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.

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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 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 the formation of a

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

authorized by state statutes, resulting in the combination of business

into the new LLC.

This Formal Interpretation was first published on October 13, 1998,

together with a request for comments, to become effective on December

14, 1998. 63 FR 54713 (October 13, 1998). The PNO received six comments

which were placed on the public record. On December 2, 1998, the

effective date of this Interpretation was postponed until February 1,

1999, to give the PNO staff more time to analyze and respond to the

comments. 63 FR 66546 (December 2, 1998).

Formal Interpretation 15 as republished here has been modified in

response to the comments. Under the revised Interpretation, the

formation of an LLC which combines under common control in the LLC two

or more pre-existing businesses will be treated as subject to the

requirements of the HSR act under Sec. 801.2(d) of the HSR rules, 16

CFR Sec. 801.2(d), which governs mergers and consolidations. Because

Formal Interpretation 15 has been modified substantially, the effective

date of the Interpretation is postponed until March 1, 1999.

DATES: The effective date is March 1, 1999.

FOR FURTHER INFORMATION CONTACT: Richard B. Smith, Deputy Assistant

Director, Premerger Notification Office, Bureau of Competition, Room

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

326-2850. 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 Sec. 803.30, Concerning the Reporting

Requirements for the Formation of Certain Limited Liability Companies

(``LLCs'').

This is a Formal Interpretation pursuant Sec. 803.30 of the

Premerger Notification Rules (``the rules''), 16 CFR Sec. 803.30. The

rules implement Section 7A of the Clayton Act, 15 U.S.C. Sec. 18a,

which was added by sections 201 and 202 of the Hart-Scott-Rodino

Antitrust Improvements Act of 1976 (``the act''). This Formal

Interpretation and a request for comments were originally published on

October 13, 1998, to become effective on December 14, 1998. See 63 FR

54713 (October 13, 1998). The PNO staff received six comments. The

staff postponed the effective date until February 1, 1999, in order to

have more time to analyze these comments. 63 FR 66546 (December 2,

1998). Formal Interpretation 15, published here, has been modified

substantially in response to the comments received and postpones the

effective date until March 1, 1999.

The act requires the parties to certain acquisitions of voting

securities or assets to notify 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. Under the rules, certain types of transactions, such as

mergers, consolidations, and the formation of corporate joint ventures,

are treated as acquisitions of voting securities potentially subject to

the act, while other transactions, such as the formation of

partnerships, are deemed non-reportable. See Secs. 801.2(d) and 801.40

of the rules, 16 CFR Secs. 801.2(d) and 801.40.

The LLC \1\ is a relatively new form of business organization that

is neither a partnership nor a corporation but a hybrid legal entity

that 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

[[Page 5809]]

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. 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 Sec. 801.1(a)(2), and that,

until it had more experience with them, the PNO would treat LLCs like

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

Sec. 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 too inclusive. LLCs at the time were primarily used as vehicles 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 believed

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

like a partnership interest than 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 that functioned

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

the holders appointing person(s) other than their employees,

officers, or directors (or those of entities controlled by such

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 treatment of LLCs has not been completely satisfactory. The

use of LLCs has evolved, and while LLCs continue to be used as vehicles

for start-up enterprises, they are now often used 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 businesses were combined under common control when

they were both contributed to a single, newly-formed LLC. Nevertheless,

the creation of the LLC to combine competing businesses under common

control was typically not treated as reportable under the PNO's then-

current treatment. However, the union of competing businesses under

common control is of obvious potential antitrust concern. Since the

past treatments of LLCs have not been satisfactory at singling out

those transactions that were the most likely to have anticompetitive

effects, the PNO staff has decided to revise its approach to LLCs in

order to better carry out the purposes of the act.

The formation of an LLC into which two or more businesses are

contributed, like other unions of businesses under common control, is a

kind of merger or consolidation.\5\ Section 801.2(d)(1)(i) of the

rules, 16 CFR Sec. 801.2(d)(1)(i), states that ``[m]ergers and

consolidations are transactions subject to the act * * *.'' \6\ A

filing requirement for those LLC formations that involve the

combination of businesses is appropriate and advances the purposes of

the act and the rules, namely, to ensure that the antitrust enforcement

agencies have advance notice of, and a timely opportunity to challenge,

transactions which may violate the antitrust laws.

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\5\ While combining businesses in an LLC may not be a ``merger''

or ``consolidation'' in the strictest sense because they do not

involve corporations, the rationale of this interpretation is

similar to that used by the PNO under Sec. 801.2(d) to require

filing for acquisitions of non-profit corporations which, like LLCs,

typically do not issue voting securities. (See ABA, The Premerger

Notification Practice Manual, 1991 ed., Interp. #109.)

\6\ In fact, as it was originally promulgated in 1978,

Sec. 801.2(d)(1)(i), 16 CFR Sec. 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) 43 Fed Reg 33539, July

31, 1978. In 1983, this section was changed to clarify the treatment

of mergers and consolidations under the rules, and the italicized

wording was eliminated. However, there is no indication that this

change was intended to narrow the scope of Sec. 801.2(d). Rather,

according to the Statement of Basis and Purpose to the 1983 changes,

48 Fed Reg 34430, July 29, 1983, the Commission simply sought to

make clear that mergers and consolidations are treated as

acquisitions of voting securities and to aid the parties to a merger

in determining which is the acquiring person and which is the

acquired person.

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

of LLC's as follows: The PNO will henceforth treat as reportable the

formation of an LLC if (1) two or more preexisting, separately

controlled businesses will be contributed, and (2) at least one of the

members will control the LLC (i.e., have an interest entitling it to 50

percent of the profits of the LLC or 50 percent of the assets of the

LLC upon dissolution).\7\ The formation of all other LLCs will be

treated similar to the formation of a partnership which, under the

PNO's longstanding position on partnership formations, will not be

reportable.

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\7\ Of course, as with all transactions, the HSR size of person

and size of transaction requirements need to be met as well, and

exemptions may apply.

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Post-formation acquisitions of membership interests in LLCs will

not be reportable except in two situations: (1) when the acquisition of

the membership interest results in the acquiring person, who had not

previously filed for and consummated the acquisition of control of that

LLC, holding 100 percent of the membership interests of the LLC

(similar to the PNO's treatment of the acquisition of a partnership

interest), and (2) when the acquiring person contributes a business to

the LLC in exchange for the LLC membership interest. The PNO will treat

this contribution of an additional business to the business(es) already

in the LLC as a formation of a new LLC under this Interpretation.

In determining what is a ``business'' for purposes of this

Interpretation, the PNO will look to the definition of ``operating

unit'' for purposes of Sec. 802.1(a) of the rules, 16 CFR

Sec. 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.'' In addition, 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.

Under this Interpretation, the approach of Sec. 801.2(d) will be

used to determine the acquiring person(s) and acquired person(s) for

potentially reportable LLC formations.\8\ Section 801.2(d)(2)(i) states

that ``[a]ny person party to a merger or consolidation is an acquiring

person if as a result of the transaction such person will hold any

assets or voting securities which it did not hold prior to the

transaction'' (emphasis added). In the context of the formation of a

new LLC, this means that any person that will control an LLC in which

two or more previously separate businesses will be combined will be an

acquiring person. Thus, if ``A'' and ``B''

[[Page 5810]]

form a 60-40 LLC, the 60 percent member, ``A'' will be an acquiring

person with respect to the contributions of ``B.'' Section

801.2(d)(2)(ii) states that ``[a]ny person party to a merger or

consolidation is an acquired person if as a result of the transaction

the assets or voting securities of any entity included within such

person will be held by any other person'' (emphasis added). In the

above example of the formation of a 60-40 LLC, ``B'' would therefore be

an acquired person.

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\8\ The Formal Interpretation as published in October described

a method to determine reportability that was based on concepts found

in Sec. 801.40 of the HSR rules, 16 CFR Sec. 801.40. Certain

comments suggested that such an approach was confusing and would

increase the likelihood that parties would make erroneous

conclusions on their reporting obligations. In light of those

comments, and the change in approach this Formal Interpretation

adopts, there will no longer be any need to look to Sec. 801.40 to

determine reporting obligations.

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If ``A'' and ``B'' were to form a 50-50 LLC to which both were to

contribute businesses, both would be both acquiring and acquired

persons because both would control the LLC and thus hold assets or

voting securities it did not hold prior to the transaction. ``A'' and

``B'' would file in both capacities, assuming the relevant size

criteria were met. Thus, both the acquiring and acquired persons will

be required to file notification and, in accordance with Sec. 803.10 of

the rules, the 30-day waiting period will begin when both persons have

substantially complied with the notification requirements.

Under this Interpretation, the nature of the acquisition(s) taking

place when an LLC is formed, that is, whether it is an acquisition of

assets or of voting securities, depends on what is being contributed by

the other member(s) of the LLC.\9\ In the 50-50 LLC described above,

suppose that ``A'' contributes a group of assets constituting a

business and ``B'' contributes 50 or more percent of the voting

securities of a corporate subsidiary, S. Under this Interpretation,

``B'' will have made an acquisition of assets and ``A'' will have made

an acquisition of voting securities.

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\9\ In this respect, the Interpretation necessarily departs from

the text of Sec. 801.2(d)(1)(i), which provides that all mergers and

consolidations shall be treated as acquisitions of voting

securities.

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In addition, any exemption in the act or rules that would make any

other acquisition non-reportable may make the acquisition by one or

more of the contributors to an LLC non-reportable. If, for example,

``A's'' asset contribution consists of hotel properties the acquisition

of which would be exempt under Sec. 802.2(e), ``B's'' acquisition in

the formation of this LLC would not be reportable. Similarly, if S has

sales and assets of less than $25 million and the value of the S stock

that will be held by ``A'' as a result of the acquisition is $15

million or less, then ``A's'' acquisition in the formation would be

exempted by Sec. 802.20(b).

To determine whether a filing is required, the parties to

potentially reportable formation transactions also must determine the

size-of-person and size-of-transaction, which should be done just as in

any other asset or voting securities acquisition in accordance with

Secs. 801.10 and 801.11 of the HSR rules. Since these transactions are

similar to asset exchanges, for most such transactions there will not

be a determined acquisition price for the acquired assets or voting

securities to use in applying the size-of-transaction test. For such

transactions, parties should use the market price or fair market value

where another contributor contributes 50 or more percent of the voting

securities of an issuer (see Sec. 801.10(a)), or the fair market value

where another contributor puts assets constituting a business into the

LLC (see Sec. 801.10(b)).

This Formal Interpretation will not require reporting regarding

some LLC formations and some acquisitions of existing LLC interests

that would have required reporting under the Interpretation announced

by the PNO in October of 1998. Unlike the October version, this Formal

Interpretation requires reporting of the formation of an LLC only if

the formation brings together within the LLC two formerly separately

controlled businesses. Comments received suggested that the treatment

announced in the October version would have covered a substantial

number of LLCs that are not likely to raise competitive concerns. For

example, the October Formal Interpretation would have viewed LLCs that

are created solely as financing vehicles as reportable. In these

transactions, a financial institution (or other party providing

financing) in the ordinary course of its business contributes only cash

or other financial assets and one other party contributes one or more

operating units to a new LLC that the financial institution may control

for HSR purposes, at least for a period of time. Under this revised

Interpretation, so long as such financing transactions do not result in

the contribution of a business to the LLC by two or more members, it

will not be treated as reportable.\10\

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\10\ There is no evidence to suggest now that LLC formations

where only one business is contributed are being used to accomplish

a merger or consolidation of two businesses. However, the PNO will

look carefully at these transactions in the future and, if they

begin to be used to accomplish a merger or consolidation, will re-

visit this issue.

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As described above, except for situations where a new business is

contributed in exchange for an interest in existing LLC or where, as a

result of an acquisition, the acquiring person would hold 100 percent

of the interests in an existing LLC, no acquisition of an interest in

an existing LLC is reportable under this Interpretation. Several

comments indicated that LLC agreements are sometimes entered into in

which the right to receive more than 50 percent of the LLC's profits

shifts from one member to another upon the happening of some event

outside the control--or even the knowledge--of the members. Under the

definition of control applicable to LLCs (i.e. Sec. 801.1(b)(ii)),

under the October Interpretation, such a shift in the right to receive

profits might have created a reporting obligation. The commenters

argued that it would be unduly burdensome to require the beneficiaries

of such shifts to file and that no substantive law enforcement interest

would be served. The PNO does not intend that such shifts be reportable

under this Formal Interpretation. Since such a shift would be the post-

formation acquisition of an interest in an existing LLC without the

contribution of another business, it will not be treated as subject to

the reporting requirements of the act.

Some of the reasons for concluding that the formation of certain

LLCs should be treated as reportable may apply equally well to

partnerships. The position of the PNO, however, is that the formation

of a partnership is not reportable and acquisitions of partnership

interests that do not result in one person's holding 100 percent of the

interests in a partnership are non-reportable. Several comments

received on the Formal Interpretation published in October suggested

that no change to the treatment of partnerships was necessary at this

time. 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 by

implication in many typical business arrangements. Furthermore, there

has been no suggestion in any of the comments that partnerships are

being used with any greater frequency now to combine competing

businesses. Consequently, the PNO has decided not to change its

treatment of partnerships at this time, but it may re-visit this issue

in the future as developments require.

The following examples are an integral part of this Formal

Interpretation:

1. ``A'' and ``B'' both plan to contribute businesses to a new LLC

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

would involve both ``A'' and ``B'' making reportable acquisitions if

the size-of-person and size-of-transaction tests are met. Each

acquisition would be reportable unless exempted by Section

[[Page 5811]]

7A(c) of the act or Part 802 of the HSR rules. ``A'' would file as an

acquiring person and ``B'' as an acquired person for ``A's''

acquisition of the assets being contributed by ``B,'' and ``B'' would

file as an acquiring person and ``A'' as an acquired person for ``B's''

acquisition of the assets contributed by ``A.'' If ``A'' or ``B'' (or

both) contributed 50 percent or more of the voting securities of a

corporation, the acquisition(s) would be treated as an acquisition of

voting securities of the issuer whose shares are contributed.

2. ``A,'' ``B,'' and ``C'' form an LLC in year 1 in which each

receives a one-third interest and to which each contributes a business

valued at approximately $20 million. ``A,'' ``B,'' and ``C'' are $100

million persons. This formation would not be reportable because no

member controls the LLC. In year 2, ``X,'' also a $100 million person,

acquires the membership interests of ``A'' and ``B'' for cash. This

would not be reportable because two or more separate businesses are not

being united in the LLC even though ``X'' is gaining control of it.

Note, however, that the result would be different if ``X'' also

contributed a business to the LLC in exchange for the LLC membership

interests it receives. In the latter case, the transaction will be

treated as the formation of a new LLC. Note also that in the example

where ``X'' contributed only cash and did not file under HSR, if ``X''

were subsequently also to acquire ``C's'' membership interest it would

then hold 100 percent of the interests in this LLC and would therefore

have to file for the acquisition of all of the assets of the LLC.

3. ``A'' and ``B'' form a new LLC, to which ``A'' will contribute

its widget business and ``B'' will contribute cash for operating

capital. This formation would not be reportable because two previously

separate businesses are not being contributed to the LLC.

4. ``A,'' ``B,'' and ``C'' form a 60-20-20 LLC to which ``A''

contributes cash and receives a 60 percent membership interest and

``B'' and ``C'' each contribute an operating unit for a 20 percent

interest. This is a kind of consolidation of ``B's'' and ``C's''

operating units into the new LLC and ``A'' will control the LLC. There

are two reportable transactions (assuming the size criteria are met and

no exemption applies): ``A'' acquiring the operating unit contributed

by ``B,'' and ``A''' acquiring the operating unit contributed by ``C''.

5. ``A'' proposes to consolidate its weighted 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.

6. ``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 and the assets of a pharmaceutical

product which is currently on the market. This pharmaceutical product

lines constitutes a business. ``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. With a 60 percent interest, ``A'' will

control the LLC. Since the licenses ``B'' will contribute are not

exclusive as against it, they do not constitute a business. However,

the licenses being contributed by ``C'' do constitute a business, even

though they have not generated any revenue. ``A'' has a potential

reporting obligation for the formation of this LLC for acquiring assets

from ``C.'' This formation combines two pre-existing, separately

controlled businesses in an LLC which ``A'' will control.

7. ``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

Sec. 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''

and ``B'' had used their equipment to provide any data processing

services to others prior to contributing it to the new LLC, for then

each would be contributing an existing business.

8. In year 1, ``A,'' ``B,'' and ``C'' form a new LLC to which each

contributes a business in exchange for a one-third interest. This

formation is not reportable because no member controls the LLC. Suppose

that in year 2 ``A'' sells additional assets to the LLC for cash. This

transaction is not covered by this Formal Interpretation. However, the

LLC has a potential filing obligation as the acquiring person of those

assets and ``A'' as the acquired person. Note that it is irrelevant

whether the assets sold by ``A'' in year 2 constitute a business.

Donald S. Clark,

Secretary.

[FR Doc. 99-2640 Filed 2-4-99; 8:45 am]

BILLING CODE 6750-01-M