Understanding FedEx’s Pre-Spin Debt Solicitation

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

On December 19, FedEx Corp. (NYSE: FDX) (FedEx, or the Company) announced its decision to “pursue a full separation of FedEx Freight through the capital markets, creating a new publicly traded company.” ¹  The news release states that the separation “is expected to be achieved in a tax-efficient manner for FedEx stockholders and executed within the next 18 months.”²  So far, the Company has not spoken directly to the exact terms of the separation, but there is a strong expectation that it will involve a distribution to shareholders qualifying for tax-free treatment under Section 355 of the Internal Revenue Code (IRC).

Shortly after announcing the Freight separation, the Company announced an exchange offer for most of its outstanding senior notes for new notes with the same economic terms, plus a small fee, coupled with consent to a limited change in the legal terms.³  The Notes are currently subject to a guarantee by FedEx’s Freight subsidiary, which guarantee is automatically eliminated in the event FedEx disposes (including through distribution) of 100 percent of the stock of the subsidiary. ⁴   Under the Exchange Offer and Consent Solicitation, the guarantee would be eliminated once FedEx Freight is no longer a FedEx Subsidiary, even if there is a retention of some stock.  “Subsidiary” is generally defined in the indentures as a legal entity of which the parent owns more than 50 percent of the voting interests.

No details are yet available about how the separation will be effected, but we know that FedEx will have to distribute at least 80 percent “control” of its FedEx Freight subsidiary to shareholders or a combination of shareholders and security holders (generally holders of longer term debt). ⁵   We might also infer from the reference to a “full separation” that the Company intends to distribute, or distribute and sell, 100 percent of FedEx Freight.  In any case, many in the investor community are trying to reconcile the Company’s seeking consents to amending its debt terms to eliminate FedEx Freight’s guarantee when it is no longer a Subsidiary with the fact that the guarantee disappears anyway upon the Company’s achieving the “full separation” that is its announced intention to execute.

The Company’s announcement stated that the separation would occur “through the capital markets,” which is an unusual way of referring to how a separation will take place.  A public offering of shares in a subsidiary would not be unusual, but a tax-free full separation necessarily involves a tax-free distribution of control to the shareholders (or shareholders and security holders).  FedEx could possibly do a public offering of 20 percent or less of the stock of FedEx Freight and follow that up with a distribution of the remaining 80-plus percent of the now- public subsidiary, either pro rata or pursuant to a non pro rata exchange offer/split-off.  Except that, in such a case and immediately following the IPO, FedEx Freight would continue to be a FedEx Subsidiary, and so even with the desired amendment to the debt indenture, the guarantee would remain in place.

We are looking for a series of steps or transactions that would involve a full separation qualifying under Section 355, in which a first step would involve a distribution of a majority of the stock of FedEx Freight where it would be important to assure investors in FedEx Freight that the guarantee of FedEx debt was no longer in place.  Our best guess is that FedEx wants to allow for at least the possibility that it will do what a number of other companies have done in connection with tax-free spin-offs, which involves an initial distribution of at least 80 percent of the stock of FedEx Freight while retaining the remaining 20-percent or less interest for a subsequent step in the process.  We note here that the Offering Memorandum and Consent Solicitation Statement states that “[t]he Exchange Offers and the Consent Solicitations are being made to help FedEx and FedEx Freight optimize their respective capital structures after the Separation.” ⁶  This suggests to us that FedEx at least wants to have the flexibility to use a portion of the FedEx Freight stock to pay down outstanding debt on a tax-favored basis. ⁷ 

Under the tax-free spin-off rules, a Parent corporation can distribute stock in the Spinco tax-free to Parent’s creditors if it is pursuant to a reorganization involving Parent’s transfer of assets to Spinco in exchange for Spinco stock. ⁸  If there is no asset-transfer reorganization, but only a distribution of stock of a preexisting Spinco subsidiary, then in order to use Spinco stock to pay down debt, additional technical hurdles must be overcome.  Section 355 grants tax-free status to Parent’s distribution of Spinco stock to Parent’s shareholders and security holders. ⁹  In this context “security” refers to a debt instrument with a longer term deemed to represent a deeper interest in the issuer corporation than shorter term debt instruments.  Not defined anywhere in a statute or regulation, in practice securities are commonly acknowledged to exist where a term debt instrument has a maturity of longer than five years. ¹⁰ 

Separate from the above nonrecognition rules that tie the “monetization” of Spinco stock to the spin-off/reorganization transaction, the spin-off rules require that the Parent distribute all of its shares in the Spinco, but provide that it may retain a portion of the Spinco stock (though in any case, 80-percent control must be distributed) ¹¹ provided it establishes to the Internal Revenue Service (IRS) that the retention is not for tax avoidance purposes.  Over the years, the IRS has developed a ruling approach in which it will permit retention based on information confirming nontax business reasons for the retention (usually these are financial), confirming no continuing influence over Spinco and a disposition of any retained shares no later than five years after the spin-off.¹²

Under the IRS’s current ruling guidelines, ¹³ FedEx would generally have up to a year following the main spin-off to engage in a transaction that uses the retained shares to pay down debt.  It would presumably have as a back-up plan to distribute the remaining shares to its shareholders.  Note that using retained shares to pay down debt does not require a direct exchange with existing holders of Company debt.  Details vary, but essentially a banker (acting as a principal) purchases outstanding debt, exchanges the debt for SpinCo stock and then sells that SpinCo stock in a public offering.

We look forward to seeing more details about the Company’s plans for the separation of FedEx Freight, including what they have in mind by their reference to capital markets.  Meanwhile, we see how it would make sense for them to increase flexibility regarding FedEx Freight’s guarantee of the parent company debt to allow for a two-step spin-off process.

^{[1] Press release, FedEx, FedEx Announces Intent to Separate FedEx Freight, Creating Two Industry-Leading Public Companies (Dec. 19, 2024) (https://newsroom.fedex.com/newsroom/global-english/fedex-announces-intent-to-separate-fedex-freight-creating- two-industry-leading-public-companies#:~:text=FedEx%20Corp.,a%20new%20publicly%20traded%20company.).}

^{[2] Id.}

^{[3] Press release, FedEx, FedEx Announces Commencement of Exchange Offers and Consent Solicitations for Senior Notes (Jan. 7, 2025) (https://www.sec.gov/ix?doc=/Archives/edgar/data/1048911/000119312525002886/d919743d8k.htm).}

^{[4] Indenture dated as of Oct. 23, 2015 between FedEx and Wells Fargo, pages 46-47 (https://www.sec.gov/Archives/edgar/data/230211/000110465915072361/a15-21267_15ex4d1.htm).  5 See IRC §§355(a)(1) and 368(c).}

^{[5] See IRC §§355(a)(1) and 368(c).}

^{[6] Supra, Note 3.}

^{[7] A recent example of a spin-off expected to use these monetization techniques is Topgolf Callaway Brands Corp.’s spin-off of the Topgolf business, announced on Sept. 4, 2024, about which we wrote in an Oct. 10, 2024 report (“Handicapping A Callaway–Topgolf Tax-Free Spin-Off”).}

^{[8] IRC §361(c).  Other rules allow Parent to receive cash from Spinco and use the cash to pay down debt, limited to the amount of Parent’s basis in Spinco.  Given the financial characteristics of this transaction, that seems to be inapplicable.}

^{[9] IRC §355(a)(1).}

^{[10] See Bittker & Eustice, Federal Income Taxation of Corporations & Shareholders para.  12.11[13] (Warren Gorham & Lamont).  For discussion of the criteria for qualification as a security, albeit without setting forth even a rule of thumb as to length of maturity, see Camp Wolters Enterprises, Inc. v. Commissioner, 230 F.2d 555 (5th Cir. 1956); Rev. Rul. 59-98.}

^{[11] See IRC §§355(a)(1)(D) and 368(c).}

^{[12] See Rev. Proc. 96-30, Appendix B.  The information and criteria for rulings on retentions and other spin-off issues were significantly modified in Rev. Proc. 2024-24, with much controversy surrounding many changes.}

^{[13] See Rev. Proc. 2024-24.}