock to the Appellant.  Closing of the merger was to take place on the first business day after satisfaction of the conditions in s 6.  Following closing the parties were to take steps to obtain admission to the official list of the London Stock Exchange of the shares to be issued, and simultaneously with such admission to file a Delaware Certificate of Merger (“the Effective Time”).
(2)	Section 2 deals with the procedures for exchange of certificates.
(3)	 Section 3 contains representations and warranties by both MCI, and the Appellant and Tadworth.
(4)	Section 4 contains covenants by MCI and the Appellant to apply until the Effective Date that each of them will carry on business in the ordinary course; neither will pay any dividends (other than stated exceptions) or alter or repurchase its share capital or issue new capital; alter its governing documents; make any acquisitions (subject to an exception with a maximum cost); dispose of subsidiaries; borrow money; increase employee benefits; take other actions that would result in breach of the warranties; change its accounting methods or tax elections; or take any action that would prevent the merger from qualifying as a tax-free reorganisation; or make agreements restricting the geographical area of business.  The parties would confer on a regular basis to report on operational matters, of any changes in compliance with the warranties, and any changes having a material adverse effect (as defined) on the party.  Provision was made for transition planning.
(5)	Section 5 requires MCI and the Appellant to prepare prospectuses; for MCI to convene a stockholders’ meeting; for its directors to recommend the merger (unless otherwise required by the directors’ fiduciary duties to the stockholders); while the agreement remains in effect for the Appellant to vote its MCI shares in favour of the merger.  The Appellant was to convene a shareholders’ meeting; the directors to recommend the merger and to use all reasonable good faith efforts to secure the affirmative vote of the Appellant’s shareholders.  Provision was made for changes in the Appellant’s board from the Effective Time, for board meetings to be held alternately in the UK and the US, and for it to have headquarters from Closing in the UK and the US.  Each party was to have access to information about the other until the Effective Time in accordance with a confidentiality agreement.  They would cooperate with each other and use all reasonable best efforts to consummate and make effective the merger.  The Appellant would apply for stock exchange listing in London and New York of the shares to be issued as American Depositary Shares.  Section 5.7(a) relating to acquisition proposals provides:
“MCI and BT each agrees that neither it nor any of its Subsidiaries…shall… directly or indirectly initiate, solicit, encourage or otherwise facilitate…any inquiries or the making of any proposal, or offer with respect to a merger… involving,… 10% or more of the equity securities of, it…that, in any such case, could reasonable be expected to interfere with the completion of the Merger or the other transactions contemplated by this Agreement (any such proposal or offer being hereinafter referred to as an ‘Acquisition Proposal’).  MCI and BT each further agrees that neither it nor any of its Subsidiaries…shall…have any discussion with or provide any confidential information or data to any Person relating to an Acquisition Proposal, or otherwise facilitate any effort or attempt to make or implement an Acquisition Proposal; provided, however, that nothing contained in this Agreement shall prevent either MCI or BT or its Board of Directors from 
(A) complying with Rule 14e-2 promulgated under the Exchange Act or complying with the City Code, as applicable, with regard to an Acquisition Proposal; 
(B) engaging in any discussions or negotiations with, or providing any information to, any Person in response to an unsolicited bona fide written Acquisition Proposal by any such Person; or 
(C) recommending such an unsolicited bona fide written Acquisition Proposal to the stockholders of MCI or BT, as the case may be, if and only to the extent that, in any such case as is referred to in clause (B) or C), 
(i) the Board of Directors of MCI or BT, as the case may be, concludes in good faith (after consultation with its financial advisers) that such Acquisition Proposal is reasonably capable of being completed, taking into account all legal, financial, regulatory and other aspects of the proposal and the Person making the proposal, and would, if consummated, result in a transaction more favorable to MCI’s or BT’s stockholders, as the case may be, from a financial and strategic point of view than the transaction contemplated by this Agreement (any such more favorable Acquisition Proposal being referred to in this Agreement as a ‘Superior Proposal’),
(ii) the Board of Directors of MCI or BT, as the case may be, determines in good faith after consultation with legal counsel that such action is necessary for its Board of Directors to act in a manner consistent with its fiduciary duties under applicable law,
(iii) prior to providing any information or data to any Person in connection with an Acquisition Proposal by any such Person, such Board of Directors receives from such Person an executed confidentiality agreement on terms substantially similar to those contained in the confidentiality agreement previously entered into between BT and MCI in connection with their consideration of the Merger and 
(iv) prior to providing any information or data to any Person or entering into discussions or negotiations with any Person, the Board of Directors of MCI or BT, as the case may be, notifies the other party immediately of such inquiries, proposals or offers received by, any such information requested from, or any such discussions or negotiations sought to be initiated or continued with, any of its representatives indicating, in connection with such notice, the name of such Person and the terms and conditions or any proposals or offers.”
There are also provisions relating to stock options applying until the Effective Time; provisions relating to employment agreements; payment of fees; directors’ and officers’ insurance; a rights agreement; interim cooperation arrangements; public announcements; an investment agreement; share repurchase authorisation; change of name of the holding company after the Effective Time; joint management of the integration planning of the companies’ global activities; and that no burdensome conditions had been imposed by governmental entities.  
(6)	 Section 6 sets out conditions precedent to the effecting of the merger to be satisfied (or waived) by the Closing Date, including shareholder approvals, stock exchange listing, a consent decree relating to a US court action, an order of the Federal Communications Commission, termination of a review and investigation under “Exon-Florio” [relating to the US Defense Production Act of 1950], compliance with securities law, there being no injunctions against the merger, and UK Treasury consent under s 765 of the Taxes Act 1988.  
(7)	Section 7 provides for termination of the agreement before the Effective Time in the following events: (a) by mutual consent, (b) if either MCI or the Appellant if the Effective Time has not occurred by 31 December 1997 (except by a party whose failure caused it) and a party whose condition has not been fulfilled may extend the date to 30 April 1998, (c) by either party if a governmental entity prevented the merger, (d) by either party if the Appellant’s shareholders’ approval is not obtained, (e) by either party if the directors modify their recommendation, (f) [this is set out in paragraph 3(5) above], (g) by the Appellant on a breach of warranty by MCI, and (h) by MCI on a breach of warranty by the Appellant.  If the Appellant fails to effect the merger after the conditions are satisfied MCI is entitled to damages of not less than $450m.  If (d) applies because of the failure of the Appellant to obtain its stockholders’ approval it has to pay liquidated damages of $750m (this does not apply if MCI’s shareholders do not approve the merger).  If the Appellant terminates in accordance with (e) when there is an Acquisition Proposal for MCI, or if MCI terminates in accordance with (f) when it has received a Superior Proposal, MCI is to pay the Alternative Transaction Fee of $450m and the Appellant’s expenses up to $15m (and vice versa).  The Alternative Transaction Fee is to be paid as a pre-condition of termination.  If the Appellant terminates in accordance with (e) in circumstances in which the Alternative Transaction Fee is not payable [ie there is no Acquisition Proposal] MCI is to pay a Termination Fee of $150m and the Appellant’s expenses up to $15m (and vice versa).
(8)	Section 8 contains definitions and general provisions.
11.	The Termination Agreement of 9 November 1997 recited that MCI and WorldCom proposed to enter into an agreement and plan of Merger.  The agreement, which is governed by Delaware law, provided:
“2.  Termination of [the Merger Agreement].  BT and MCI hereby agree that [the Merger Agreement] shall be, and hereby is, terminated, effective immediately.
3.  Fees.  (a) The Alternative Transaction Fee of $450,000,000 and BT’s Expenses in an amount up to $15,000,000 will be paid to BT promptly by WorldCom in immediately available funds by 5 pm on Wednesday, November 12…”.
The Appellant agreed to vote its MCI shares in favour of the merger with Worldcom; to vote against any other merger agreement, and against anything that would prevent the merger; and not to transfer its shares in MCI except in accordance with the merger; not to solicit another merger proposal; and to use all reasonable efforts to make the merger effective.
12.	The merger agreement between Worldcom and MCI (“the Worldcom Merger Agreement”) also dated 9 November 1997 (to which the Appellant is not a party) contains the following recitals:
“WHEREAS, BT, MCI and Worldcom have entered into an agreement dated as of the date hereof pursuant to which, among other things, BT has consented to and agreed to support the Merger [defined as the merger with Worldcom] and the other transactions contemplated by this Agreement (“the [Termination Agreement]”);
WHEREAS, in the [Termination Agreement], Worldcom has agreed to pay BT $450 million and expenses not in excess of $15m…in connection with the plan of reorganization in order to induce BT to waive its rights under, and agree to terminate, [the Merger Agreement]; and
WHEREAS, [the Merger Agreement] has been terminated by MCI and BT by mutual agreement pursuant to Section 7.1(a) of [the Merger Agreement].”
Reasons for the decision 
13.	Essentially Mr Goldberg’s argument is that s 7.1(f) of the Merger Agreement provides that where the directors of MCI determine that they are required to accept a Superior Proposal for MCI, then MCI has to pay the Appellant the Alternative Transaction Fee and as a result the agreement terminates.  Mr Jones, on the other hand, concentrates on the fact that termination under that provision is not automatic but is an option for MCI to terminate in these circumstances, and he contends that the reason for MCI exercising such option would be to buy the surrender of the Appellant’s rights against MCI.  I shall not consider what is the reason for s 7.1(f), which I find puzzling, or what would have been the tax consequences if MCI had exercised its rights under that provision, because it did not exercise such rights, and nor do I find that Worldcom was doing so on its behalf.  If it had, it would make no sense for the Worldcom Merger Agreement to recite that Worldcom had made the payment when that agreement is with the person for which it was acting as agent in making the payment.  I prefer to deal with the actual situation where Worldcom made the payment equivalent to the Alternative Transaction Fee, even though this is contrary to what Mr Goldberg thought he had agreed.
14.	I shall consider the position as it was immediately before the Termination Agreement and the Worldcom Merger Agreement were entered into on 9 November 1997.  By that time Worldcom had made the 1 October 1997 offer and there was a rival offer from GTE.  It was clear that the MCI stockholders would not be likely to vote for the merger with the Appellant so that the conditions precedent in s 6 of the Merger Agreement would never be satisfied.  I find it difficult to understand what provisions of the Merger Agreement survive the acceptance by the directors of MCI of Worldcom’s Superior Proposal.  For example, while s 5.7 (set out above) provides that because of their fiduciary duties to their stockholders the directors of MCI are no longer required to recommend adoption of the Merger Agreement to MCI stockholders, there is nothing to say that the Appellant is not still obliged (expressed to be “while this Agreement [the Merger Agreement] remains in effect”) to vote its MCI shares in favour of the merger with itself (a provision appearing twice in the Merger Agreement because it was also added to s 5.1(b) following Amendment Agreement No.2), to recommend approval of the merger to its shareholders, and not to sell any of its MCI shares.  The duty to cooperate and use all reasonable best efforts to make the merger effective still appears to stand, although it may be reasonable in the circumstances not to cooperate further in a merger when the agreement provides for MCI to be able to recommend adoption of Worldcom’s Superior Proposal to its stockholders.  Other parts of the agreement, such as the mutual covenants in s 3, continue until the Effective Date.  I do not therefore think that Mr Goldberg is right in contending that nothing in the Merger Agreement survived except MCI’s obligation to pay the Alternative Transaction Fee.  While I agree with Mr Jones that the Appellant has some rights to require MCI to perform its part of the agreement I am not sure that such rights are important given that MCI is free to recommend acceptance of Worldcom’s Superior Proposal to its stockholders, which will effectively mean that they will not support merger with the Appellant.  I do not therefore think that Mr Jones is right to concentrate the Appellant’s right to require MCI’s continuing obligation to cooperate because the reasonable best efforts to cooperate in doing something that it is clear will now not happen may be nonexistent.  
15.	What seems important to me is that in the Merger Agreement the Appellant agreed to vote its MCI shares in favour of its merger, to recommend the merger to its shareholders, and not to sell its MCI shares.  MCI may not have wanted to enforce such an obligation in the circumstances but it was still there, and the Appellant could not vote its MCI stock in favour of the merger with Worldcom or accept the Worldcom offer without being in breach of the Merger Agreement.  Worldcom wanted to enter into the Worldcom Merger Agreement with MCI but I do not believe that it would enter into it with these obligations on the Appellant still in existence, and, even given the let-out in respect of a Superior Proposal, nor do I believe that MCI would enter into the Worldcom Merger Agreement with the Merger Agreement still in force.  Worldcom therefore had to make sure that the Merger Agreement was terminated and it would no doubt also want to secure the Appellant’s positive support, as a 20 per cent stockholder in MCI, for the Worldcom merger.  Looking at the situation from MCI’s point of view, it would, I imagine, hope that the Appellant would agree to termination of the Merger Agreement by mutual consent since the Appellant would stand to benefit considerably from Worldcom’s offer in relation to the Appellant’s 20 per cent holding in MCI.  If it did not, then MCI could terminate the agreement without payment on 31 December 1997 as it would not, as I understand it, have failed to perform any of its obligations under the agreement.  The primary reason for the Effective Time not occurring by 31 December 1997 would be would be the failure of MCI’s stockholders to approve the merger with the Appellant, which would not be a failure by MCI itself to perform an obligation under the Merger Agreement.  From the Appellant’s point of view it would be in its interests not to agree to termination by mutual consent and to see if MCI was sufficiently keen on earlier termination under s 7.1(f) to pay the Alternative Transaction Fee.  The Appellant (but not MCI) could terminate because of MCI’s failure to recommend the merger to its stockholders in the circumstances of an Acquisition Proposal, with the result that MCI would also have to pay the Alternative transaction Fee, but the time for operating that provision would not arise until the stockholders’ meeting which was called for December 1997; the Appellant could not terminate on the ground of its own shareholders’ failure to approve the merger without paying $750m damages.  So long as its inaction did not mean that the Worldcom merger went off, it was in the Appellant’s interests to wait and see what MCI would do.  
16.	The Termination Agreement secured all these objectives of all three parties.  Payment by Worldcom of an amount equal to the Alternative Transaction Fee put the Appellant in the same position as if MCI had terminated the Merger Agreement, which it was entitled to do in the circumstances, but it was presumably reluctant to do so before Worldcom was committed to its merger (and had announced the increased offer).  MCI did not have to risk paying the Alternative Transaction Fee without Worldcom being committed to its offer.  The Merger Agreement was terminated without payment by either party.  And Worldcom obtained the Appellant’s agreement to vote its MCI stock in favour of the merger with Worldcom; to vote against any other merger agreement, and against anything that would prevent that merger; not to transfer its shares in MCI except in accordance with that merger; not to solicit another merger proposal; and to use all reasonable efforts to make that merger effective.  This understanding is, however, inconsistent with the recitals to the Worldcom Merger Agreement that payment of the equivalent to the Alternative Transaction Fee was “in order to induce BT to waive its rights under, and agree to terminate, [the Merger Agreement].”   The Appellant was not induced to waive its rights but was released from its obligations to support the original merger.  Particularly as the Appellant was not a party to such agreement I consider that I can treat this recital as loose drafting.
17.	What was the real source of the capital sum?  Was the Appellant paid for giving up the rights it had against MCI under the Merger Agreement, or for being relieved from its obligation to vote its MCI stock in favour of its merger?  In my view in reality the Appellant was not being paid to surrender its rights against MCI because in the circumstances these were very slight since MCI could in accordance with s 5.7 of the Merger Agreement recommend the Worldcom merger to its stockholders, and so the Appellant’s rights were not worth much.  The Appellant was paid by Worldcom to support the merger with Worldcom for which it was necessary first to terminate the Merger Agreement containing its obligations to MCI support the merger with itself, for which it was worth Worldcom paying the equivalent of the Alternative Transaction Fee.  I do not consider that it is a capital sum derived from assets.  The Appellant was being paid for supporting the Worldcom merger and in consequence for being relieved from an obligation, not for giving up any asset.
18.	Accordingly I allow the appeal in principle, although for different reasons from those put forward by Mr Goldberg because I have taken a different view of the facts than those that he thought he had agreed.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER
RELEASE DATE: 11 April 2006
SC 3306/05

Authorities referred to in skeletons and not referred to in the decision:
Marren v Ingles (1980) 54 TC 76
IRC v Laird Group [2003] STC 1349
Mortimore v IRC (1864) 2 H&C 838
Carreras Group Ltd v Stamp Commissioner [2004] STC 1377