United States: Hart-Scott-Rodino Rules Amended to Apply More Broadly to Partnerships, LLCs and Other Unincorporated Entities

Since the inception of the HSR regime in the late 1970’s, the FTC has wrestled with the problem of applying the HSR regulations to partnerships, LLCs and other unincorporated entities. The Act applies only to acquisition of voting securities or assets; interests in unincorporated entities have never been regarded as assets or voting securities subject to the Act. Over the years, the FTC developed a number of policies in an attempt to deal with unincorporated entities:

• Only the acquisition of 100% of a partnership was potentially reportable as it was deemed to be an acquisition of the underlying assets of the partnership.

• In the early years of HSR, a partnership was regarded as its own ultimate parent entity, incapable of being controlled by any of its partners (short of 100% ownership). The FTC attempted to close this "partnership loophole" in 1987 by adding a definition of "control" that included persons with a significant stake in unincorporated entities -- namely, those who had a right to (a) receive 50% or more of the entity’s profits, (b) receive 50% or more of the entity’s assets in the event of dissolution, or (c) designate contractually 50% or more of the "individuals [in the entity] exercising similar functions" to the directors of a corporation.

• LLCs, a more recent arrival on the business scene, were the subject of an FTC Formal Interpretation in 1999. That interpretation treated the formation of a new LLC as a reportable transaction only if it combined two or more existing businesses under common control and at least one member had a 50% control interest. Other LLCs continued to be treated like partnerships.

• Acquisitions of assets or voting securities by or from pre-existing partnerships and LLCs have always been potentially reportable and this will continue to be true.

• Out of this patchwork, the FTC has now attempted to craft a coherent structure, with what appears to be some success. Under the new proposal, for most purposes, unincorporated entities are to be treated essentially as if they are corporations. The keystone is a new definition of "non-corporate interest" in 16 CFR § 801.1(f) which includes the correlate concept of "unincorporated entity." A non-corporate interest is one that gives a holder the right to any profits of the entity or in the event of dissolution the right to any assets after payment of debts. The rules provide examples of such entities, including partnerships, LLCs, cooperatives and business trusts; other types of trusts are specifically excluded.

HSR treatment of these entities, and acquisition of these interests, is elaborated in a number of new and amended sections of the rules.

• "Control", in the unincorporated context, means only the right to 50% or more of the entity’s profits or assets on dissolution. It no longer includes the right to designate 50% or more of those who perform "director-like" functions. The only exception relates to certain trusts in which the right to appoint 50% or more of the trustees will be deemed control. 16 CFR § 801.1(b). The definition of control continues to include the right to appoint 50% or more of the members of the Board of a corporate entity or a not-for-profit corporation.

• If the right to profits and assets on dissolution is "variable", to determine control, the last regularly prepared balance sheet must be consulted or, if none exists, a pro forma balance sheet must be prepared in accordance with 16 CFR § 801.11(e)(2)(i).

• The value of non-corporate interests is to be calculated using acquisition price and fair market value -- two criteria already used to value assets and voting securities for HSR purposes. 16 CFR § 801.10(d).

• Non-corporate interests to be acquired in a transaction must be aggregated with noncorporate interests previously acquired in the same entity -- but, unless control would result from the acquisition, not aggregated with assets or voting securities being acquired or previously acquired from the same person. 16 CFR § 801.13(c).

• The formation of a new unincorporated entity is reportable, or non-reportable, on essentially the same basis as the formation of a new corporation under 16 CFR § 801.40. The important difference is that only acquisitions of control of a new unincorporated entity are potentially reportable under this section; acquisitions of less than 50% are still potentially reportable in the case of new corporate entities. 16 CFR § 801.50.

The FTC fine-tunes HSR exemptions -- adding exemptions that eliminate filings for transactions without competitive consequence, and limiting exemptions so that transactions that might otherwise escape HSR review will be reported. The new rules have several such provisions:

• The exemption for real property asset acquisitions (16 CFR § 802.2) has been amended to make clear that it does not apply to timberlands and other realty that generates forestry or logging revenues (activities falling within NAICS subsection 113 and industry group 1153).

• Section 802.4 has been expanded to apply to all HSR exemptions. Under the old rule, an acquisition of voting securities could be exempt if the target issuer held certain real property assets that would have been exempt in a direct acquisition of those assets. The new rule broadens the exemption in two ways: (a) the exemption applies to both acquisitions of voting securities and unincorporated interests and (b) the exemption applies to the acquisition of a target that holds assets that are exempt under any section of the HSR Act or rules (or holds no more than $53.1 million of non-exempt assets), rather than limiting the exemption to real property assets. 16 CFR § 802.4.

• An exemption has been added for stock splits, dividends and reorganizations to codify a longstanding informal FTC position exempting formation of an upstream holding company provided no new assets are contributed and the ownership percentages remain the same or decrease. 16 CFR § 802.10(b).

• The "intra-person" exemption has been significantly enlarged to include intra-family transactions involving unincorporated entities in which no change of control occurs. 16 CFR § 802.30.

• The exemption for the formation of not-for-profit entities has been changed to make it clear the exemption applies to all not-for-profits, not just those with a corporate form. 16 CFR § 802.40.

• Another new exemption applies to acquisitions of non-corporate interests in ordinary course financing transactions so long as the investor contributes only cash and, although having a right to more than 50% of the profits during the payback period, does not acquire long-term control of the entity. 16 CFR § 802.65.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.