New HSR Rules Create Filing Requirement for Most Non-Corporate Entities

Transcription

1 New HSR Rules Create Filing Requirement for Most Non-Corporate Entities By Neal R. Stoll and Rita Sinkfield Belin Companies, investment bankers, lawyers, and other parties who structure mergers and acquisitions will have to modify their regulatory check-list when the transaction involves a partnership, limited liability company ( LLC ), or other non-corporate entity (collectively non-corporate entities ). The premerger notification rules (the Rules ) of the Hart-Scott- Rodino Antitrust Improvements Act of 1976 (the HSR Act ) have recently been amended to apply to non-corporate entities. The FTC, however, recently amended the rules to eliminate the HSR Act s congenital partnership loophole, thus harmonizing the filing requirements of corporations and non-corporate entities under the Rules. The HSR Act requires parties to covered mergers and acquisitions of assets or voting securities to file notification with the Federal Trade Commission (the FTC ) and the Antitrust Division of the Department of Justice (the DOJ ), and to wait a specified period of time (generally 30 days) before closing the transaction. Previously, unlike transactions involving corporations, most transactions involving the formation or acquisition of interests in non-corporate entities were not subject to the HSR Act s filing and waiting period requirements. The FTC, however, recently amended the rules to eliminate the HSR Act s congenital partnership loophole, thus harmonizing the filing requirements of corporations and non-corporate entities under the Rules. Accordingly, as of April 7, most transactions involving the formation of, or the acquisition of interests in, an LLC or partnership are reportable under the new Rules and thus subject to the regulatory waiting period. Partnership Loophole Closed Slowly When the HSR Act was enacted in 1978, the FTC s view was that partnerships were not covered by the Act. This was because partnerships could not be controlled (as the term control was defined under the Rules), did not issue voting securities, and did not have individuals that were functionally equivalent to a corporation s board of directors. In addition, partnerships were governed by state law and the FTC hesitated to involve itself in situations where it would have to interpret the gamut of such laws. This view, combined with other aspects of the Rules, meant that significant transactions, including the formation of partnerships and other non-corporate entities, and the acquisition of less than 100% of a partnership or LLC, were not subject to the notification and waiting requirements of the HSR Act. In response to the perception that partnership structures were being implemented to avoid the HSR Act s requirements, the FTC amended the Rules in Pursuant to the 1987 Rules, control of a partnership was determined by the economic interests of the partners who formed the partnership i.e., a partner who had a right to 50 percent of the partnership profits or 50 percent of the partnership assets upon dissolution was deemed to control the partnership. The designation of general or limited partner and other authority granted to partners were deemed irrelevant for HSR Act filing purposes. Accordingly, the 1987 Rules relied upon an economic test rather than a governance test to define control. The 1987 Rules narrowed the loophole to require the entity that controlled the Neal R. Stoll (nstoll@skadden.com) is a partner at Skadden, Arps, Slate, Meagher & Flom LLP. He counsels clients on antitrust issues stemming from mergers and acquisitions, and represents clients in connection with investigations conducted by the staff of the Antitrust Division of the U.S. Department of Justice, the Federal Trade Commission, and the U.S. State Attorneys General. Mr. Stoll also advises corporate clients on other antitrust and consumer protection matters, including compliance programs and the implementation of proposed business plans. He is the co-author of a treatise on the Hart-Scott- Rodino Act of 1976, as amended, and author of many articles on antitrust and trade regulation matters. Rita Sinkfield Belin (rbelin@skadden.com), a senior associate at Skadden, counsels clients on antitrust and Hart-Scott- Rodino issues in connection with mergers and acquisitions. 6 The M & A Lawyer May Glasser LegalWorks

2 partnership to file an HSR Act notification to acquire the voting securities or assets of another entity. However, partnership formations still were not subject to the HSR Act. [I]n 1989, the DOJ obtained a $3 million judgment against A&P for allegedly using a partnership structure to avoid making an HSR Act filing in connection with its acquisition of a competing supermarket chain. The FTC, nonetheless, believed that Rules , prohibiting transactions or devices for avoidance, granted it authority to address and remedy instances when parties misused the partnership structure to avoid complying with the HSR Act. Indeed, in 1989, the DOJ obtained a $3 million judgment against A&P for allegedly using a partnership structure to avoid making an HSR Act filing in connection with its acquisition of a competing supermarket chain. 1 In addition, the FTC obtained an $850,000 civil penalty from Equity Group Holdings ( EGH ), alleging that EGH made several different stock purchases through a limited partnership that was established for the purpose of avoiding the notification and reporting obligations under the HSR Act. 2 The FTC also obtained a $760,000 judgment against Beazer PLC based on allegations that it misused the partnership structure to acquire additional stock and avoid complying with the Rules. 3 Notwithstanding the imposition of civil penalty proceedings, many transactions continued to use the non-corporate entity structure for legitimate business purposes, and thus were able to benefit from the narrowed HSR Act loophole. After many years of discriminating in favor of non-corporate entities, the FTC decided to apply the Rules more evenly to non-corporate and corporate structured transactions. The principle changes in the new Rules can be divided into four areas: the acquisition of interests in non-corporate entities, the formation of non-corporate entities, the formation of LLCs, and the application of certain exemptions. Acquisition of Interests in Non-Corporate Entities Under the former Rules, the acquisition of an interest in a non-corporate entity was reportable only in instances where 100 percent of the interest was acquired. As a result, many transactions that brought about a change in effective control of the unincorporated entity were not reportable, whereas many transactions that did not involve a control change were HSR Act reportable. For example, the acquisition of 90% interest in a partnership was not reportable, but the acquisition of a 10% interest by a person who already controlled 90% of the interest in the partnership was reportable. 4 The new Rules right this condition by providing that an acquisition of interests in an unincorporated entity is reportable if it results in a change of control (assuming the HSR Act s size tests are met). 5 The new Rules utilize the definition of control of a noncorporate entity (as defined in 1987 as the right to 50% or more of the entity s profits or to 50% or more of its assets upon dissolution) and provide a methodology for determining the rights where the partnership agreement provides for shifting economic interests. 6 Example: Person A purchases 60% of the partnership interests in partnership B for US$70 million. Under the former Rules, the acquisition was not reportable, but under the new Rules, it is reportable if no exemptions are available. The new Rules also unify the treatment of corporations and non-corporate entities by providing that a contribution of assets or voting securities to an existing non-corporate entity is deemed to be an acquisition by the non-corporate entity, even if the consideration for the contribution is an interest in the non-corporate entity. Example: Person A contributes a US$100 million business to an LLC in exchange for 20% of the membership interests. Under the former Rules, the transaction was not reportable, because the transaction was treated as the formation of a new LLC, but no one acquired control. Under the new Rules, the transaction is reportable as the acquisition of the business by the already-existing LLC. Formation of Non-Corporate Entities Under the former Rules (and Formal Interpretations of those Rules), the formation of a partnership was not reportable at all, but the formation of an LLC was reportable under certain circumstances. 7 Since the formation of a non-corporate entity presents potential antitrust concerns regardless of its structure, the new Rules mirror the provisions applicable to reporting the formation of corporations. The new Rules subject the formation of noncorporate entities to the HSR Act reporting requirements if the formation confers control to any person. Example: Corporations X, Y and Z form a joint venture partnership with assets valued at US$300 million, and Corporation X will have 55% of the partnership interests. Under the former Rules, the 2005 Glasser LegalWorks Vol. 9, No. 1 The M & A Lawyer 7

3 formation was not reportable, but under the new Rules, Corporation X will need to file HSR notification if no exemptions are available. After many years of discriminating in favor of non-corporate entities, the FTC decided to apply the Rules more evenly to non-corporate and corporate structured transactions. It should be noted that the new Rules do not completely harmonize the treatment of corporate and non-corporate entities. The new Rules definition of control as the right to 50% or more of the entity s profits or to 50% or more of its assets upon dissolution can still lead to situations where the formation of noncorporate entities is not reportable. Such a situation occurs, for example, when no person acquires 50% or more of an economic interest in that non-corporate entity. The situation is different, however, if one acquires voting securities rather than partnership or LLC interests. Any acquisition of voting securities in excess of US$53.1 million requires an HSR Act filing (unless an exemption is available), whereas an acquisition of partnership interests or membership interests in excess of US$53.1 million is not reportable unless the acquisition confers control. Formation of LLCs Repeal of Formal Interpretation 15 8 Under Formal Interpretation 15, 9 formation of an LLC was reportable if two pre-existing businesses were contributed to the LLC and at least one contributor acquired control of the LLC (assuming size tests were met). The formation of all other LLCs was treated like partnerships that were not reportable. Under the new Rules, which repealed Formal Interpretation 15, the formation of an LLC is reportable if one of the parties will hold 50% or more of the LLC and will acquire assets that it had not previously held. There is no requirement that pre-existing businesses be contributed to the partnership. Accordingly, in a formation transaction, if one person contributed cash and took back 50% of the membership interest, a formation filing would be required when the person holding the 50% interest obtained assets contributed by other members valued in excess of US$53.1 million. Conversely, once a person holds 50% of the interest of an LLC or partnership, a filing would not be required by that person to acquire the remaining 50% interest in the entity. In this way, the Rules relating to the acquisition of membership or partnership interests and voting securities are harmonized. The new Rules also clarify that an indirect acquisition of voting securities is separately reportable, regardless of whether the primary acquisition involves a corporation or non-corporate entity. Previously, if a person acquired control of a corporation, and that corporation itself held less than 50% of the voting securities of an issuer, the indirect acquisition of the minority stake could be a separately reportable secondary acquisition. In addition, under the former Rules, if a person acquired control of a non-corporate entity that held a minority stake in an issuer, the acquisition of the minority stake was not reportable, because the primary acquisition was not reportable. The new Rules, however, make the indirect, (i.e., secondary) acquisition reportable regardless of the form of the entity acquired in the primary acquisition. It should be noted that the new Rules do not completely harmonize the treatment of corporate and noncorporate entities. The new Rules definition of control as the right to 50% or more of the entity s profits or to 50% or more of its assets upon dissolution can still lead to situations where the formation of noncorporate entities is not reportable. Example: Person A purchases 100% of the voting securities of corporation X for US$800 million. Corporation X holds 25% of the voting securities of corporation Y, and this minority stake is worth US$70 million. Under the former Rules, the secondary acquisition by Person A of the voting securities of corporation Y was separately reportable. There is no change under the new Rules. If, however, corporation X were instead an LLC, A s secondary acquisition of voting securities of corporation Y would not be separately reportable under the former Rules. The new Rules seek to eliminate this disparity, and under the new Rules, the secondary acquisition of the voting securities of Y would be reportable even if the primary acquisition involved a non-corporate entity. Application of Certain Exemptions Exempt Intraperson Transfers. Under the former Rules, any transfer of assets from a corporation to a controlling shareholder, or a transfer of assets between two commonly controlled corporate subsidiaries, was exempt from notification. However, similar transfers involving commonly controlled non-corporate entities were subject to the HSR Act notification. 10 The new 8 The M & A Lawyer May Glasser LegalWorks

4 Rules harmonize the treatment of corporations and non-corporate entities by providing non-corporate entities an exemption. Example: Person A holds 80% of the partnership interests in partnership B. Person A purchases the remaining 20% of the partnership interests for US$60 million. Under the former HSR Rules, the acquisition was potentially reportable, as the acquisition of 100% of the underlying assets of the partnership. Under the new Rules, person A is deemed to control the partnership, and the acquisition of the remaining partnership interests would not be reportable. Exempt Assets. Pursuant to the former Rules, the acquisition of several classes of assets that are unlikely to raise U.S. antitrust issues (for instance, certain assets located outside of the U.S., or certain assets sold in the ordinary course of business), and some acquisitions of corporations whose only assets are exempt assets were not HSR Act reportable. Logically, it should make no difference whether one acquires exempt assets directly or indirectly through a corporation that controls the assets. [D]eal-makers and their lawyers will have to consider carefully whether an HSR filing is required for transactions involving the formation of, or the acquisition of interests in, partnerships, LLCs, and other noncorporate entities because in most instances a filing will now be required. Anomalously, under the former Rules if a person acquired exempt assets located outside the U.S. HSR Act notification was not required; however if exempt assets were held by a Delaware corporation whose voting securities were acquired, the acquisition of the corporation would nonetheless be reportable. The new Rules provide that the acquisition of exempt assets, either directly or through any corporate or noncorporate entities, will remain exempt so long as that entity does not hold non-exempt assets valued in excess of US$53.1 million. 11 Exempt Financing Transactions. The new Rules also create an exemption for certain financing transactions involving the formation of a new non-corporate entity. Under the former Rules, if an investor, for the purpose of providing financing, contributed only cash to a newly formed non-corporate entity, and received a preferred return in order to recover its investment, the investment qualified as an HSR Act-reportable acquisition of that entity as long as the investor had the right to 50% or more of the profits or 50% or more of the assets upon dissolution. Because the investment is more analogous to a creditor taking secured debt, the new Rules exempt this type of transaction if the formation agreement provides that the investor will no longer control the entity after realizing the preferred return. While the transaction to form this new entity is exempt from the HSR Act filing requirements, in subsequent transactions, the investor is still deemed to be the ultimate parent entity until it no longer receives the preferred return. New Rules Won t Limit Deal Structures Now that the new Rules are in effect, transaction structures with non-corporate entities will be treated more like the transactions with corporate entities. As such, deal-makers and their lawyers will have to consider carefully whether an HSR filing is required for transactions involving the formation of, or the acquisition of interests in, partnerships, LLCs, and other non-corporate entities because in most instances a filing will now be required. Accordingly, deal-makers have to add HSR approval to their checklist for many of their non-corporate transactions. While there may be some uncertainty initially as everyone becomes well-acquainted with the new Rules, their application should neither limit a dealmaker s selection of transaction options nor add any unusual steps to the process of consummating mergers and acquisitions that include non-corporate structures. 1 United States v. Tengelmann Warenhandelsgesellschaft and the Great Atlantic & Pacific Tea Co., Inc., CCH Trade Cas. 68,623 (D.D.C. 1989). 2 United States v. Equity Group Holdings, CCH Trade Cas. 69,320 (D.D.C. 1991). 3 United States v. Beazer, PLC, CCH Trade Cas. 69,923 (D.D.C. 1992). 4 These discrepancies stemmed from the position of the Premerger Notification Office that interests in unincorporated entities were neither assets nor voting securities for the purposes of the HSR Act and therefore not reportable, excluding cases where all of the entity s underlying assets were acquired (i.e., acquisition of 100% of the interests). 5 The new Rules define a non-corporate interest as any interest in any unincorporated entity which gives the holder the right to any profit of the entity or, in the event of dissolution of the entity, the right to any of its assets after payment of its debts. 6 In instances where the right to profit or assets is not fixed, control will be determined as following: If the right to profit is variable and the right to assets upon dissolution is fixed, the right to 50% or more of the assets upon dissolution will be deemed to confer control. If the right to assets upon dissolution is variable and the right to profit is fixed, the right of 50% or more of the profit will be deemed to confer control. Where M & A 2005 Glasser LegalWorks Vol. 9, No. 1 The M & A Lawyer 9

5 both are variable, control will be determined by applying the formula for determining rights to the assets upon dissolution to the total assets of the entity at the time of the acquisition as if the entity were being dissolved at that time. If the LLC or partnership has a balance sheet, the most recent regularly prepared balance sheet must be used and the formula applied as if the entity were being dissolved at the present time. If the LLC or partnership does not have a regularly prepared balance sheet, a pro forma balance sheet must be prepared and the formula must be applied as if the entity were being dissolved at the present time. If no person has the right to 50% of the assets using this method, no person has acquired control. 7 See discussion in Formation of LLCs, infra Fed. Reg (February 5, 1999). 9 Formal Interpretation 15 was repealed by Formal Interpretation 18, which was issued in connection with the new Rules. 10 The transfers were not exempt since those entities were not controlled through the holding of voting securities pursuant to 16 CFR Likewise, the new Rules expand the exemption relating to the formation of non-profit entities to include any non-profit entity (not just non-profit corporations). Moreover, the new Rules expand the exemption for newly formed corporations, so that all newly formed entities, not just corporations, are exempt from filing as an acquired person if any acquiring person is filing with respect to the formation. Bankruptcy Reform Act Loosens Restrictions on the Engagement of Investment Bankers By James Bromley and Sean O Neal The recently enacted bankruptcy reform law significantly loosens restrictions on the ability of investment bankers to provide M&A advice to debtors and creditors committees in bankruptcy proceedings. The 2005 Amendments, however, do not repeal all restrictions on hiring investment bankers during a bankruptcy case. On April 20, President Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the 2005 Amendments ). Among other things, the 2005 Amendments repeal a 60-year old provision barring the engagement of investment bankers that had been advisors on the sale of a debtor s outstanding securities or had been engaged (primarily as underwriters) in connection with the offer, sale or issuance of a security of a debtor. 1 The per se bar also applied to attorneys, officers, directors and employees of such investment bankers. By repealing the per se bar, Congress addressed a problem faced by large corporate debtors. Under the old provision, it was sometimes difficult (and occasionally impossible) to locate and retain qualified investment bankers that had not been involved in a prior offering, sale or issuance of a debtor s securities. 2 For example, in the Adelphia bankruptcy, the debtor wanted to retain an investment banker to provide M&A advice for a potential $17 to $20 billion deal. However, all of the investment banking firms with experience in such large transactions had underwritten or participated in one of Adelphia s offerings and the major boutique firms also faced problems. To resolve the issue, after a delay of several months, Adelphia hired a combination of M&A advisors an affiliate of one of the underwriters that had relatively small roles in prior offerings, plus a smaller investment banking firm that had not participated in any of the offerings. An ethical wall was imposed to prevent any affiliates that participated in prior offerings from providing M&A services to Adelphia. Ultimately, the bankruptcy court approved the engagement, without any objection from the Office of the United States Trustee, which closely monitors professional retentions. 3 Basic Rules of Engagement The 2005 Amendments, however, do not repeal all restrictions on hiring investment bankers during a bankruptcy case. Any professional to be paid out of estate funds will still be required to seek and obtain bankruptcy court approval for any engagement by a debtor or a creditors committee. General conflict of interest rules under the Bankruptcy Code continue to apply. Under Section 327(a) of the Bankruptcy Code, a debtor may employ a professional, such as an investment banker, only if such professional: (1) does not hold or represent an adverse interest to the estate; and (2) is a disinterested person, as defined in James Bromley (jbromley@cgsh.com) is a partner, and Sean O Neal (soneal@cgsh.com) is an associate, in the New York office of Cleary Gottlieb Steen & Hamilton LLP. 10 The M & A Lawyer May Glasser LegalWorks