US: Joint Ventures
Perhaps one of the most perplexing exercises facing parties to global joint ventures is the process of determining where merger control filings are required. For example, in many countries the creation of a full-function joint venture in which one or more parties may exercise decisive influence will likely trigger merger filings if the contributing parties, the parents, have sufficient turnover, assets or market share in various jurisdictions. Full functionality and decisive influence are not, however, readily discernible tests and are not necessarily consistent across the world.
The US merger control law is the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the HSR Act) and unlike a majority of the jurisdictions, the HSR Act tests are based largely on objective criteria. Yet, the HSR Act and its regulation are complex and not easy to navigate. This article uses a simple joint venture example and applies some key HSR Act concepts that determine whether a venture is subject to the HSR Act and the applicable waiting periods.
The Hart-Scott-Rodino Antitrust Improvement Act of 1976
The HSR Act provides that, unless exempted, if certain thresholds are met, ‘no person shall acquire, directly or indirectly, any voting securities or assets of any other person, unless both persons ... file notification ... and the waiting period ... has expired’.
The applicable current1 HSR thresholds are as follows:
• if the size of transaction is less than US$76.3 million, no filing is required;
• if the size of transaction is greater than US$305.1 million, the transaction is reportable (unless exempted); and
• if the size of the transaction is between US$76.3 million and US$305.1 million, the transaction is reportable (unless exempted) if:
• one person has US$152.5 million in net sales or total assets; and
• another person has US$15.3 million in net sales or total assets.
The HSR Act regulations provide precise methods of determining the size of a person and the size of a transaction. In addition, a person is defined as the ultimate parent entity of a party to the transaction. An ultimate parent entity is a person or entity that controls, directly or indirectly, any person and is not itself controlled by any person.
The size of transaction is the value of assets or voting securities ‘held as a result of the transaction’. For acquisitions of voting securities and non-corporate interests, this includes voting securities and non-corporate interests held prior to the transaction, and the voting securities and non-corporate interests acquired in the transaction. The regulations provide ways of measuring the value of publicly traded securities and non-corporate interests as well as the value of non-publicly traded voting securities and non-corporate interests.
For assets, parties must include the value of the assets to be acquired in the transaction and the assets that have been acquired from the same person in the prior 180 days or are included in a letter of intent or non-consummated agreement that has been entered within the prior 180 days and not been subject to a prior HSR Act filing.2
Application to joint ventures
Any collaboration between legal entities short of a merger (a complete consolidation of management) having a plausible efficiency could be characterised as a joint venture. In short, a joint venture is not much more than an arrangement between market participants to acquire, produce, develop or sell a product. The structure is driven by commercial goals. Thus, a contractual arrangement between market participants to serve the commercial purpose of the parties may be termed a joint venture. Alternatively, but by no means singularly, the parties may form a legal entity and contribute assets, know-how, businesses or employees to that entity. Key to the HSR Act analysis is whether one or more parties have acquired assets or voting securities. Thus, for example, an arrangement whereby two parties agree that one party will construct a multibillion-dollar chemical plant and a second party will agree to buy 50 per cent of the offtake using a formula-based price for 20 years does not constitute an acquisition of assets or voting securities. Alternatively, if the parties agree to set up a corporation (Newco), and Party A constructs and contributes the plant to Newco for 50 per cent of the Newco ownership interest and Party B agrees to contribute US$250 million in cash and to take all of the production from Newco in exchange for 50 per cent of Newco, there would be an acquisition of assets and voting securities.
We use this example and certain additional assumptions to demonstrate how to apply the HSR Act. We will further assume that Party A will manage Newco and has the right to designate two of the four directors. Party B will have the right to designate two of the other four directors of Newco.
Example 1: Newco is a corporation
In this example, we assume that Newco is a newly formed corporation. As such, there are specific rules treating the formation of a newly established entity.
The HSR Act regulations explain that in a ‘formation transaction’ the contributing parties are the ‘acquiring persons’ and the newly formed entity is the ‘acquired person’.3 The thresholds for a newly formed entity are slightly different than the standard thresholds. For an existing entity, the thresholds we explained above apply and those acquiring interests are the acquiring persons and the entity whose voting securities being acquired is the acquired issuer. In contrast, for the formation of an entity, the transaction is reportable if the size of the transaction is greater than US$305.1 million (the value of interests held as a result of the transaction). Where the size of the transaction is between US$76.3 million and below US$305.1 million, the transaction is reportable if:
• one contributing person has net sales or total assets greater than US$152.5 million;
• the joint venture will have total assets above US$15.3 million; and
• at least one other contributing party has net sales or total assets greater than US$15.3 million;
• if at least two contributing persons have net sales or total assets above US$15.3 million; and
• the joint venture has total assets of US$152.5 million.
The total assets of a newly formed joint venture includes all assets that are contributed to the joint venture, including any credit or other obligations. In asset acquisition, debt is added to the value of the transaction.
Here, Party A and Party B contributed a combined US$500 million to Newco. Party A and Party B acquired voting securities (Newco is a corporation) with a value of US$250 million. Because the value of the acquired voting securities is between US$76.3 million and US$305.1 million, one needs to examine the size of person test.
For HSR Act purposes, the acquiring person is the acquiring entity and any entity that directly or indirectly controls the acquiring entity. Thus, to determine size of a person, we need to determine if any person controls Party A and Party B.
For HSR Act purposes, control of a corporation is defined as holding 50 per cent of the voting securities or the right to designate 50 per cent of the board of directors. Control of a non-corporate entity is having the right to 50 per cent of the profits or assets on dissolution. The right to manage the non-corporate entity is not relevant to this analysis. If either Party A or Party B is controlled by a person or entity, the analysis requires one to ask whether its parent is controlled by any other person. The analysis stops when one identifies a person that is not controlled by another person, the ultimate parent entity. For the size of person test, one needs to identify the total assets and net sales of all the entities controlled, directly or indirectly, by the ultimate parent entity. If the thresholds are satisfied, a filing is required. We assume that Party A and Party B are their own ultimate parent entities and meet the size of person test.
The analysis must proceed to considering whether particular exemptions apply. We start the analysis by examining what is typically called the ‘look through rule’:
An acquisition of voting securities of an issuer or non-corporate interests in an unincorporated entity whose assets together with those of all entities it controls consists or will consist of assets whose acquisition is exempt from the requirements of the Act pursuant to section 7A(c) of the Act, this part 802, or pursuant to Section 801.21, is exempt from the reporting requirement if the acquired issuer or unincorporated entity and all entities it controls does not hold non-exempt assets with an aggregate fair market value of more than [US$76.3 million]. The value of voting or non-voting securities of any other issuer or interests in any unincorporated entity not included within the acquired issuer or unincorporated entity does not count toward the [US$76.3 million] limitation for non-exempt assets.
In practice, the rule allows parties to look through the corporate entity and examine all of the assets and entities controlled by the acquired entity to determine if the whole or any part of the entity is exempt. Thus, parties to a joint venture should look at the underlying assets of the joint venture to determine whether any are exempt.
The example above raises several possible exemptions. We first examine the intraperson exemption, which provides that a transaction is exempt when the acquiring or acquired persons are the same. Thus, when applying the look through rule, each party to a joint venture may exclude the value of the assets it contributes to the joint venture that it controls. This exemption is easy to apply here because Party A already owns the plant and controls the joint venture.4
In addition, the HSR Act rules exempt from reporting the acquisition of cash and cash equivalents.
Also, the HSR Act regulations exempts the acquisition of unproductive real property. Unproductive real property is any ‘real property, including raw land, structures or other improvements (but excluding equipment) [...] and assets incidental to the ownership of real property, that has not generated total revenues in excess of US$5 million during the thirty-six (36) months preceding the acquisition’. Unproductive real property excludes manufacturing facilities that have not yet begun operation, or such facilities ‘that were in operation at any time during the twelve (12) months preceding the acquisition’ and real property that is adjacent to or used in conjunction with real property that is not unproductive real property. This last point is designed to exclude from the exemption land upon which a manufacturing plant is located, for example. This exemption comes into play when parties form a joint venture to build a new facility rather than a situation where the parties contribute existing businesses.
When applied to the joint venture example, Party A and Party B examine the assets being contributed to Newco. Newco holds the plant contributed by Party A and the cash contributed by Party B. From the perspective of Party A, the contributed assets are exempt either as an intraperson transfer or as unproductive real property (assuming the plant is not built). And, cash is an exempt asset. Thus, Party A would not need to submit an HSR Act filing.
For Party B, it can exclude the value of the cash because cash is exempt or as an intraperson exemption. It can exclude the plant, assuming the plant is not built. Thus Party B would have no filing if Newco was acquiring a to-be-built plant. If, however, the plant was built and had been operating with sales over US$5 million in the last 36 months, Party B would have a filing. Under the formation rules, Newco would not need to file.
We note that there is a particular exemption for the acquisition of foreign assets and voting securities. The acquisition of assets located outside of the US is exempt under section 801.50 of the HSR Act regulations if the foreign assets did not generate sales in or into the US of US$76.3 million the preceding fiscal year.
Even where the assets had sales in or into the US over US$76.3 million, the transaction could be exempt if:
• the contributing party and newly formed venture are not US entities;
• where the aggregate sales in or into the US of the contributing party and the newly formed venture are less than US$167.8 million in their respective most recent fiscal years;
• the total aggregate assets located in the US of the contributing party and the newly formed venture are less than US$167.8 million; and
• the size of the transaction does not exceed US$305.1 million.
Note that this must be undertaken for each contributing party.5
Example 2: Newco is a limited liability company
We now apply the HSR Act regulations for joint venture, assuming the joint venture is a limited liability company, not a corporation. We assume here that Party A will set up a general partner that will operate Newco. Further, we assume the general partner is given an increasing share of the profits as profits increase, which are called incentive distribution rights.
We note that under the EU merger control regulation, if this was a full-function joint venture and if Party B had significant veto rights over corporate matters, the transaction would be reportable in the EU, provided other thresholds are met. Those thresholds, however, are applied to Party A and B, not the joint venture entity.
The acquisition of non-corporate interests is reportable only if the acquiring person would obtain control of the non-corporate entity. The control concept is unique to non-corporate entities and is a significant distinguishing feature of the acquisition of non-corporate entities from voting securities (which were addressed above). In a corporate setting, the acquisition of voting securities exceeding certain value (eg, US$76.3 million) is reportable even if the acquiring person will not obtain control of the corporate entity. In a non-corporate setting, control is essential regardless of value.
As indicated above, control is obtained when a party holds as a result of the transaction the right to 50 per cent of the profits or 50 per cent of the assets on dissolution of the non-corporate entity or Newco. It does not matter that an entity would acquire a general partner, if that general partner did not have HSR control over the non-corporate entity or if the general partner has no economic interests in the non-corporate entity.
When considering the profits or assets on dissolution test, it is not sufficient to examine ownership interests. In many joint ventures, there are classes of membership interests. Some are given preferential rights. Some are given a fixed rate of return on capital commitments. This must all be taken into account when determining control. Further, if the distribution of profits is dependent on the prior distribution or profitability of the joint venture, then the assets on dissolution test applies and the profits test can be ignored. If the profits and dissolution of assets on dissolution are both variable, only the assets on dissolution test applies.
It is important to consider the difference between a voting security and non-corporate interest. Voting securities are any ‘securities which at present or upon conversion entitle the owner or holder therefore to vote for the election of director of the issuers of an entity included within the same person as the issuer’. In contrast, a non-corporate interest is:
an 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, limited liability companies, cooperatives and business trusts.
Turning to our example, Newco has a single membership interest but it has incentive distribution rights. We thus look to the assets upon dissolution test. If upon formation Party A and Party B are entitled to 50 per cent of the assets on dissolution, then both Party A and Party B control Newco and must look to the applicable thresholds and possible exemptions. This test is determined based the last regularly prepared balance sheet of Newco (or the pro forma balance sheet) at the time of formation.
Assuming both Party A and Party B will obtain control of Newco, we apply the look through rule. The exemptions discussed above would apply. Thus, if Party A is contributing a to-be-built plant, no filing would be required. If the plant was operating, then Party B would need to make a filing. Under the formation rules, Newco will not have to file.
Consider one alternative. Suppose Party A has incentive distribution rights and those rights or preferential rights allow it to enjoy more than 50 per cent of the assets on dissolution of Newco. Applying the look-through rule, Newco only has exempt assets and Party A does not need to file. Party B does not have control and therefore does not need to file. If Party B had the preferential right, then it likely would need to file if Party A were contributing an operating plant, and Party B was entitled to 50 per cent of the assets on dissolution.
The application of the HSR Act and its regulations presents a puzzle for practitioners. While the HSR Act and its regulations present a maze, the standards are quite distinct from the applicable merger control regulations outside of the US.
- All thresholds identified herein are current as of January 2015. The thresholds are adjusted annually.
- One should not rely on this discussion to render legal advice. Consult with experienced counsel when determining whether a transaction is subject to the HSR Act. This example is for discussion purposes only.
- The HSR Act regulations can be found at 16 CFR section 801, et seq The 2015 HSR Act regulations can be found at www.gpo.gov/fdsys/browse/collectionCfr.action?collectionCode=CFR&searchPath=Title+16 per cent2FChapter+I&oldPath=Title+16 per cent2FChapter+I per cent2FSubchapter+H&isCollapsed=true&selectedYearFrom=2015&ycord=696.
- The intraperson exemption does not apply when one person controls another person by virtue of the right to designate more than 50 per cent of the directors of a corporate entity. For the intraperson test, only having 50 per cent of the voting securities in an issuer or 50 per cent of the profits or assets on dissolution of a non-corporate entity are relevant.
- An exemption applies when a US person acquires voting securities of a foreign issuer and when a non-US person acquires voting securities of a non-US issuer. We do not address that in this article.