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New Regulations Exempt REITs from Antitrust Notification (Summer 1996)By: Tony M. Edwards and Margaret Campell Jaffe Background The HSR Act is intended to serve as an "early warning system" for anticompetitive mergers and acquisitions that have the potential of raising prices and diminishing services for consumers. By providing advance notice, the antitrust enforcement agencies can investigate the anticompetitive implications of these acquisitions and are assured an opportunity to seek a preliminary injunction halting the transaction before the acquisition is consummated. For example, in April 1996 the FTC halted Rite Aid Corporation's proposed acquisition of Revco DS Inc. After the FTC decided to seek a preliminary injunction to block the transaction, Rite Aid abandoned the transaction. Under this system of advance notice, the problem of unscrambling assets after the transaction has been completed is reduced greatly. A transaction is generally subject to the HSR Act if the seller or acquiror is engaged in interstate commerce and the size-of-transaction and size-of-person tests are met, unless an exemption is available.2 A transaction is subject to the HSR Act only if, as a result of the proposed acquisition, the acquiror and all entities under common control will hold either (i) at least 15% of the voting securities or assets of the seller or (ii) an aggregate amount of voting securities and assets of the target valued at more than $15 million. In addition, the acquiror (or the seller, if larger than the acquiror) must have combined total assets or net sales greater than $100 million and the seller (or the acquiror, if larger than the seller) must have combined total assets or annual net sales greater than $10 million.3 Complying with the HSR Act can be a costly endeavor. If an acquisition is subject to the HSR Act, both the acquiror and target must incur legal expenses to prepare a filing for the FTC and DOJ. The filing fee also is rather steep, currently $45,000 (paid by the acquiror only). When there is uncertainty that a transaction is exempt or a filing is required, parties are wise to err on the side of caution. Violation of the HSR Act's filing requirements can result in substantial penalties, up to $10,000 per day that the violation continues. For example, in 1995 the FTC and DOJ obtained a record $3.1 million penalty from Sara Lee Corporation to settle charges that it violated the HSR Act's filing requirements.4 As reported several years ago in The REIT Report5 , since at least 1991 the FTC has taken the position that a REIT's acquisition of an interest in real estate is exempt from the HSR Act's filing requirements. The FTC's view has been that such an acquisition fits the statutory exemption available for "goods or realty transferred in the ordinary course of business."6 However, the FTC's policy was not codified in any formal regulation. REITs wishing to avail themselves of this exemption with some sense of comfort would send the FTC a letter describing the proposed transaction and asserting that it was exempt from the HSR Act. Unlike the IRS or SEC, the FTC would not issue any formal ruling letter but would respond by telephone to the accuracy of the exemption claimed.
New Regulations 1. Acquisitions of Certain Real Estate This new rule, codified at 16 C.F.R. 802.2 ("Rule 802.2"), exempts from the HSR Act acquisitions of eight categories of real estate that have been deemed to be abundant and to have a widely-dispersed ownership so that their acquisition is not likely to violate the antitrust laws. This rule exempts acquisitions of the following types of real estate: office and residential property, hotels and motels, retail rental space, warehouses, certain recreational land, new facilities, certain used facilities, unproductive real property and agricultural property. Rule 802.2 is available not only for REIT acquisitions, but also for dispositions of property types that fall under the eight categories included in the exemption. "Office and residential property" is property used primarily for office or residential purposes and includes common areas, such as parking and recreational facilities, and assets incidental to the ownership of such property. At least 75 percent of the space in the property should be used for office or residential purposes to satisfy this exemption. If, however, the purchaser is acquiring a business that is conducted on the office or residential property (presumably other than the management of the leased premises), the acquisition of the business, including the space in which the business is conducted, is separately subject to the HSR Act's notification requirements. The exemption for hotels and motels includes assets incidental to ownership, such as management contracts and trademark licenses. The exemption also includes improvements such as golf, swimming, tennis, restaurant, health club or parking facilities, but excludes ski facilities.8 Rental retail and warehouse properties include shopping centers, strip malls and stand alone buildings, as well as incidental assets. The exemption for "recreational land" includes real property used for golf, swimming or tennis club facilities and assets incidental to the ownership of such property. A "new facility" is defined to include only a structure that has not produced income and that was either constructed by the seller (in the transaction at issue) for sale or held at all times by the seller solely for resale. The new facility may include equipment or other assets incidental to the ownership of the facility. Also exempt is the acquisition of a used facility (and any incidental assets) by a lessee from the lessor when the lessee has had sole and continuous possession and use of the facility since it was built and the lessor holds title for financing purposes in the ordinary course of business. "Unproductive real property" is any real property (including incidental assets) that has not generated total revenues of more than $5 million in the 36 months preceding the acquisition, but does not include facilities that have not yet begun operation or that have been in operation at any time during the twelve months preceding the transaction. It is important to keep in mind that these exemptions apply solely to the acquisition of the real property (and its incidental assets). If such property is acquired along with a business (presumably other than the management of the leased remises) or other nonexempt assets, the nonexempt portion of the acquisition is separately subject to the notification requirements of the HSR Act if the nonexempt portion meets the size-of-transaction threshold of $15 million, which triggers the Act's filing requirement. There may be other statutory and regulatory exemptions available that exempt portions of the acquisition that fall outside of the scope of Rule 802.2. For example, the acquisition of obligations that are not voting securities, such as bonds, mortgages, deeds of trust, and nonvoting preferred stock, are exempted from the HSR Act.9 The usefulness of this exemption will depend on how broadly the term "incidental assets" is construed. The regulation does not give much guidance, beyond providing a few examples, as to the meaning of incidental assets. Hopefully, it will be interpreted broadly to include such assets as associated personal property. 2. Acquisitions of Investment Rental Property Assets Another new exemption, codified at 16 C.F.R. 802.5 ("Rule 802.5"), applies to acquisitions of "investment rental property assets," which is defined to mean real property that will be held solely for rental or investment purposes by the acquiror and that will be rented only to third parties. The acquiror may occupy the property only for the purpose of maintaining, managing or supervising the operation of the property. Investment rental property assets include property currently rented, property held for rent but not currently rented, common areas on the property, and assets incidental to the ownership of property, such as cash, prepaid taxes or insurance and rental receivables. Rule 802.5 supplements the exemption under Rule 802.2 by recognizing that there are additional categories of real property assets not covered by Rule 802.2, such as nursing homes, self-storage, net leased restaurants and industrial parks, that when acquired as investment rental property are not likely to violate the antitrust laws. Many REIT transactions may meet the requirements of both Rule 802.2 and Rule 802.5. In such a situation, so long as the type of property acquired is covered by Rule 802.2, there is no need to ensure that the transaction meets the requirements of Rule 802.5 as well. In the adopting release for these new rules, the FTC (replying to comments submitted by NAREIT) stated that it expects that the Rule 802.5 exemption applies to most real property acquisitions made by REITs.10 The FTC also explained that the new rule is not intended to narrow the currently available exemption for acquisitions of realty under the ordinary course of business exception. Indeed, new Rule 802.5 is broader than the current policy in that it exempts acquisitions by any type of investor, not just REITs, so long as the acquisition is made for investment purposes. The differences between Rule 802.2 and Rule 802.5 are simple. Rule 802.2 applies only to specific categories of real property and does not depend on the intent of the acquiror. This exemption also permits the acquiror to occupy the property for any purpose. Rule 802.5, on the other hand, applies to an acquisition of any type of real property assets so long as the acquiror has the requisite intent and occupies the property only for purposes of managing or operating the property. This difference is particularly important in the case of a REIT's disposition of property. A property sale will not be exempt under Rule 802.5 if the acquiror plans to operate a business on the property.11 For example, a sale of a shopping center property to a retail chain would not be exempt under Rule 802.5. The sale would, however, meet the requirements of the Rule 802.2 exemption, to the extent that the retail chain is not also acquiring $15 million of nonexempt assets from the REIT. 3. Acquisitions of Voting Securities of Holders of Certain Real Estate The FTC believes that whether an acquisition of real estate is likely to violate the antitrust laws should not depend on whether the transaction is structured as an asset acquisition or a purchase of voting stock. Accordingly, another new rule, codified at 16 C.F.R. 802.4 ("Rule 802.4"), exempts the acquisition of voting securities of certain real estate companies. Such an acquisition is exempt if the assets of the seller, together with those of all entities it controls, consist of assets the direct purchase of which would be exempt under Rule 802.2, Rule 802.5 or section 7A(c)(2) of the Clayton Act.12 Section 7A(c)(2) exempts from the HSR Act the acquisition of obligations that are nonvoting securities, such as bonds, mortgages or deeds of trust. The Rule 802.4 exemption is available so long as the acquired issuer does not hold non-exempt assets with a fair market value greater than $15 million. In the case of an acquisition of REIT shares, the target's investments in nonvoting securities, including presumably nonvoting preferred stock in the REIT's third party service subsidiary, would not count towards the $15 million threshold of non exempt assets that would trigger a filing obligation. If the target owns more than $15 million of non-exempt assets, such as perhaps third party service contracts, an HSR Act filing would be necessary. Accordingly, anyone contemplating a large investment in a REIT's voting securities should consult with antitrust counsel to determine whether the $15 million threshold of non-exempt assets has been crossed.
Conclusion 1 Section 7A of the Clayton Act, 15 U.S.C. 18a. 2 Acquisitions that need to be examined for HSR Act compliance include like kind exchanges as well as acquisitions of REIT stock or Operating Partnership Units. 3 15 U.S.C. 18a(a). 4 Sara Lee Corporation, FTC Docket No. C-3523 (Consent order, Aug. 24, 1995). 5 "More Hart-Scott-Rodino," The REIT Report (Winter 1991) p. 15. 6 15 U.S.C. 18a(c)(1). 7 61 Fed. Reg. 13666 (March 28, 1996). 8 This exemption does not apply to a hotel or motel that includes a casino. 9 15 U.S.C. 18a(c)(3). 10 61 Fed. Reg. 13666, 13681 (March 28, 1996). 11 There may be situations when an acquiror initially purchased a property for investment purposes and later occupied it for purposes of running a business. In the adopting release, the FTC explained that the circumstances or conduct of the acquiror may be scrutinized to determine whether the acquiror's intent at the time of the transaction was to hold the property solely as investment rental property assets. 12 15 U.S.C. 18(a)(c)(2).
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