United States: Private Equity Viewpoint: Will Proposed Hart-Scott-Rodino Revisions Affect Private Equity Transactions?

The Federal Trade Commission has proposed changes to the Hart-Scott-Rodino (HSR) rules that would require regulatory filings for a number of partnership and limited liability company (LLC) transactions that historically have been exempt from the HSR "report and wait" regime. The proposed new rules may go into effect later this year or early in 2005. The good news for the private equity industry is that the proposed rules exempt from the HSR regime many private equity transactions that might otherwise have been covered by the new, general approach to partnership and LLC transactions.

The HSR Act. Generally, the HSR Act requires parties to significant mergers or acquisitions to file a pre-transaction notification form with the federal antitrust enforcement agencies and then observe a 15-day or, more often, a 30-day "waiting period" prior to closing the proposed transaction. A filing fee, which ranges from $45,000 to $280,000 depending on the size of the transaction, also is required. When the antitrust enforcement agencies are concerned that a proposed transaction may result in a substantial lessening of competition, the agencies may request further information, thereby delaying the closing, or they may seek to challenge the proposed transaction in court. There are substantial monetary penalties for failure to submit a required HSR filing.

Contrary to common assumptions, the HSR Act is not limited in application to mergers and acquisitions. Subject to a series of exemptions, the HSR Act generally applies to any acquisition of voting securities or assets valued in excess of $50 million. Notwithstanding the breadth of the statute, historically it has been interpreted not to apply to the formation of partnerships, and to apply only in very limited circumstances to the transfer of partnership interests, the formation of LLCs and the transfer of interests in LLCs. The proposed new rules would change that.

The Proposed Rules. Under the proposed rules, the formation of a partnership, LLC or other non-corporate entity would be reportable under the HSR Act if one person or entity will acquire a 50% or greater interest in the newly-formed entity, and that interest is valued in excess of $50 million based on the HSR valuation rules, unless an exemption applies. In addition, unless an exemption applies, the acquisition of an interest in an existing partnership, LLC or other non-corporate entity would be reportable if the acquisition will result in one person or entity holding 50% or more of the interests in the existing entity, and the interests held by that person or entity are valued in excess of $50 million. As is the case under the existing rules, an acquisition of interests by a group of persons or entities that is under common control would be treated as an acquisition by a single person or entity. The proposed rules would apply only to transactions occurring after the effective date of the new rules. Generally, the HSR Act would apply to transactions involving interests in a non-U.S. partnership or other non-corporate entity only if that entity, together with any entities that it controls, has U.S. assets (other than investment assets and securities) valued in excess of $50 million, or if the entity and its controlled entities generated sales in the U.S. in excess of $50 million in the most recent year.

The proposed changes to the HSR rules would potentially affect several scenarios that are of particular interest to the private equity industry.

"Bell Cow" Closings. It may at first blush appear that so-called "bell cow" closings — in which a single limited partner may commit to contribute in excess of $50 million in the first closing of a new fund and initially hold a majority of the issued limited partnership interests — would require an HSR filing under the new rules. As presently proposed, however, the rules (1) exempt the acquisition of limited partnership interests where the partnership’s non-cash assets are valued at $50 million or less (as is almost invariably the case in "bell cow" closings), and (2) exempt from the $50 million valuation test, with respect to any person acquiring 50% or more of the partnership interests, any assets that are contributed to a new entity upon its formation by that person (exempting, as to the "bell cow," any assets that it has contributed or committed to contribute). Assuming these exemptions remain in the final rules, it will be a rare instance in which a "bell cow" closing actually requires an HSR filing. Nonetheless, an early assessment of potential HSR issues in a fund formation involving a majority owner would be important in order to identify any potential problems.

Captive Private Equity Funds. Similarly, an early HSR assessment would also be prudent in connection with the formation of a so-called "captive" private equity fund — typically, a fund organized by an operating company in which the operating company is the sole or majority limited partner. A filing may be required if the fund exceeds $50 million in size and there is at least one other holder of interests in the fund, such as the fund manager. However, the formation of a typical captive fund, where the only asset contributed is cash or nearly all of the non-cash assets are contributed by the majority limited partner, should also be exempt under the exemptions described above.

LLC Formation. Under the existing HSR rules, the formation of an LLC is subject to the HSR regime only if, among other things, at least two parties involved in the formation of the LLC are contributing a "business" to the LLC. This requirement exempts the formation of LLCs by financial buyers for purposes of facilitating a portfolio company investment or acquisition, although the portfolio company investment or acquisition itself could be independently subject to the HSR Act. Under the proposed rules, the formation of an LLC by a group of otherwise independent private equity funds to make an investment could be subject to HSR filing requirements. As with "bell cow" closings, however, the formation of an LLC whose only asset upon formation is cash or committed cash should be exempt under the proposed rules. An HSR filing by a holder of 50% or more of the interests in the LLC is likely only if non-cash assets that are valued in excess of $50 million are being contributed to the LLC by other persons. Under the existing HSR rules, private equity funds, particularly buyout funds and those venture capital funds that participate in larger transactions, have needed to consider whether a proposed portfolio company investment requires an HSR filing. As a result of the proposed rules, in those instances where the formation of an LLC as an acquisition vehicle is under consideration, the parties should also assess whether the LLC formation itself may require an HSR filing.

Secondary Transactions. Under the proposed rules, the purchase of a partnership or LLC interest from an existing holder of the interest would likely be subject to HSR filing requirements if (1) the purchaser will hold 50% or more of the interests in the entity after the transfer, (2) the interests in the entity held by the purchaser after the transfer are valued in excess of $50 million and (3) the entity’s non-cash assets (excluding any minority interests that the entity owns in its portfolio companies) are valued in excess of $50 million. A separate HSR filing may be required if any of the minority interests that the entity holds in portfolio companies are valued in excess of $50 million. Under the existing HSR rules, the purchaser would have to acquire 100% of the interests in the entity before the transaction would potentially be subject to HSR reporting. Secondary purchasers of significant positions in private equity funds will need to be aware of potential HSR filing requirements.

Conclusion. In the situations described above in which an HSR filing may be required, it is difficult to imagine that the transaction by itself would raise any substantive antitrust concerns. Nonetheless, the potential applicability of the HSR "report and wait" regime under the proposed new rules, and the time and expense required to comply, should be factored into the planning process so that the HSR system does not cause unnecessary delays or surprises.