FTC Announces Amendments to Hart-Scott-Rodino Rules Governing Unincorporated Entities and Not-for-Profit Corporations
The Federal Trade Commission has announced changes to certain regulations under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the Act) which will become effective on April 7, 2005. The Act requires certain parties intending to merge, purchase or sell voting securities or engage in other acquisition transactions to provide the Federal Trade Commission (FTC) and the Department of Justice (DOJ) with information regarding their operations and the proposed transaction for review and wait a specified period of time prior to consummation of the transaction. The reporting and waiting period requirements enable the FTC and DOJ to determine whether a proposed merger or acquisition may violate the antitrust laws if consummated. The most significant changes to regulations under the Act attempt to reconcile inconsistent treatment of corporations, partnerships, limited liability companies and other types of unincorporated entities, both in acquisitions of interests in such entities and formations of such entities. The changes are a reaction to the expanding number of formations of unincorporated entities such as limited liability companies (LLCs) and limited liability partnerships and the acquisitions by such unincorporated entities of both corporate and other unincorporated entities.
The provisions of the Act specifically apply to acquisitions of voting securities or assets. However, neither the Act nor the regulations thereunder have ever specifically addressed whether interests in unincorporated entities, such as limited liability companies or partnerships, are deemed to be voting securities or assets for purposes of the Act. Through informal interpretations, the Premerger Notification Office of the FTC has previously taken the position that partnership interests and, by extension, interests in other types of unincorporated entities, are neither assets nor voting securities. Based on this position, any acquisition of such non-corporate interests has previously not been deemed a reportable event under the Act unless 100 percent of such interests are acquired in which case the acquisition was deemed to be that of all of the assets of the unincorporated entity. Under the new rules, acquisitions of “control,” but less than 100 percent of a partnership or limited liability company, will be reportable for the first time in the history of the Act. While the new rules bring treatment of acquisitions of non-corporate interests closer to the treatment accorded acquisitions of voting securities under the Act, differences do remain as an acquisition of even a minority interest in voting securities valued in excess of $53.1 million remains reportable under the Act.
Acquisitions of Interests in Unincorporated Entities
Prior to April 7, 2005, a person who held no interest or a minority position in an unincorporated entity could acquire up to 99 percent of the interests of such entity without a filing obligation under the Act but would have a filing requirement if it acquired 100 percent of the interests. In promulgating the changes to the regulations, the FTC indicated that meaningful antitrust review should occur at the time control of the unincorporated entity changes and not after control is already acquired.
Under the new rules, the term “non-corporate interest” is defined as an interest in any unincorporated entity which gives the holder the right to any profits of such entity or, in the event of dissolution of the entity, the right to any assets of such entity after payment of its debts. To further clarify, the rule also provides a non-exclusive list of unincorporated entities, namely partnerships, LLCs, cooperatives and business trusts. In addition, the acquiring person in an acquisition of non-corporate interests which confers “control” of the unincorporated entity will now be deemed to hold the assets of the acquired entity (except as to certain trusts where “control” is defined as having the right to designate 50 percent or more of the trustees). “Control” for purposes of unincorporated entities is defined as having the right to 50 percent or more of the profits of the entity, or having the right in the event of dissolution to 50 percent or more of the assets of the entity. Therefore, the new rules effectively shift the reporting requirement from when 100 percent of the interests in an unincorporated entity are acquired to the point where control of such entity is obtained. Any non-corporate interests in the same entity already held by the acquiring party are required to be aggregated with the interests being acquired to determine if a change in control will occur as a result of the acquisition.
The new rules also provide how to value the acquisition of a controlling interest in an unincorporated entity. Such value will be the acquisition price, if determined, or the fair market value if the acquisition price is not determined.
Formation of a New Unincorporated Entity
The current rules provide that the formation of any unincorporated entity is not reportable under the Act with the exception of the formation of certain limited liability companies where one person controls the LLC and it is made up of a combination of two existing businesses. The new rules require reporting so long as at least one of the forming persons acquires control of the new unincorporated entity provided that the Act’s size-of-person thresholds are met by the newly formed entity and the acquiring person. Thus, the formation of a partnership or limited liability company where no person acquires 50 percent or more of the interests remains exempt from reportability under the Act.
New Financing Transaction Exemption
Unincorporated entities such as limited liability companies and partnerships are often formed to effect financing transactions with the investor taking a preferred return on the profits of the entity until it recoups its investment. During this initial period, the investor would be deemed to control the entity under the new rules as it has the right to more than 50 percent of the profits of the entity. However, the FTC has identified this type of financing transaction as a class of acquisition that does not ordinarily have significant competitive effects and, therefore, the rules provide a new exemption from the requirements of the Act for such financing transactions if: (i) the investor is only contributing cash to the new entity, (ii) the investor is making the contribution for the purpose of providing financing, and (iii) the investor will no longer control the entity after the investor realizes its preferred return.
Acquisitions of Not-for-Profit Corporations
Acquisitions of not-for-profit corporations are not exempt from the Act. The new rules formalize a longstanding informal position of the FTC that acquiring the right to designate 50% or more of the board of directors of a not-for-profit corporation is an acquisition of all of the underlying assets of such entity.
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