medtronicOne of the more distinctive business trends in recent months has been the surge of so-called corporate inversion transactions, in which a domestic U.S. company merges with a non-U.S. company, with the the successor company to be based in the foreign country in order to take advantage of a more favorable corporate tax regime. These transactions have drawn a great deal of criticism from Washington, and on September 22, 2014, the U.S. Treasury department issued regulations to deter companies from entering into these kinds of transactions.  But at least according to some press reports, while the new regulations may remove some of the benefits the transactions have offered in the past, may not end the transactions altogether.


While it might be expected that these transactions would be unpopular in Washington, you would think that shareholders would welcome these transactions, given the tax advantages that the transactions afforded. However, as I noted in a prior post, in some cases, the shareholders of some of these companies have filed lawsuits against the companies and senior management, complaining, for example about the immediate tax consequences for the individual shareholders that the transactions trigger.


Now a shareholder of Medtronic has filed another of these lawsuits, in connection with the company’s planned $42.9 billion merger with the Irish-based company, Covidien. As discussed in an October 6, 2014 St. Paul Pioneer Press article (here), on October 3, 2014, a Medtronic shareholder filed a derivative lawsuits against the company, as nominal defendant,  and certain of its directors and officers in connection with Medtronic’s planned “inversion” merger with Covidien.


In her complaint (here), the plaintiff asserts claims for breach of fiduciary duties, waste of corporate assets, and unjust enrichment. The crux of the plaintiff’s complaint is that the company’s board has agreed to make “gross-up” payments to certain officers and board members, in order to offset certain excise taxes these individuals will owe under the Internal Revenue Code as a result of the company’s inversion transaction. (The excise taxes are due under a revision to the Tax Code Congress enacted in 2004 to try to discourage inversion transactions.) The purpose of the gross up payments is to put the same position after tax that the individuals would have been in if the excise tax had not applied.


The plaintiff’s complaint alleges that the total cost to the company of these payments will total approximately $63 million, including $25 million to the company’s Chairman and CEO. Because the gross-up payments themselves represent taxable income to the individuals, and because the payments to the individuals includes further amounts to offset the additional  income tax expense, the cost to the company to provide the gross-up payments is far greater than the $32.7 million owed for the excise taxes.


The plaintiff alleges that the company has justified these payments on the ground that the affected individuals should not be discouraged from taking actions they believe to be in the best interests of the company because of their own personal tax situation. The plaintiff alleged that this justification showed that the Board was “incapable of acting in Medtronic’s best interests when their personal interests are at stake,” and therefore that a demand on the “self-serving” board would be futile.


The complaint seeks restitution from the individual defendants for all illicit and improper tax reimbursements, as well as corporate governance reforms to address what the plaintiff calls “self-dealing” by the board.


Lawmakers in Washington undoubtedly will continue to try to find ways to address concerns relating to these kinds of corporate inversion transactions. It remains to be seen whether other companies press ahead with these kinds of transactions after the latest round of regulatory changes out of the Treasury department. But if there are other transactions, companies engaging in inversion transactions not only risk attracting the ire of Washington lawmakers, but also may face the possibility of shareholder litigation, as this latest lawsuit shows.


Special thanks to a loyal reader for sending me a link to the news article about the lawsuit.