Question
From:(redacted)
Sent: Wednesday, May 30, 2007 9:43 PM
To:Verne, B. Michael
Subject:Acquisition of limited partnership interests
Mr. Verne:
I left a voicemailwith you regarding the contents of this e-mail. I am writing in an effort toobtain informal guidance as to whether a pre-merger notification filing underthe Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended from timeto time (the "HSR Act"), is required for a proposed transaction.
I do apologize for thelength of this e-mail, but the transaction as a whole is quite complicated froman HSR Act perspective and I would like to be thorough in my analysis.
I.Transaction
The proposedtransaction involves Corporation A acquiring 100% of the voting securities ofCorporation B for approximately $350 million. Corporation B, through a seriesof subsidiaries, owns two hotel resorts (which do not include ski facilities)valued at approximately $290 million. Corporation B also owns 2,400,000 Series APreferred Units (the "Preferred A") in Partnership A.
II.Rules
A.Generally
An acquisition ofvoting securities of an issuer whose assets consist of exempt assets is exemptfrom the pre-merger notification requirements of the HSR Act. 16 C.F.R. Section 802.4. Accordingly, we need to examine the assets ofCorporation B to determine whether a filing obligation exists.
B.Resort Properties
The Federal TradeCommission exempts an "acquisition of a hotel or motel, its improvementssuch as golf, swimming, tennis, restaurant, health club or parking facilities(but excluding ski facilities), and assets incidental to the ownership andoperation of the hotel or motel (e.g., prepaid taxes or insurance, managementcontracts and licenses to use trademarks associated with the hotel or motelbeing acquired)" from the pre-merger notification requirements of the HSR Act. 16 C.F.R. Section 802.2(f).
Accordingly, theapproximate $290 million in resort value is exempt from the pre-mergernotification obligations of the HSR Act.
C. Preferred Units
However, "[i]n anacquisition that includes a hotel or motel, the transfer of any assets that arenot a hotel or motel, its improvements such as golf, swimming, tennis,restaurant, health club or parking facilities (but excluding ski facilities)and assets incidental to the ownership of the hotel or motel, shall be subjectto the requirements of the act and these rules as if they were being acquiredin a separate acquisition." 16 C.F.R. Section 802.2(f).
Accordingly, theacquisition of the Preferred A may, under certain circumstances, be separatelysubject to the pre-merger notification requirements of the HSR Act. Notably, anacquisition of non-corporate interests is only reportable if it confers controlof the unincorporated entity on the acquiring person. See Pre-MergerNotification Practice Manual, American Bar Association, Interpretation No. 69(4th ed.). "Control" is defined, in the case of an unincorporatedentity, as having the right to 50% or more of the profits of the entity orhaving the right in the event of a dissolution to 50% or more of the assets ofthe entity. 16 C.F.R. Section 801.1(b)(1).
Capitalization
Partnership A has35,000,000 common units, 2,400,000 Preferred A units, and 1,100,000 Series BPreferred Units (the "Preferred B") outstanding. Only the Preferred Aunits are at issue in the proposed transaction
Each unit of PreferredA is entitled to a distribution of $1.8125 per day, payable quarterly, for anannual distribution of $4,350,000. The distribution is calculated as 7.25% ofthe $25 per unit liquidation preference applicable to the Preferred A.
Each unit of PreferredB is entitled to a variable distribution calculated on 1.5% plus LIBORmultiplied by a liquidation preference of $25 per unit. Let us assume thatLIBOR is 5.5%, so the distribution to which the Preferred B is entitled is 7%of the liquidation preference, or $1.75 per unit, for an annual distribution of$1,925,000.
The Preferred A andPreferred B are senior to the common units in all respects, but pari passu withone another.
2.Application of Rule
The rules under theHSR Act speak in terms of percentages, but how do those rules apply when theunincorporated entity's governing documents speak in terms of set dollarpreferences? I think two examples will help demonstrate the issue.
Example 1:
Partnership A had, atthe end of 2006, approximately $2.15 billion in assets and approximately $99million in income from continuing operations.
If Partnership A wereto liquidate, the Preferred A would get $60 million, or 2.79% of the assets,the Preferred B would get $27.5 million, or 1.23% of the assets, and the commonwould get $2.063 billion, or 95.9% of the assets.
Partnership A isobligated by its partnership agreement to distribute its income from continuingoperations to its partners. Accordingly, from the $99 million in income, thePreferred A would get $4.35 million, or 4.4%, the Preferred B would get $1.925million, or 1.9%, and the common would get $92.73 million, or 93.7% of thedistributions.
Clearly, using the2006 actual numbers, a sale of the Preferred A would not constitute a sale ofcontrol of Partnership A that would trigger a pre-merger notification filing.
Example 2:
Assume now thatPartnership A had $50 million in assets and approximately $5 million in incomefrom continuing operations.
If a liquidation wereto occur, the Preferred A and Preferred B would split, pro rata, the assetsbecause they are pad passu with one another and there are insufficient assetsavailable for the common unit holders. Accordingly, the Preferred A wouldreceive 68.57% (2,400,000/(2,400,000 + 1,100,000)) of the assets and thePreferred B would receive 31.43%. If a distribution were to occur, thePreferred A and Preferred B would split, pro rata, the distributions in thesame percentages.
Based on a technicalreading of "control" under the HSR Act, it would appear that usingthese hypothetical numbers a sale of the Preferred A would constitute a sale of"control" of Partnership A, thereby triggering a filing obligation(unless another exemption applies). However, this seems to make little sense,especially considering the size of Partnership A.
III.Ultimate Issue
How does is thedefinition of "control" applied in the context of an unincorporatedentity that has distribution provisions, and liquidation preferences, based onset dollar values, rather than percentages?
I look forward todiscussing this issue with you and appreciate any help you can provide.Sincerely,