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On March 30, the Federal Trade Commission issued proposed amendments to the Hart-Scott-Rodino (HSR) premerger notification rules. See www.ftc.gov/os/2004/03/premergerfrn.pdf. If enacted, the proposed rules will fundamentally change the manner in which the U.S. premerger notification requirements are applied to partnerships and limited liability companies. Many transactions that have not been reportable throughout the entire period of the HSR regime would become reportable under the proposed amendments. This reflects a fundamental change in enforcement policy that will subject more transactions to meaningful premerger antitrust review. The proposed rules could take effect following a 60-day comment period if they are issued in final form, which may occur later this summer. Ever since the HSR act and rules came into effect in the 1970s, partnerships, and later limited liability companies (LLCs), generally have not required premerger notification. Partnership interests were not deemed to be “voting securities” or “assets.” The HSR act itself only applies to acquisitions of voting securities and assets. 15 U.S.C. 18a(a). The Federal Trade Commission (FTC) Premerger Notification Office has historically taken the position that formation of a partnership is not a reportable event. The treatment of LLCs has varied over time as the FTC gained more experience with this relatively new form of business combination. The current LLC interpretation has been in place for approximately five years. Formations of LLCs are only reportable when one party acquires a controlling interest in the LLC, two separately controlled businesses are contributed into the LLC and the party not acquiring control has contributed a business valued in excess of $50 million. Under the current rules, many significant LLC and partnership transactions have been completed without any HSR filing or premerger review. In some cases, the antitrust agencies have made post-closing challenges to partnership or LLC transactions that have created substantial competitive issues. For example, in 1998 the FTC challenged a large roofing-tile joint venture that was formed as an LLC and therefore was not reportable. In the Matter of Monier Lifetile LLC, Boral Ltd. and Lafarge S.A., No. 9290 (D.D.C. May 19, 1999). Under the FTC’s historical treatment of partnerships and under its interpretations, parties also could acquire control of such entities, even if significant ongoing businesses, without the need to make an HSR filing. By way of example, one company could acquire a significant, and even controlling, stake in its only competitor without filing HSR notification if the second firm was a partnership or LLC. For transactions involving an acquisition of an interest in an existing partnership or LLC, a filing has been required only when the acquiring party holds 100% of the interest in the partnership or LLC following a transaction. The rationale used by the FTC to reach such transactions has been that when a party holds 100% of the interests in a partnership or LLC, it can be deemed to own all of the assets of that acquired entity and accordingly the “asset” acquisition can fit within the HSR act language. There are several problems with this approach. First, the treatment is at odds with other provisions of the rules themselves. Under the HSR rules, a party is deemed to hold all of the assets of all of the entities that it controls. 16 C.F.R. 801.1(c)(8). Accordingly, a party that holds a 60% interest in a partnership is deemed to hold all of the assets of that partnership. However, under the FTC’s long-standing interpretation, a 60% partnership holder would need to report for an acquisition of assets if it acquired the remaining 40% interest in the partnership from its partner. It is contradictory to treat the party as acquiring assets that the rules say it already holds-a flaw the FTC staff recognized. A second major shortcoming of requiring filings upon obtaining 100% control is that most of the filings that are received for such transactions are essentially meaningless. There is no reasonable likelihood of any anti-competitive effect for a person who controls a partnership acquiring further control of the partnership. Indeed, similar transactions involving corporate entities have always been exempted by the rules as “intraperson” transactions. See 16 C.F.R. 802.30 and 15 U.S.C. 18a(c)(3). The proposed rules The FTC’s proposed amendments to the HSR rules are intended to eliminate some of the anomalies related to partnerships and LLCs. The proposals seek to harmonize their treatment, to the extent practicable under the HSR act, with the treatment for corporations. The logic in seeking more consistent treatment is difficult to challenge. Transactions involving partnerships or LLCs can raise the same competitive issues as comparable transactions involving corporate entities. The substantive analysis for transactions involving partnerships or LLCs is comparable to that for corporate entities. Any such transaction that results in a substantial lessening of competition can violate � 7 of the Clayton Act. 15 U.S.C. 18. The proposed rules attempt to make the filing obligations for partnership or LLC transactions as similar as possible to filing situations involving corporations. The proposed rules establish a new definition of “non-corporate entity” to cover partnerships and LLCs. The proposed rules will require an HSR filing for the formation of partnerships or LLCs in which one party will obtain a controlling interest. Premerger Notification; Reporting and Waiting Period Requirements, 69 Fed. Reg. 18,686, 18,690 � 801.2(f)(1) (April 8, 2004) (to be codified at 16 C.F.R. pts. 801, 802 and 803). The control test for noncorporate entities is defined as having the right to 50% or more of the profits or 50% or more of the assets on dissolution. Id. at 18,688, � 801.1(b). Thus, control for a noncorporate entity will be based on a purely economic test. When a party would obtain control of the noncorporate entity on its formation, it generally would need to file if the value of the interest in the entity that it is acquiring exceeds $50 million. However, a controlling party would not have to file unless other contributors to the new venture contributed assets or voting securities worth in excess of $50 million. Id. at 18,698, � 802.30. Thus, a formation of a partnership in which a financial backer obtains 51% interest with a $51 million investment while another party obtains a 49% interest for a contribution of a $49 million plant would not be reportable. Notably, the proposed rules would still leave a significant difference in the treatment of corporate joint ventures and noncorporate joint ventures. Formation of a noncorporate entity can only be reportable if one person acquires a controlling interest in the entity. In contrast, formation of a joint venture corporation can be reportable by any person that acquires an interest valued in excess of $50 million, even if that interest does not convey control. The proposed rules’ approach toward acquisitions of interests in existing noncorporate entities also is based on an economic-control test. Historically, an HSR filing has been required only when an acquired party holds 100% of the interest in a noncorporate entity as a result of a transaction. The proposed rules require filing when a party obtains an interest in an entity and, as a result of that acquisition, has a right to more than 50% of the profits or assets of that entity on dissolution. Id. at 18,690, � 801.2(f)(1). It appears that FTC staff felt constrained by the language of the HSR act itself, and some of the long-standing definitions in the HSR rules, in determining that the appropriate point at which to impose filing obligation is upon obtaining a controlling interest in a noncorporate entity. The HSR act only applies to acquisitions of “assets or voting securities.” The staff’s interpretation does not change the long-standing position of the FTC that a partnership interest is neither an asset nor a voting security. However, using the “hold” and “control” definitions in the existing HSR rules, the FTC has created a way to require filing on the control change. A party is deemed to hold all of the assets of the entities that it controls. Thus, a party that obtains a controlling interest in a partnership can be deemed to hold the assets of the partnership. The proposed rules attempt to make the valuation rules for noncorporate entities similar to those for corporations. Instead of requiring a filing based on the value of all of the assets of the partnership, the proposed rules mandate that the valuation be made based upon the value of the interest in the noncorporate entity that is being acquired. Thus, a 51% interest in a partnership with assets valued at $60 million might be worth in the neighborhood of $30 million, and a filing likely would not be required. This approach to valuation is an effective mechanism for trying to provide similar treatment for corporate and noncorporate entities. Despite the efforts to harmonize their treatment, some differences remain in the treatment of acquisitions of interests in noncorporate entities in contrast to corporate entities. For example, acquisition of a $50 million interest in a corporation generally will be reportable even if control is not acquired. However, a $50 million acquisition of an interest in a partnership or LLC will only be reportable if that interest provides the acquiring party with the right to 50% or more of the profits or assets of the entity. All in all, the FTC predicts that the proposed changes to the filing requirements for noncorporate entities on formation or change of control will lead to an increase of 117 filings annually. Id. at 18,695. Additional exemptions One major improvement in the proposed rules is their application of similar “intraperson” exemption treatment to acquisitions of noncorporate and corporate interests. Under the HSR rules applicable to corporations, a party that controls a corporation by holding 50% or more of its voting securities can acquire additional shares of that entity without having to make an HSR filing. 16 C.F.R. 802.30; 15 U.S.C. 18a(c)(3). The same has not been true for partnerships or LLCs. Under the traditional staff interpretation, a party that owned 90% of, and fully controlled, a partnership would have to file to obtain the 10% interest in the partnership that it did not already own. Requiring filings in these circumstances is meaningless from the substantive review standpoint. The proposed rules attempt to avoid this bizarre result by applying the intraperson exemption to acquisitions of noncorporate interests. 69 Fed. Reg. 18,693, � 802.30(a). The FTC projects that the expansion of the intraperson exemption will result in a decrease of approximately 59 filings per year. Id. at 18,695. Thus, on a net basis, those changes to HSR rules applicable to noncorporate entities would likely result in a net increase of 58 filings annually (117 more filings required for acquisition of control, but 59 filings exempted under the expanded intraperson exemption rules). An increase of 58 filings per year based on the changes in the treatment of noncorporate entities would represent an approximately 5% increase in the number of HSR filings. There were 1,187 transactions reported in fiscal year 2002. FTC 2002 Annual Report to Congress (2003). The proposed rules also broaden the exemptions applicable to acquisitions of entities that hold assets exempted under various other existing rules. 69 Fed. Reg. 18,693, � 802.4. The FTC estimates that the expansion of this exemption would reduce the number of reportable transactions by approximately 50 per year. Id. at 18,695. Overall, on a total net basis, the FTC anticipates that the proposed rule changes would have a de minimis impact on the number of HSR filings required every year. While approximately 117 additional transactions would require filing, approximately 109 transactions would be exempted under the various expanded exemption rules. The net increase of roughly eight filings per year represents an approximately 1% increase in the total number of filings. More significantly, and to the FTC’s credit, the proposed rules would increase the quality of the transactions being filed. A large number of competitively insignificant transactions that currently require filing would be exempted under the proposed rules. For example, a 99% partnership holder’s acquisition of the remaining 1% interest in the partnership has no competitive significance, but would require an HSR filing today. Under the proposed rules, that transaction would be exempt. Transactions that are more likely to involve a competitively significant event, such as acquiring control of a partnership or LLC, may require an HSR filing when they would not under the current rules and interpretations. If enacted, the proposed rule changes will require parties to give additional consideration to the HSR filing implications of transactions involving noncorporate entities. In particular, there is an increased likelihood that such transactions may be subject to premerger antitrust review. This will place a premium on counseling and guidance. Subjecting a transaction to the premerger review process can increase the time and expense required to complete a transaction. The HSR filing fee alone is $45,000, $125,000 or $280,000, depending on the size of a transaction. Perhaps more significantly, subjecting a transaction to premerger review substantially increases the likelihood that a transaction that raises competitive issues will be investigated or challenged by the antitrust agencies. The FTC and U.S. Department of Justice (DOJ) increasingly have become active in the past several years in challenging consummated transactions. Even so, post-closing challenges represent a very small portion of the overall transactions challenged by the agencies. In fiscal year 2002, the agencies challenged three consummated transactions. In the same fiscal year, the FTC and DOJ combined challenged 34 merger transactions. FTC 2002 Annual Report to Congress (2003). These statistics demonstrate that an HSR-reportable transaction stands a much greater chance of substantive review and ultimate challenge by the agencies. This fact places an increased premium on obtaining effective antitrust counseling for transactions involving noncorporate entities. Jon Dubrow is a partner in the antitrust and trade regulation practice group in the Washington office of McDermott, Will & Emery. He can be reached at [email protected].

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