Avoidance devices won’t avoid HSR penalties

The Commission and Department of Justice’s recent case against Canon Inc. and Toshiba Corporation for violating the Hart-Scott-Rodino Antitrust Improvements Act makes an important point: restructuring a deal to avoid or delay an HSR filing may subject the merging companies to substantial penalties if the restructured transaction still results in an acquisition by the A side. As antitrust practitioners know, HSR Rule 801.90 provides that whenever a person enters into a transaction or device to avoid the reporting requirements, the agencies will look through the structure to the substance of the transaction. Moreover, it doesn’t matter whether the avoidance device eliminates the filing altogether or merely delays it.

According to the Commission’s complaint, Canon’s acquisition of a Toshiba subsidiary, Toshiba Medical Systems Corporation (TMSC), violated Rule 801.90 by using a device – here, the creation of a special purpose company – to avoid the obligation to file premerger notification and to wait for the expiration of the initial review period before closing the transaction. The complaint alleged that Canon and Toshiba together devised a scheme that, through a series of transactions, was intended to evade the obligation to timely file a notification under the HSR Act for Canon’s acquisition of TMSC. Canon and Toshiba each agreed to pay $2.5 million to settle these charges.

Several unusual maneuvers pointed to a desire to obscure the underlying transaction. First, Toshiba restructured the ownership interests in TMSC into different share classes and options. Second, the parties collectively caused the creation of a third party, a special purpose company called MS Holding Corporation (MSH); MSH’s purpose was to acquire and nominally hold TMSC until Canon was able to take full control of TMSC. Third, Toshiba sold all the outstanding voting securities of TMSC to MSH for a mere $900 and, simultaneously, sold to Canon a single non-voting share of TMSC, plus options, for roughly $6 billion. Thus, the parties evaded a timely filing of a premerger notification form required under HSR because, formally speaking, neither MSH’s acquisition of all TMSC’s voting shares nor Canon’s acquisition of one non-voting share plus options were reportable transactions under HSR. But this convoluted series of transactions could not distort the reality of what was really going on.

Looking more closely at the end result reveals the real purpose behind this series of transactions: Toshiba no longer owned TMSC and had already received the full purchase price of the sale of TMSC. Moreover, MSH had no incentive to maximize the performance of TMSC because, pursuant to the parties’ scheme, MSH would surrender its ownership of TMSC to Canon for a predetermined fee that was unrelated to TMSC’s performance. Accordingly, the complaint alleged that the substance of the transaction was that Toshiba sold TMSC to Canon as of the date it sold all the restructured TMSC shares and options.

This transaction was particularly troubling because Toshiba sold all its interests in and rights to TMSC prior to any HSR filing. The purpose of the HSR Act is to preserve the pre-transaction status quo pending antitrust review. That did not happen here. If that review led to the conclusion that Canon’s proposed acquisition of TMSC was likely to violate Section 7 of the Clayton Act, there would have been no way effectively to enjoin the illegal transaction, because Toshiba would already have exited.

According to the Statement of Basis and Purpose for Rule 801.90, “[f]or purposes of determining whether transactions or devices for avoidance have been employed, of obvious relevance will be the existence of reasons other than avoidance for the manner in which a particular transaction is consummated.” Some have argued that so long as there is a legitimate purpose for the overall structure of the transaction, then there is not a purpose to avoid. This is not correct. Rule 801.90 is not a normative provision, nor is it even focused on the competitive effects of transactions. Rather, it poses a simple question: does the benefit that is the motive behind the transaction’s structure result from avoiding or delaying filing? If the answer is yes, the structure is an avoidance device under the Rule. So, in this case where Toshiba’s desire to quickly realize the gains from the transaction so as to avoid bankruptcy may have been “legitimate”—and certainly was not anticompetitive—that benefit flowed directly from delaying the filing. In contrast, if a transaction’s structure creates a benefit entirely unrelated to HSR filing – such as a tax benefit from a proposed structure that has nothing to do with filing – but the filing is delayed or avoided as an incidental consequence of the structure, there is no avoidance device.

Of course, 801.90 does not, itself, determine whether a transaction is actually reportable. It merely determines what substantive transactions should be tested for reportability. Thus, even if there is a purpose to avoid antitrust review, there is no violation of Rule 801.90 unless the substance of the transaction is reportable. For example, if a party buys voting securities on the open market for less than the $50 million threshold (as adjusted) and does not file an HSR form, even if there was an intent to avoid pre-acquisition antitrust review, there is no violation because the substance of the transaction was the same as its form – an acquisition below the HSR threshold. (Of course, HSR filing requirements are not an exemption from Section 7; if the acquisition of the shares resulted in a substantially lessening of competition in any relevant market, the Commission could seek remedies to prevent or cure harm as it does in other consummated mergers.)

Even though this was the first penalty case brought under Rule 801.90 in a number of years, the agencies have been alert to the use of avoidance devices. Parties should be aware that if they try to restructure a transaction to avoid or delay the timely reporting requirements under HSR, they may be subject to substantial penalties if the substance of the restructured transaction is an acquisition by the A side. Thus, practitioners should exercise caution when considering restructuring a potential transaction if, in doing so, it would cause a delay in a timely HSR filing.