In the last post of this series, I posed a challenge: to find the UPE, or ultimate parent entity, and acquired person in a hypothetical.  To find the answer, three steps are necessary:

1. Identify the acquired entity, that is (1) the enitity whose assets are being acquired, or (2) issuer whose voting securities are being acquired, or (3) the unincorporated entity whose membership interests are being acquired.
2. Trace the chain of control up, using the definitions for control for corporations, unincorporated entities, and trusts, until the entity is reached which itself is not controlled by another entity. That is the UPE. (Individuals are never controlled, and therefore always UPEs.)
3. Trace the control down from the UPE (or UPEs) until all controlled entities are identified. They are the entities “included” in the person. The person is the UPE plus all entities controlled by it, directly or indirectly, 801.1(a)(1). Without finding all entities included in the acquired or acquiring person, the size-of-person test cannot be applied.

Remember 801.1(c)(8): A person holds all assets and voting securities held by the entities included within it; in addition to its own holding, an entity holds all assets and voting securities held by the entities which it controls directly or indirectly.

In the hypothetical the acquired entity is H Inc. It is the corporation whose voting securities are being acquired. Tracing the chain of control up, you’ll find three UPEs (marked with UPE crowns): Mrs. Z, Mr Z, and A Inc.

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Some explanations:

• Mrs. Z and Mr Z are both UPEs, even though neither of them individually meets the definition of control for corporations (holing 50%+ voting securities of H Inc, or having the right to appoint 50%+ of directors). The reason is that the holdings of spouses (and their minor children) are aggregated under Rule 801.1(c)(2).  Mrs. Z and Mr Z are therefore treated as if they were each holding 55% of H Inc’s voting security, which is enough to give them control. Since individuals can’t be controlled by another entity, they are each a UPE and will have to file as acquired persons. Only one notification form is required for spouses, however, 803.2(a).
• F LLC controls H Inc because it has the right to appoint 50% directors (even though it holds less than 50% voting securities).
• Mr Y does not control F LLC: While he has the right to appoint the entire management board of F LLC, for HSR purposes unincorporated entities are “controlled” only by entities with a right to 50% of profits or assets upon dissolution. This distinguishes the treatment of unincorporated entites from that of corporations.
• Instead F LLC is controlled only by E Inc., which has a right to 99% of F LLC’s profits or assets upon dissolution.
• But who controls E Inc? There is no single entity that either holds 50%+ of E Inc’s voting securities or has a right to appoint 50%+ of directors. The four shareholders of E Inc are Mr Y (1% voting securities or vs), B Inc (29% vs), C Inc (30% vs), and D Inc (40% vs). B and C are controlled by A Inc, their sole shareholder, and D Inc is controlled by both C Inc and L Inc (each 50% vs). This means that A Inc. indirectly controls E Inc., since A Inc, through B, C, and D controls a total of 99% of the voting securities of E Inc. Even though E Inc at first blush looks like it is controlled by no other single entity, it is indirectly controlled by A Inc. (L Inc does not indirectly control E Inc, even though it controls D Inc, since D Inc has only a 40% stake in E Inc.)
• Finally, at the top, A Inc. is a UPE because it is not controlled by anyone else: Mrs. X 25% stake is insufficient, as will be the stakes of all the public shareholders included in the 75% public float.

Once the UPEs have been identified the next step follows: tracing control down until all controlled entities have been identified. The following graph shows the analysis for A Inc only. (The other two UPE’s, Mrs. Z and Mr Z, each control H Inc, I Inc, and J Inc.)

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The only additional explanation required here concerns G GP, the general partner entity of G LP (G GP is some unincorporated entity, like an LLC). G GP is controlled by E Inc, which has the right to 51% of G GP’s profits or assets upon dissolution. But G GP does not control G LP for HSR purposes, even though in practical terms G GP will make all business decisions of G LP, as its general partner. The Rules’ definitions of control are rigid and formalistic:  G GP determines the competitive behavior of G LP, but only profits and assets upon dissolution are considered HSR control. Since 99% of those rights rest with the dispersed limited partners, no one controls G LP. (This is a common situation for investment funds organized as limited partnerships, or other unincorporated entities where governance rights and economic rights are divorced from each other.)

In closing it’s important to emphasize that control is not exclusive under HSR. An entity may be controlled by more than one other entity. For example, a corporation may have a 50%+ shareholder but another person who may appoint the majority of directors.  In fact, a corporation may be controlled by a maximum of 4 entities (ignoring spouses as shareholders):

• The first holding 50% voting securities,
• The second holding the other 50% voting securities,
• The third having the contractual right to appoint 50% of the board of directors, and
• The fourth having the contractual right to appoint the other 50% of the board.

An unincorporated entity can also be controlled by a maximum of 4 entities:

• The first having the right to 50% profits,
• The second the right to the other 50% profits,
• The third having the right to 50% assets upon dissolution, and
• The fourth the right to the other 50% assets upon dissolution.

(The right to assets upon dissolution refers to the residual distribution after all claims and preferences have been resolved; if the rights are not clear, determine control of an unincorporated entity as if it were being dissolved now.)

The next post in this series will deal with unincorporated entities in more detail, answering the question whether they are “assets” or “voting securities” under §7A.

Previous posts: §7 and HSR. The Basic Test. Parsing Acquisitions. Getting to the Person.

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