Question
February 23, 2004
VIA EMAIL AND REGULAR MAIL,
Mr. B. Michael Verne
Federal Trade Commission -
Premerger Notification Office
Room H-314
600 Pennsylvania Avenue, N.W.
Washington, D.C. 20580
Re: LLC FormationInterpretation
DearMike:
This letter follows up on our discussion on Wednesday, February 18, 2004relating to a proposed LLC formation, as supplemented by my email to you onFriday, February 20 providing additional details on the nature of thetransaction. During our call, you concluded that the situation described belowwould not be reportable under Formal Interpretation 15 which applies to theformation of new LLCs.
I also understand from our discussion that the proposedchanges to the HSR treatment of LLCs may be issued in the near term and couldpossibly become effective this summer. I understand that the proposedtransaction would need to be evaluated in light of those changes if thosechanges go into effect and the transaction has not been closed prior to theeffective date. Based on our discussion and the analysis set forth below, theparties intend to complete the transaction without making an H-S-R filing(subject to the closing occurring prior to the effective date of any new rulesgoverning LLCs, as noted above). Please advise me as soon as possible if youhave any questions regarding the analysis set forth below.
Facts1
CompanyA, through various wholly-owned subsidiaries, owns several Businesses. Company Aand Company B have reached an agreement in principle to create a new, jointlyowned LLC that will control and operate the Businesses. After the transaction,the operations of the new LLC will consist entirely of the Businesses held byCompany A prior to the transaction. Mechanically, Company 8 will contributecash to the LLC (or various of its subsidiaries). The LLC (or the varioussubsidiaries) will also arrange to borrow additional funds. Company A will thensell the assets of the Businesses to the LLC in exchange for cash (from CompanyB's investment and the borrowed funds) and a 10% interest in the LLC. Thus,after the LLC's formation, funding and acquisition of the Businesses fromCompany A, Company B will hold a 90% interest in the LLC and Company A willhold a 10% interest in the LLC, and will have received a significant cashpayment. The LLC will consist of the Businesses previously owned by Company B,which will now be burdened by significant debt. Company B also will obtain anoption to purchase Company A's 10% LLC interest. The option will be exercisableat any time. However, the price that Company B would have to pay to exercisethe option is approximately three times the valuation that Company B is payingfor its 90% LLC interest. Put another way, in order to exercise the option toacquire a 10% interest, Company B would need to pay Company A an amount that isapproximately one-third of the amount that Company B is going to invest toobtain its 90% interest. Thus, this is a bona fide option that is subject tocontingencies that may or may not occur. Further, there is no agreement betweenCompany B and Company A requiring Company B to exercise its option to purchasethe remaining 10% LLC interest.
Analysis
As wediscussed on Wednesday, under the facts described above, you concurred that theformation of this LLC would not be reportable as an acquisition by Company B ofCompany A's Businesses. This analysis is governed by Formal Interpretation 15relating to the treatment of LLCs under the H-S-R rules. Under FormalInterpretation 15, where two independent entities form an LLC in which theywill both hold interests, that LLC formation is reportable only if two or moreseparately controlled and preexisting businesses are combined in the LLC. In thiscase, all of the businesses being put into the LLC were controlled by CompanyA, and Company B is paying only cash in exchange for its LLC interest. CompanyA will retain an ownership interest in the LLC. Thus, the underlying LLCformation is not reportable under Formal Interpretation 15.
In addition to the foregoing, wediscussed Company B's option to acquire Company A's 10% LLC interest andwhether that option would change the basic conclusion that the LLC formationwas not a reportable event under Formal Interpretation 15. We specificallydiscussed the option in light of Interpretation 191 of the PremergerNotification Practice Manual (which discusses an LLC formation with anequalization payment and an option to purchase LLC interests). You concludedthat if the option in the scenario we described to you was a bona fide optionand was subject to contingencies that might or might not occur, then theInterpretation 191 analysis would not apply and the analysis would be governedby Formal Interpretation 15. Here, where there is no agreement or presentintention for Company B to exercise the option, and where exercise of theoption is subject to legitimate contingencies, you advised that the PremergerOffice would not view the option as removing this transaction from the baselineFormal Interpretation 15 analysis. Accordingly, as noted above, since only oneparty (Company A) controlled the Businesses that are going in to the LLC andsince Company A will retain a 10% interest in the LLC, the LLC may be formed ina manner described above without an H-S-F, filing as long as FormalInterpretation 15 governs the H-S-R analysis related to the formation of LLCs.