On March 30, 2004, the U.S. Federal Trade Commission (FTC) published significant proposed changes to the Hart-Scott-Rodino Act (HSR) premerger notification rules. These proposed changes, if adopted, will fundamentally change HSR treatment of partnerships and limited liability companies (LLCs), both at the time of formation as well as for post-formation transfers of interests in those entities. The HSR imposes mandatory premerger notification and waiting period requirements for transactions meeting certain criteria. In general, absent a specific exemption, acquisitions that result in a holding in excess of $50 million of assets or voting securities are subject to HSR requirements.
The primary thrust of the proposed rules is to harmonize the HSR treatment of corporations and "non-corporate entities." Under the proposed rules, many transactions involving partnerships and LLCs that currently are not reportable will become reportable. In light of these impending changes, counsel involved in negotiating and implementing transactions need to be aware of these new rules. Many transactions that are currently under consideration will need to be analyzed under the new regime.
The proposed rules are subject to a 60-day public comment period, and these comments may result in some modifications. However, absent significant changes, the final rules should be issued reasonably soon after end of the comment period. If the FTC issues final rules following the comment period, they will become effective 30 days following the publication of the final rules. Under this schedule, it is likely that the new rules will apply to transactions that have not been completed prior to the end of July 2004.
Current HSR Treatment of Corporate Joint Venture Entities
The HSR rules have always applied to the formation of corporate joint ventures. Formation of a new corporation by two or more parties is generally reportable where 1) at least one party will acquire an interest in the venture valued in excess of $50 million and 2) the acquiring party and the venture have sales or assets in excess of $100 million and $10 million, respectively (or vice versa) and another party to the venture has $10 million or more in sales or assets. Acquisitions of shares in an already established corporate joint venture are treated the same as acquisitions of any other corporation. If a party will hold shares valued in excess of $50 million, that transaction can be reportable, without regard to the percentage of shares it will hold.
Current HSR Treatment of Partnerships and LLCs
Since the beginning of the HSR regime in 1976, partnership formations have been exempt from reporting under HSR. Thus, today, Microsoft and Intel could form a partnership to combine their businesses, and that transaction would not require an HSR filing. LLC formations have occupied a middle ground between joint venture corporation formation (which can be reportable) and partnership formation (which has not been reportable), and the HSR treatment of LLCs has evolved over time. As it presently stands, LLC formations are reportable where 1) two or more parties each contribute a "business" to the entity; 2) one party will hold 50 percent or more of the LLC interests; and 3) another party will contribute assets or voting securities valued in excess of $50 million to the LLC. Thus, under the current LLC rules, Microsoft, Intel and Oracle could combine all of their operations into an LLC, with each taking a one third interest, and not have to report under the HSR.
Acquisitions of interests in existing partnerships and LLCs have been analyzed under a common test, although that treatment differs significantly from the rules governing corporate joint venture entities. Once a partnership or LLC has been formed, a party currently can acquire an interest in that entity without an HSR filing unless, as a result of the acquisition, that person would hold 100 percent of the interests in the partnership or LLC. This interpretation has several strange ramifications. For instance, a party can acquire a controlling interest in an existing LLC or partnership, for hundreds of millions of dollars, yet not have to report that acquisition. On the other hand, a party that owns 90 percent of a partnership or LLC and already controls it would need to file before acquiring the remaining 10 percent interest.
In sum, there are significant differences in the HSR treatment of joint venture corporations and other types of non-corporate entities under the current rules. More to the point, these differences give rise to a situation where transactions raising potential competitive concerns are not subject to HSR premerger notification and waiting period requirements solely as a consequence of the parties’ choice of entity.
Proposed Rules Seek to Harmonize HSR Treatment of Corporate and Non-Corporate Entities—but Significant Differences Will Continue
As described above, there are fundamental differences in the current treatment of partnerships, LLCs and corporate entities, both at the time of formation and for later transfers of interests in the entities. The proposed rules attempt to harmonize these differences by capturing more transactions involving the formation of non-corporate entities, as well as the subsequent transfers of interests in those entities. Even so, some significant differences will remain between the treatment of corporations and non-corporate entities.
The proposed rules create a new definition of "non-corporate entity" to govern partnerships, LLCs, cooperatives and other non-corporate entities that allow interest holders to have an interest in the profits or assets of the entity. Because the HSR only applies to acquisitions of "assets" or "voting securities," the proposed rules are focused on the acquisition of a controlling interest in the non-corporate entity, because that controlling interest confers ownership, for HSR purposes, of all of the assets of the entity. The proposed rules capture transactions involving the formation of, or transfer of interests in, non-corporate entities when a party will control that entity under the HSR rules. A partnership or LLC is controlled by any party that has a right to 50 percent or more of its profits or assets on dissolution.
The formation of a new joint venture partnership or LLC will be reportable if any party will hold a controlling interest in the entity, and that party’s interest will be valued at $50 million or more. This means that partnership formations can now be reportable if they meet this fairly simple test, whereas they are never reportable under the current rules. Likewise, many LLC formations that are not currently reportable will become reportable. For example, today a LLC to which one party contributes cash and another contributes a business is not reportable since the requirement that "two businesses" be contributed to the LLC is not met. Under the proposed rules, if the party contributing cash acquires a controlling interest and that interest is valued over $50 million, an HSR filing likely will be required.
Acquisitions of Existing Interests
Acquisitions of interests in an existing non-corporate entity will potentially be reportable under the new rules if the acquiring person will hold a controlling interest valued in excess of $50 million following the acquisition. Thus, whereas under the current rules, a transfer of an existing partnership or LLC interest is reportable only if the transfer results in a party holding 100 percent of the interests in the entity, the reporting threshold will be reduced to 50 percent under the proposed rules. This seems to be a more logical approach, and is more likely to trigger a reporting requirement at a time when substantive antitrust issues, if any, can be effectively addressed.
A significant advancement of the proposed rule changes is to harmonize the treatment of "intracompany" transactions involving corporate and non-corporate entities. A party that holds 50 percent or more of the voting securities of a company can acquire additional shares without reporting. However, under current rules, the same is not true for a party that holds a controlling interest in a partnership or LLC. As noted above, currently acquisitions by a person already controlling a partnership or LLC are potentially reportable if the party will hold 100 percent of the interests in the entity following the acquisition. This has led to many bizarre filings, with a party that controls a partnership being required to make an HSR filing to "acquire" the assets of a partnership which it already controls. The proposed rules extend "intracompany" treatment to non-corporate entities, which, again, is both logical and consistent with the underlying purposes of the HSR Act itself.
The proposed rule changes published by the FTC represent a laudable effort to eliminate some of the historical inconsistencies in the HSR rules. The rules will expand HSR coverage to include a wide range of previously non-reportable transactions involving non-corporate entities. At the same time, the new rules will eliminate reporting requirements as to intracompany transactions. At bottom, they reflect the agency’s understandable desire to subject potentially problematic transactions to HSR review irrespective of the form of entity selected by the parties to bring about a business combination or acquisition.