Premerger Notification: Reporting and Waiting Period Requirements

FEDERAL TRADE COMMISSION

Premerger Notification: Reporting and Waiting Period Requirements

AGENCY: Federal Trade Commission.

ACTION: Notice of adoption of formal interpretation and request for

comments.

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SUMMARY: The Premerger Notification Office (``PNO'') of the Federal

Trade Commission (``FTC''), with the concurrence of the Assistant

Attorney General in charge of the Antitrust Division of the Department

of Justice (``DOJ''), is adopting a Formal Interpretation of the Hart-

Scott-Rodino Act, which requires certain persons planning certain

mergers, consolidations, or other acquisitions to report information

about the proposed transactions to the FTC and DOJ. The Interpretation

concerns the reportability of certain transactions involving a Limited

Liability Company (``LLC''), a relatively new form of entity authorized

by state statutes. Under the Interpretation, the formation of an LLC

will be reportable if it will unite two or more pre-existing businesses

under common control. Similarly, acquisitions of existing LLC

membership interests will be reportable if they would have the effect

of uniting two or more pre-existing businesses under common control.

DATES: The effective date is December 14, 1998. Comments must be

submitted on or before November 12, 1998.

ADDRESSES: Send written comments to Joseph G. Krauss, Assistant

Director for the Premerger Notification Office, Bureau of Competition,

Room 301, Federal Trade Commission, Washington, DC 20580.

FOR FURTHER INFORMATION CONTACT: Joseph G. Krauss, Assistant Director

for the Premerger Notification Office, Bureau of Competition, Room 301,

Federal Trade Commission, Washington, DC 20580. Telephone: (202) 326-

2713. Thomas F. Hancock, Attorney, Premerger Notification Office,

Bureau of Competition, Room 301, Federal Trade Commission, Washington,

DC 20580. Telephone: (202) 326-2946.

SUPPLEMENTARY INFORMATION: The text of Formal Interpretation Number 15

is set out below:

Formal Interpretation Number 15

Formal Interpretation Pursuant to Sec. 803.30 of the Premerger

Notification Rules, 16 CFR 803.30, Concerning the Reporting

Requirements for the Formation of Certain Limited Liability Companies

(``LLCs'') and for Acquisitions of Membership Interests in Certain

Existing LLCs.

This is a Formal Interpretation pursuant to Sec. 803.30 of the

Premerger Notification Rules (``the rules''), 16 CFR 803.30, and

801.2(d) of the rules, 16 CFR 801.2(d). The rules implement Section 7A

of the Clayton Act, 15 U.S.C. 18a, which was added by sections 201 and

202 of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (``the

act'').

The act requires the parties to certain mergers, acquisitions, and

other business combinations to file reports with the FTC and the DOJ

and to wait a specified period of time before consummating the

transaction. The purpose of the act and the rules is to ensure that

such transactions receive meaningful scrutiny under the antitrust laws,

with the possibility of an effective remedy for violations, prior to

consummation.

The LLC 1 is a relatively new form of business

organization which is neither a partnership nor a corporation but a

hybrid legal entity which combines certain desirable features of both

partnerships and corporations. Specifically, an LLC is taxed as a

partnership but shields its members from liability as a corporation

shields its shareholders. The first LLC statute was passed in 1977 by

Wyoming 2 and a trickle of other states followed. The use of

LLCs expanded significantly after 1988 when the Internal Revenue

Service (``IRS'') concluded that an LLC organized under the Wyoming

statute was taxable as a partnership.3 By 1993 all 51

jurisdictions had LLC laws of one form or another.

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\1\ This Formal Interpretation applies only to the reportability

of the formation of certain LLCs and of acquisitions of interests in

certain existing LLCs. The position of the FTC staff on the status

and treatment under the act of other non-corporate entities such as

partnerships remains unchanged.

\2\ Wyo. Stat. Secs. 17-15-101 to -135 (Supp. 1989).

\3\ Rev. Rul. 88-76, 1988-2 C.B. 360, 361.

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When it first encountered these types of organizational structures,

the PNO concluded that as ``companies'' LLCs are ``entities'' within

the meaning of Sec. 801.1(a)(2), 16 CFR 801.1(a)(2), and that, until it

had more experience with them, the PNO would deem LLCs to be

corporations. Initially, therefore, Sec. 801.40 of the rules, 16 CFR

801.40, ``Formation of joint venture or other corporations,'' governed

the formation of LLCs and an interest in an LLC was treated as a voting

security for HSR purposes.

On further analysis, the PNO concluded that this initial approach

was inadequate. LLCs at the time were primarily used as a vehicle for

the creation of start-up businesses. The PNO's treatment of LLCs

resulted in requiring HSR filings in a large number of transactions

that did not raise antitrust concerns. Furthermore, the PNO determined

that in most LLCs the interest held by the members of the LLC was more

like a partnership interest than that of a voting security interest.

Consequently, in 1994, the PNO began to informally advise parties that

the treatment of LLCs' for reporting purposes would depend on a

determination of whether the interest acquired in the LLC was more like

a voting security interest or more like a partnership

interest.4

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\4\ Specifically, the formation of an LLC was treated as

potentially reportable only if the LLC had a group which functioned

like a board of directors and the LLC ownership interest resulted in

the holder appointing person(s) other than its employees, officers,

or directors (or those of entities controlled by the holder or its

ultimate parent entity) to that group. In such cases, the LLC

interest was treated as a voting security interest. In all other

instances, LLC interests were treated as partnership interests and

the acquisition of these interests was not reportable (unless the

acquiring person would hold 100 percent of the interests as a result

of the acquisition).

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This subsequent treatment of LLCs has not been completely

satisfactory. The use of LLCs has changed from primarily being a

vehicle for start-up enterprises to being used now more frequently to

combine competing businesses under common control. Indeed, the

Commission's litigation staff has investigated several transactions

raising potential antitrust concerns involving the formation of LLCs.

In these transactions, previously separate

[[Page 54714]]

businesses were combined under common control when they were

contributed to a single, newly-formed LLC. Nevertheless, the creation

of the LLC to combine competing businesses under common control was not

reportable under the PNO's current treatment. The union of competing

businesses under common control is of obvious potential antitrust

concern. Since the current approach to LLCs has not been useful in

requiring filings for those transactions that are the most likely to

have anticompetitive effects, the PNO staff has decided to revise its

approach to LLCs to be more consistent with the intent of the act.

This Formal Interpretation, therefore, changes the PNO's treatment

of LLCs as follows: The formation of an LLC which brings two or more

pre-existing separately controlled businesses under common control

(i.e. an interest entitling one party to 50 percent of the profits of

the LLC or 50 percent of the assets of the LLC upon dissolution) is now

reportable if the HSR size-of-person and size-of-transaction

requirements are met. The formation of all other LLCs will be treated

like the formation of a partnership and their reportability will be

determined according to the partnership rule. The current analysis used

to determine whether an LLC interest acquired is more like a voting

security or a partnership interest will no longer be used.

The combination of businesses into a new LLC under common control

is the functional equivalent of a merger or consolidation. Such

combinations, like other unions of businesses under common control, are

subject to the act. Sec. 801.2(d)(1)(i) of the rules, 16 CFR

801.2(d)(1)(i), states that ``[m]ergers and consolidations are

transactions subject to the act * * *'' Although combinations of

businesses in LLCs are not mergers or consolidations in the strictest

sense because they do not involve corporations,5 they are

substantively similar. As it was originally promulgated in 1978,

Sec. 801.2(d)(1)(i), 16 CFR 801.2(d)(1)(i), stated that ``[a] merger,

consolidation, or other transaction combining all or any part of the

business of two or more persons shall be an acquisition subject to the

act * * *'' (emphasis added).6 A similar rationale has long

been used to require filings for acquisitions of non-profit

corporations which, like LLCs, do not issue voting

securities.7 Imposing a filing requirement on the parties to

such transactions promotes the basic purpose of the act and the rules,

namely, to give the antitrust enforcement agencies advance notice of,

and an opportunity to oppose, transactions which may violate the

antitrust laws.

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\5\ See, e.g., 19 W. Fletcher, Cyclopedia of the Law of Private

Corporations Sec. 3:141 (perm. ed.1994). Mergers and consolidations

are defined as transactions in which all constituent corporations

(in the case of consolidations) or all but one (in the case of

mergers) lose their separate legal identities as part of the

transaction. When two or more businesses are united in an LLC, they

do not lose their legal identities in this sense, but they do cease

to be separate and independent.

\6\ 43 FR 33539, July 31, 1978. This language does not appear in

the current version of Sec. 801.2(d). In 1983, this provision was

changed to clarify and change the treatment of mergers and

consolidations under the rules and this particular wording was

eliminated. There is no indication that this change was intended to

narrow the scope of Sec. 801.2(d), however. According to the

Statement of Basis and Purpose to the 1983 changes, 48 FR 34430,

July 29, 1983, the Commission sought to make clear that mergers and

consolidations are treated as acquisitions of voting securities and

to change Sec. 801.2(d) to enable the parties to a merger to

determine which is the acquiring person and which is the acquired

person.

\7\ See, The Premerger Notification Practice Manual, ABA, 1991

ed., Interp. #109.

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Furthermore, when a person contributes a business to an LLC to be

controlled by another, such transfer is the functional equivalent of an

acquisition of the assets of that business and should be so treated for

HSR purposes. Reportable acquisitions of non-profit corporations are

also reported as asset acquisitions for the same reason. Consequently,

assuming the size-of-person and size-of-transaction tests are met,

contributors to combinations of businesses in LLCs should report as if

they were acquiring the assets to be contributed to the LLC by the

other contributor(s).

Although Sec. 801.40 of the rules, 16 CFR 801.40, which governs the

reporting of the formation of corporate joint ventures and other new

corporations, is not directly applicable to combinations of businesses

in LLCs because LLCs are not corporations and do not issue voting

securities, the principles embodied in Sec. 801.40--especially in

Sec. 801.40(c)--are applicable here. The value of the assets of the new

LLC for size-of-person test purposes should be determined in accordance

with Sec. 801.40(c). Parties required to file should complete Item 5(d)

of the Notification and Report Form for Certain Mergers and

Acquisitions. Like a new corporation under Sec. 802.41 of the rules, 16

CFR 802.41, the new LLC need not file notification (but each

contributor who meets the size-of-person test may need to do so).

Typically, there would be no acquired person filing, as in the case of

the formation of corporate joint ventures. The waiting period will not

begin until all parties required to file have filed and are in

compliance (cf. Sec. 803.10(a)(2) of the rules, 16 CFR 803.10(a)(2)).

A ``business'' is defined for purposes of this Interpretation the

same as an ``operating unit'' for purposes of Sec. 802.1(a) of the

rules, 16 CFR 802.1(a), namely, ``* * * assets that are operated * * *

as a business undertaking in a particular location or for particular

products or services, even though those assets may not be organized as

a separate legal entity.'' For purposes of this Formal Interpretation,

the contribution to an LLC of an interest in intellectual property,

such as a patent, a patent license, know-how, and so forth, which is

exclusive against all parties including the grantor, is the

contribution of a business, whether or not the intellectual property

has generated any revenues.

This new treatment of LLCs also affects the reportability of the

acquisition of membership interests in existing LLCs. The acquisition

of existing membership interests will be potentially reportable in two

situations. Any person which acquires (or, as a result of an

acquisition, will hold) a controlling interest in an existing LLC (i.e.

an interest entitling it to 50 percent of the profits or 50 percent of

the assets upon dissolution) may be required to file because such a

transaction may bring two or more separate businesses under common

control. Whether a filing is necessary when a person acquires a

controlling interest in an existing LLC would depend on whether the

acquiring person also has a business and whether the size of person and

size of transaction criteria of the act are met. In situations where

the acquisition of a membership interest in an LLC does not result in

the combination of existing businesses under common control, the

acquisition of such membership interest will be treated like the

acquisition of a partnership interest. If any person subsequently

acquires (or, as a result of an acquisition, will hold) 100 percent of

the interests in that LLC, and has not previously filed for and

consummated the acquisition of control of that LLC, that person will

then be deemed to be acquiring the assets of that LLC and so may be

required to file at that time.

Some of the considerations for why the formation of certain LLCs

(and the acquisition of certain LLC interests) should be reportable may

apply equally well to partnerships. The formation of a partnership is

not reportable; 8 the position of the PNO is that

acquisitions of partnership interests which do not result in one

person's holding 100

[[Page 54715]]

percent of the interests in a partnership is non-reportable. The PNO

believes that the current treatment of partnerships should remain

unchanged for the time being. The treatment of partnerships was

originally adopted, in part, because of the difficulty of monitoring

compliance with HSR reporting obligations since many partnerships can

be formed informally or through implication in many typical business

arrangements. Furthermore, there has been no suggestion that

partnerships are being used in any greater frequency now to combine

competing businesses. In addition, a change in treatment of

partnerships would likely require filings in a large number of

transactions that do not raise any antitrust concern. Consequently, any

change in the treatment of partnerships at this time appears premature.

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\8\ Sec. 801.40, 16 CFR 801.40.

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In 1987, when the Commission promulgated Sec. 801.1(b)(1)(ii) of

the rules which allows a partnership to be controlled by another

entity, the Commission reiterated this position on the reportability of

acquisitions of partnership interests. It stated, however, that it

would reconsider this issue from time to time to see whether any

revision in this position is appropriate. See 52 FR 20058, 20061 (May

29, 1987). Accordingly, in connection with the adoption of this Formal

Interpretation, the PNO is asking for comments on whether partnerships

should be treated the same as LLCs with regard to formation,

acquisition, or both. The PNO may in the future change its treatment of

partnerships based on the comments received.

The following examples are an integral part of this Formal

Interpretation:

1. ``A'' and ``B'' both plan to contribute their widget businesses

to a new LLC in which each will acquire a 50 percent interest. This

acquisition would be reportable if the size-of-person and size-of-

transaction tests are met using the analysis in Sec. 801.40(c) of the

rules.

2. In Example 1, above, the result would be the same if ``A'' and

``B'' each intended to transfer its widget business into its own LLC,

LA and LB, and ``A'' planned to take a 50 percent interest in LB and

``B'' a 50 percent interest in LA. In each case, two businesses would

be coming under common control. Note, however, that the result may be

different if ``A'' and ``B'' each get a 49 percent interest in the

other's LLC. There, two businesses are not being united under common

control. However, if the Commission concluded that this technical lack

of common control was being used as an avoidance device it would apply

the act and rules to the substance of the transaction pursuant to

Sec. 801.90 of the rules, 16 CFR 801.90.

3. Suppose ``A'' will contribute its widget business and ``B'' will

contribute cash for operating capital to a new LLC. This would not be

reportable if ``A'' will be the only controlling person because it does

not unite two or more businesses. If ``B'' is also to be a controlling

person and is engaged in a business, it will be reportable by ``B.''

4. Suppose that ``A'' proposes to consolidate its widget business,

which it has conducted in two subsidiaries and a division, into a

newly-formed LLC in which it will hold a 60 percent membership

interest. This would not be reportable because, although separate

businesses are being combined, they were not under separate control

prior to the transaction.

5. Suppose that in year 1 ``A'' and ``B'' each contributes its

widget business to a newly-created LLC, that the transaction was deemed

to be reportable, that filings were made and the waiting period

observed. Then, in year 5, ``C'' proposes to acquire ``B's'' interest

which constitutes a controlling interest in the LLC. Assume that ``C''

is engaged in a business or businesses. The acquisition by ``C'' is

potentially reportable because it unites under common control the

business of the LLC and ``C's'' businesses, which were separate.

6. Suppose ``A,'' ``B,'' and ``C'' form a new LLC in which ``A''

will have a 60 percent interest and ``B'' and ``C'' each will have 20

percent interests. ``A,'' a large, international pharmaceutical

company, contributes $100 million in cash. ``B'' contributes licenses

to several patents which it will also continue to use to manufacture

various drugs. ``C'' will contribute licenses which are exclusive even

against itself for several drugs which are still at the testing stage

and which have never been marketed. ``A'' has a potential reporting

obligation for the formation of this LLC. With a 60 percent interest,

``A'' will control the LLC and it has its own business. Since the

licenses ``B'' will contribute are not exclusive as against it, they do

not constitute a business. The licenses being contributed by ``C'' do

constitute a business, however, even though they have not generated any

revenue, and this business is being brought under the control of ``A''

with ``A'''s own business when the new LLC is formed.

7. Suppose ``A'' and ``B'' are both regional grocery store chains

which do their data processing in-house. ``A's'' data processing unit

does work only for ``A'' and ``B's'' only for ``B.'' ``A'' and ``B''

decide to contribute the assets used in their data processing

operations to a new jointly-controlled LLC which will provide data

processing services to ``A'' and ``B.'' Assume the size tests are met.

This would not be reportable because the assets used to provide such

management and administrative support services do not constitute

businesses. Cf Sec. 802.1(d)(4) of the rules and Examples 10 and 11, 16

CFR 802.1(d)(4). This would be the case even if the new LLC intends to

begin offering data processing services to third parties, since this

would be beginning a new business rather than uniting existing

businesses. Note however, that the result would be different if ``A''

or ``B'' had used its equipment to provide data processing services to

others prior to contributing it to the new LLC for then it would be an

existing business. The result would also be different if ``A'' and

``B'' were engaged in manufacturing and the assets to be contributed to

the new LLC were used in part of a manufacturing process.

* * * * *

Request for Comments

The Federal Trade Commission staff asks for comments on this Formal

Interpretation and may further modify its approach to LLCs based on the

comments it receives. The staff would particularly like Commenters to

address the following two issues:

A. Burden

The staff has assumed that compliance with this Formal

Interpretation would not be unduly burdensome on any party or class of

parties. The staff requests comments on the issue of the burden of

compliance. Commenters who believe that the Formal Interpretation does

create a special burden by, for example, significantly increasing the

number of filings should describe the burden in detail.

B. Partnerships

At the time of the promulgation of the so-called partnership

control rule, 16 CFR 801.1(b)(1)(ii), in 1987, the Commission stated

that it might at some time in the future re-visit the subject of

partnerships to see if it might be appropriate to revise the staff

position that acquisitions which do not confer on the acquiring person

100 percent of the interests in a partnership are not reportable. The

Commission suggested that, instead, it might make the acquisition of

control of a partnership reportable. See 52 FR 20058, 20061 (May 29,

1987). Is this an appropriate time to do this? More specifically, is

there a reason why partnerships and LLCs should be treated the same?

Are

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partnerships, for example, also being used increasingly to combine

existing businesses? What factors influence the choice of creating a

partnership versus an LLC?

Donald S. Clark,

Secretary.

[FR Doc. 98-27355 Filed 10-9-98; 8:45 am]

BILLING CODE 6750-01-P