New FTC Position on Debt and HSR Valuation | Dorsey & Whitney LLP
On August 26, the Federal Trade Commission announced a new position on an important factor in determining whether a transaction should be reported under the Hart-Scott-Rodino Act: whether debt repayment at closing counts in determining whether the value of a transaction.1
Background. HSR requires parties to report certain M&A transactions to the FTC and the United States Department of Justice, and then meet a mandatory waiting period (typically 30 days) before closing. This gives agencies the opportunity to review the transaction to determine if it presents competition concerns.
Size of the transaction. Not all transactions are reportable. The first gate is “trade size” – if the value of the voting securities or assets to be acquired falls below the legal minimum, then the trade is not reportable. This minimum is adjusted annually, and for transactions closed in 2021 (and early 2022, before the next annual adjustment), the minimum is $ 92 million. Transactions whose value, as determined under the HSR Law, is equal to or less than this number are not to be reported. Additionally, transactions valued at $ 184 million or less (also adjusted annually) are subjected to another test – “people size”.
Value. Under the HSR Act and its regulations, the value of securities with voting rights is the higher of the purchase price (if determined) and the market price (or, for securities with voting rights). vote that are not publicly traded, fair market value).
Previous debt processing and debt repayment. But what if a business is in debt? Suppose, for example, that a company with an enterprise value of $ 100 million has debt of $ 45 million. The value of the voting securities is likely to be approximately $ 55 million (more or less, depending on the terms of the debt). On the other hand, if the debt is eliminated (for example, shareholders bring in additional capital which is used to pay off third party debt), then the value of those same voting securities would now be $ 100 million. . Historically, if a portion of the purchase price were to be used for debt repayment at closing, the FTC allowed parties to exclude that portion from the value of voting securities. This made sense, because at least theoretically, the buyer could have bought the acquired issuer with the existing debt still in place, and then repay the debt after closing. In this case, the value of the securities with voting rights was clearly (in our example) below the reporting threshold.
The perceived problem. The FTC blog post states that target companies “may be encouraged to take on debt immediately before an acquisition, so that the acquiring company can repay the debt as part of the transaction. These deals then go unreported to the FTC and DOJ, meaning the merging parties are effectively bending the law and avoiding accountability. “
New debt treatment. The FTC recognizes that “all debt repaid under a proposed transaction is not consideration,” but “sometimes the debt repayment is part of the consideration of a transaction in that it benefits the party. (x) selling shareholder (s). The new position of the FTC is that “the total or partial repayment of the debt must be included in the calculation of the purchase price in all cases where the selling shareholder (s) benefit from the repayment of this debt”.2
Application. What does “benefit the selling shareholders” mean? It’s not clear, but one can envision at least one case where the FTC would not view debt repayment as “benefiting the selling shareholders”: repayment of long-term debt to unrelated third parties who don’t. has not been guaranteed by a shareholder or parent company / affiliates. Here are some types of debt that parties might want to assess for inclusion as “consideration” if any part of the sale proceeds will be used for debt repayment:
- Debt to natural or legal persons who themselves sell shares.
- Debt to affiliates or parent companies of the target issuer or the entity that sells the shares.
- Debt that has been recently incurred, if a significant portion of the loan proceeds has been distributed to selling shareholders or has been used to repay debts owed to selling shareholders or parent / affiliate companies.
To be clear, the FTC blog post acknowledges that certain types of debt repayments are not a “consideration,” but that determination will require a fact-specific assessment.
Consequences. The HSR Act provides for civil penalties for each day of non-compliance. The maximum daily civil fine is currently $ 43,792 (adjusted annually).3 In addition, the HSR Act also authorizes the courts to grant equitable relief (for example, an injunction against future violations). In certain circumstances, a reportable but unreported transaction may also be subject to further scrutiny for possible material competition concerns.
Effective date. The FTC blog post states that “As of September 27, 2021, the [FTC] will begin recommending enforcement actions for companies that do not file when debt repayment is part of the deal’s consideration. “4 We read this to mean that if a trade ends on or before September 26, the FTC would not recommend enforcement action (at least not based on the debt repayment issue).
1 Holly Vedova, FTC Competition Bureau Reform the pre-filing process for companies considering consolidation and change in debt handling, (August 26, 2021), https://www.ftc.gov/news-events/blogs/competition-matters/2021/08/reforming-pre-filing-process-companies-considéring.
2 FTC Competition Bureau, The treatment of debt as consideration, https://www.ftc.gov/enforcement/premerger-notification-program/hsr-resources/treatment-debt-consideration.
3 For example, on September 2, 2021, the United States Department of Justice announced the settlement of an enforcement action in which the purchaser agreed to pay a civil fine of $ 637,950. United States v. Fairbank, Case 1: 21-cv-02325, Dkt # 1-4 (DDC 02 Sep 2021).
4 The FTC is making a “recommendation” because the enforcement actions are brought by the US Department of Justice.