The Federal Trade Commission ( FTC ) has announced amendments to the premerger

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1 , Arps, Slate, Meagher & Flom LLP & Affiliates March 2, 2005 Federal Trade Commission Makes Changes to HSR Regulations These Rules will become effective on April 1, If you are concerned how these new changes may affect any transaction you are working on, please contact your usual contact person or any of the undersigned. Neal R. Stoll New York Brian C. Mohr Washington, D.C Joseph P. Nisa New York * * * This memorandum is provided by, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum may be considered advertising under applicable state laws. The Federal Trade Commission ( FTC ) has announced amendments to the premerger notification rules (the Rules ) relating to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the HSR Act ), which become effective April 1, The most significant change involves the elimination of the so-called partnership loophole. Accordingly, many acquisitions of partnership interests and formations of partnerships that were not reportable will be reportable under the new Rules. Further, the treatment of limited liability company ( LLC ) formations and the acquisition of LLC interests will also change, in the attempt to provide the same result, whether the transaction is the formation of a new corporation, partnership or LLC. The current Rules treat acquisitions of voting securities in corporations differently than acquisitions of non-corporate interests, such as partnership interests and LLC membership interests. Additionally, the current Rules treat the formation of a corporate Newco differently than the formation of a partnership. The new Rules attempt to reconcile, as far as practical, this disparate treatment. The new Rules also make a few technical changes to correct drafting errors in earlier amendments and codify a few interpretations and informal understandings. Formation of Non-Corporate Entities The most important changes to the HSR Rules involve the harmonization of the treatment of transactions involving corporations and non-corporate entities. In particular, the partnership loophole is eliminated, because the new Rules would subject the formation of non-corporate entities to the HSR reporting requirements if the formation confers control 2 to any person. Thus the current Rules distinction among the type of entities formed will be eliminated. Example: Corporations X, Y and Z form a joint venture partnership with assets valued at $300 million, and corporation X will have 55 percent of the partnership interests. Under current Rules, the formation is not reportable, but under the new Rules, corporation X would need to file HSR notification if no exemptions are available. 1 Other new Rules became effective on March 1, These Rules change the notification thresholds to reflect the growth in Gross National Product. As of March 1, 2005, the new thresholds are $53.1 million, $106.2 million, $530.7 million, 25 percent if valued at $1,061.3 million and 50 percent. The $10 million Size-of-Person threshold is now $10.7 million; the $100 million threshold is now $106.2 million, and the $110 million threshold (for foreign exemptions) is now $116.8 million. All references in the memo use the thresholds as adjusted. 2 With respect to a corporation, control is defined as having 50 percent or more of the voting securities, the contractual right to appoint 50 percent or more of the board of directors, or the right, by virtue of the holding of voting securities plus the contractual right, to appoint 50 percent or more of the board. For unincorporated entities, control is defined as having the right to 50 percent or more of the profits, or 50 percent or more of the assets upon dissolution.

2 2 It should be noted that even the new Rules do not completely harmonize the treatment of corporate and non-corporate entities. In the above example, the formation is only reportable because corporation X has control over the new partnership; if the three partners each had equal shares, the formation would not be reportable. If the joint venture were a corporation, HSR could be triggered even though no shareholder would have control. However, in those situations where the formation of a new entity, irrespective of its structure, confers to any person control over assets that it did not have before, the new Rules require notification regardless of the type of entity formed. Acquisitions of Interests in Non-Corporate Entities The new Rules define a non-corporate interest as any interest in any unincorporated entity which gives the holder the right to any profits of the entity or, in the event of dissolution of that entity, the right to any of its assets after payment of its debts. These unincorporated entities include, but are not limited to, general partnerships, limited partnerships, limited liability partnerships, LLCs, cooperatives and business trusts (except common trust funds, collective investment funds, a revocable or irrevocable trust in which the grantor retains a reversionary interest or a pension trust). The new Rules require notification of the acquisition of 50 percent or more of the interests in a noncorporate entity. Under current Rules, only the acquisition of 100% of the interests is reportable. The new Rules thus require notification at the time of the acquisition of control, which, in most instances, is economically and competitively more significant. Example: Person A purchases 60 percent of the partnership interests in partnership B for $70 million. Under current Rules, the acquisition is not reportable, but under the new Rules, it would be reportable if no exemptions are available. The new Rules also conform the treatment of corporations and non-corporate entities by providing that contributions of assets or voting securities to an existing non-corporate entity is deemed to be an acquisition by that entity, even if the consideration for the contribution is interests in the entity. Example: Person A contributes a $100 million business to an LLC in exchange for 20 percent of the membership interests. Under current Rules, the transaction is not reportable, because the transaction is treated as the formation of a new LLC, but no one is acquiring control. Under the new Rules, the transaction is reportable, as the acquisition of the business by the already existing LLC. Repeal of Formal Interpretation 15 Formal Interpretation 15 (64 Fed. Reg (February 5, 1999)), relating to the treatment of LLCs, is repealed by Formal Interpretation 18. Formerly, the formation of an LLC was reportable if two pre-existing businesses were contributed to the LLC and at least one of the contributors would acquire control of the LLC. Anyone could acquire less than 100 percent of the membership interests of an LLC without having to file HSR. Under the new Rules, the formation of an LLC is reportable so long as at least one of the parties will hold 50 percent or more of the LLC and will acquire assets that it had not previously held. There is no requirement that pre-existing businesses be contributed.

3 3 Accordingly, in a formation transaction, if one person contributed cash and took back 50 percent of the membership interests, a formation filing would be required provided that no exemptions were available. On the other hand, once a person holds 50 percent of the interests of an LLC or partnership, a filing would not be required to acquire the remaining 50 percent. In this way, the Rules relating to the acquisition of membership or partnership interests and voting securities are harmonized. The new Rules also clarify that an indirect acquisition of voting securities is separately reportable, regardless of whether the primary acquisition involves a corporation or non-corporate entity. Currently, if a person acquires control of a corporation, and that corporation itself holds less than 50 percent of the voting securities of an issuer, the indirect acquisition of the minority stake could be a separately reportable secondary acquisition. However, under the current Rules, if a person acquires control of a non-corporate entity which holds a minority stake in the issuer, the acquisition of the minority stake is not reportable, because the primary acquisition is currently not reportable. The new Rules make the indirect, i.e., secondary, acquisition reportable regardless of the form of the entity acquired in the primary acquisition. Determining Control Example: Person A purchases 100 percent of the voting securities of corporation X for $800 million. Corporation X holds 25 percent of the voting securities of corporation Y, and this minority stake is worth $70 million. Under current Rules, the secondary acquisition by A of the voting securities of corporation Y is separately reportable. There would be no change under the new Rules. If, however, corporation X were instead an LLC, A s secondary acquisition of voting securities of corporation Y would not be separately reportable under current Rules. The new Rules seek to eliminate this disparity, and under the new Rules, the secondary acquisition of the voting securities of corporation Y would be reportable even if the primary acquisition involved a non-corporate entity. Control with respect to partnerships and LLCs is defined as having the right to 50 percent of the profits or 50 percent of the assets of the entity upon dissolution. However, it may be difficult to apply this definition when the right to profits or assets is variable. The comments accompanying the new Rules provide a methodology for determining control in these situations. If the right to profits is variable, the right to 50 percent or more of the assets of the entity upon dissolution is determinative. If the right to the assets is variable and the right to the profits is fixed, the right to the profits is deemed to control. Where both are variable, control will be determined by applying the formula for determining rights to the assets upon dissolution to the total assets of the entity at the time of the acquisition as if the entity were being dissolved at that time. If the LLC or partnership has a balance sheet, the most recent regularly prepared balance sheet must be used and the formula applied as if the entity were being dissolved at the present time. If the LLC or partnership does not have a regularly prepared balance sheet, a proforma balance sheet must be prepared and the formula must be applied as if the entity were being dissolved at the present time. If no person has the right to 50 percent of the assets using this method, no person has acquired control.

4 4 This conclusion is significant because, unless someone acquires control, there is no filing either at the time of formation of an LLC or partnership or to acquire membership or partnership interests. Accordingly, there are still situations where the formation of a partnership or LLC is not reportable (assuming size tests are met), namely, when no one acquires 50 percent or more of that entity. This is one situation where the result is different when acquiring voting securities rather than partnership or LLC interests. Any acquisition of in excess of $50 million of voting securities requires an HSR filing (unless an exemption is available) whereas the acquisition of in excess of $50 million of partnership interests or membership interests is not reportable unless the acquisition confers control. Valuation When one acquires a controlling interest in a non-corporate entity, the value of the non-corporate interest is the acquisition price, if determined, or, if undetermined, the fair market value of the interests being acquired. The value of any non-corporate interests which are held prior to the present acquisition is the fair market value of the previously held interests. Example: Corporation X holds 35 percent of the membership interests of LLC B. Corporation X intends to acquire another 30 percent of B for an additional $35 million. The transaction is reportable. Corporation X already holds 35 percent of B and will acquire control when it acquires another 30 percent. The value of the interests already held by corporation X must be a fair market valuation determined by corporation X s board. Assume the value to be approximately between $30 million - $35 million (because corporation X is now willing to pay $30 million for 30 percent of B, it is legitimate for corporation X s board to infer that $1 million per LLC unit is fair), which when added to the acquisition price of $30 million for the additional units, provides a total value of $60 million - $65 million. Harmonization of Certain HSR Exemptions The new Rules also make other similar conforming changes to HSR exemptions that eliminate the distinctions among the types of entities involved in the transaction. Most importantly, the new Rules eliminate the distinction between corporations and non-corporate entities when determining whether to apply the exemption for acquisitions of entities that hold only exempt assets. The Rules currently exempt the acquisition of several classes of assets that are unlikely to raise U.S. antitrust issues (for instance, certain assets located outside of the U.S., or certain assets sold in the ordinary course of business), and the current Rules also exempt some acquisitions of corporations whose only assets are exempt assets. Logically, it makes no difference whether one acquires assets or a corporation that controls the assets. However, the current Rules create an anomaly whereby the form of the transaction dictates disparate treatment for essentially the same acquisition. If one were to acquire directly assets located outside the U.S. that did not have a sufficient U.S. connection, there would be no HSR filing. But if those same assets were held by a Delaware corporation whose only assets were these foreign assets, the acquisition of the corporation would be reportable. The new Rules provide that the acquisition of exempt assets remains exempt even if held by another entity the acquisition of which would not be otherwise exempt assets. The new Rules also expand the exemption to cover the acquisition of all entities, not just corporations, that hold these exempt assets.

5 5 Likewise, the new Rules expand the exemption related to the formation of nonprofits to include any nonprofit entity, not just non-profit corporations, and expand the exemption related to newly formed corporations, so that all newly formed entities, not just corporations, are exempt from filing as an acquired person if any acquiring person is filing with respect to the formation. Exemption for Intraperson Transfers Under current Rules, a corporation may make intraperson transfers without triggering the requirement to make an HSR filing. Thus, a corporation could transfer assets among controlled subsidiaries, or purchase the remaining voting securities of any controlled subsidiary, or even sell an asset to its controlling shareholder, without having to make an HSR filing. However, a parallel exemption is not currently available to non-corporate entities. The new Rules provide such an exemption. Example: Person A holds 80 percent of the partnership interests in partnership B. Person A purchases the remaining 20 percent of the partnership interests for $60 million. Under current HSR Rules, the acquisition is potentially reportable, as the acquisition of 100 percent of the underlying assets of the partnership. Under the new Rules, person A is deemed to control the partnership, and the acquisition of the remaining partnership interests would not be reportable. Other Substantive Changes to the HSR Rules The Rules also address a number of areas unrelated to the primary goal of harmonizing the treatment of voting securities and interests in non-corporate entities. For example, the new Rules correct a 1978 drafting oversight in the aggregation Rules. Currently, when acquiring assets, one must aggregate the value of those assets with any assets purchased in the previous 180 days from the same seller to determine whether the $50 million filing threshold has been met, but purchased means that the original transaction has been consummated, not just agreed to. The new Rules require aggregation with any assets purchased, or agreed to be purchased, in the prior 180 days. Example: Person A agrees to purchase $30 million of assets from person B. 45 days later, person A agrees to purchase another $30 million of assets from the same seller, but the first transaction has not closed. Under current Rules, neither transaction is reportable; the two purchases are not aggregated because the first transaction has not closed. Under the new Rules, the second transaction could be reportable, because the value of the two purchases, when aggregated, exceed $50 million. The new Rules also require the aggregation of any newly acquired interest in a non-corporate entity with any previously acquired interests of the same non-corporate entity, for the purpose of valuing the new acquisition. In addition, the new Rules correct a drafting error relating to the calculation of sales into the U.S. by foreign entities. Under current Rules, if a person purchases foreign assets and voting securities from

6 6 the same foreign person, the transaction is reportable only if the U.S. sales attributable to the assets and the acquired foreign corporation each independently meet the $50 million jurisdictional threshold. The new Rule would aggregate the person s U.S. sales to determine if the reporting threshold had been met. Example: Person A purchases assets located outside the U.S. from foreign corporation X. Annual sales of $30 million into the U.S. are attributable to these assets. Person A also purchases 100 percent of the voting securities of foreign corporation Y, which is also wholly owned by corporation X. Corporation Y has sales of $25 million into the U.S. Under current Rules, neither acquisition is reportable, because neither issuer independently has sufficient nexus with the U.S. However, under the new Rules, the sales would be aggregated, and the entire transaction could be reportable. The new Rules also create an exemption for certain financing transactions involving the formation of a new non-corporate entity. If an investor, for the purpose of providing financing, contributes only cash to a newly formed non-corporate entity, and receives a preferred return in order to recover its investment, the investment currently qualifies as an HSR-reportable acquisition of that entity so long as the investor has the right to 50 percent or more of the profits or 50 percent or more of the assets upon dissolution, meeting the economic test discussed above, even without operational control of the entity. Because the investment is more analogous to a creditor taking secured debt, the new Rules would exempt this type of transaction if the formation agreement provides that the investor will no longer control the entity after realizing the preferred return. However, although the formation of this new entity would be exempt from the HSR filing requirements, in subsequent transactions, the investor is still deemed to be the ultimate parent entity until it no longer receives the preferred return. Finally, the new Rules correct an earlier drafting error that improperly defined agricultural real property to include timberland, for purposes of the HSR exemption applicable to the acquisition of such real property. The new Rule excludes timberland from this definition, and thus from the exemption, as originally intended. Codification of Existing Interpretations and Understandings The new amendments also codify the position of the FTC regarding a number of informal understandings. For instance, the new Rules codify a longstanding informal FTC staff position that the combination of any two entities into a new holding company is the functional equivalent of a consolidation and will be treated the same regardless of whether the entities are corporations or non-corporate entities. The new Rules also codify the current understanding that acquiring the right to appoint 50 percent or more of the board of directors of a not-for-profit corporation is deemed to be an acquisition of 100 percent of the underlying assets of the corporation. Finally, the new Rules codify the existing understanding that reincorporations and formations of upstream holding companies are not reportable, under certain circumstances.