Act's Application to Exclusive IP Licences
The Commerce Test
The Size-of-Person Test
The Size-of-Transaction Test
Potential Exemptions
Under the Hart-Scott-Rodino Antitrust Improvements Act 1976, as amended, parties to certain exclusive IP licences must file notifications with the US federal antitrust agencies and observe a waiting period before closing on the licences. Whether a particular exclusive IP licence is reportable under the Hart-Scott-Rodino Act turns on such factors as:
- the cumulative size of the parties to the licence;
- the amount of royalties or other consideration being paid for the licence;
- the size and nature of any prior transactions between the parties; and
- the manner in which the licence is structured.
Act's Application to Exclusive IP Licences
Section 7A of the Clayton Act,(1) as added by the Hart-Scott-Rodino Act, requires that parties to certain acquisitions of assets or voting securities provide advance notification to the Federal Trade Commission (FTC) and Antitrust Division of the US Department of Justice, and observe a waiting period before consummating the transaction. These procedures are designed to give the agencies an opportunity to review the transaction and, if necessary, challenge it before it is consummated. The normal waiting period is 30 days. This period may be shortened if the FTC and Department of Justice do not believe that the transaction presents any competitive concerns. It may also be lengthened if one of these agencies wishes to investigate the transaction and issues a request for additional information regarding the transaction.
Failure to file the notification and observe the statutory waiting period in transactions subject to the Hart-Scott-Rodino Act can result in the imposition of penalties of up to $11,000 for each day that elapses between consummation of the transaction and the subsequent expiration or termination of the waiting period applicable to the transaction. In some cases these fines have been several million dollars.
The grant of an IP licence would not normally involve a transfer of voting securities. It could, however, involve the transfer of an 'asset' subject to the Hart-Scott-Rodino Act. The act and its implementing regulations(2) do not define the term 'asset'. However, the FTC representatives responsible for Hart-Scott-Rodino notification requirements take the position that an exclusive IP licence (even for a limited period, territory or field of use) involves the transfer of an 'asset'.(3) The facts that the licence does not cover all territories and fields of use and is not perpetual may affect the value of the licence, but do not preclude the possibility that an 'asset' is being transferred.
There are at least two recognized limitations on the FTC's position. First, entering into a non-exclusive licence is not reportable. The FTC does not regard a non-exclusive licence, under which the licensor retains the right to use the intellectual property or licence it to someone else, as the transfer of an asset for Hart-Scott-Rodino purposes.(4) Second, the policy may not apply to exclusive licences of all types of intellectual property. While it maintains that the policy generally applies to patent, trademark and know-how licences, the FTC staff has indicated that the policy may apply to some, but not all, transfers of copyright.
The transfer of an asset (or voting security) is potentially subject to Hart-Scott-Rodino notification requirements only if it satisfies the applicable threshold tests:
- the 'commerce' test;
- the 'size-of-person' test under certain circumstances; and
- the 'size-of-transaction' test.
Even where each test is satisfied, one or more exemptions may apply. These threshold tests are discussed below.
The commerce test is satisfied only where a licensor or its licensee, or any entity under common control (as 'control' is defined in the Hart-Scott-Rodino regulations) with either of them, is "engaged in commerce or in any activity affecting commerce".(5) In this context, 'commerce' generally includes trade among the various states and territories of the United States, or between one or more of them and a foreign nation.(6)
The Size-of-Person Test
The size-of-person test is only applicable for transactions valued in excess of $50 million but not in excess of $200 million. For transactions valued in excess of $200 million there is no size-of-person threshold test.
The size-of-person test is generally satisfied if either the acquiring person or the acquired person has total assets or annual net sales of $100 million, and the other has total assets or annual net sales of $10 million.(7) In defining the 'acquiring' and 'acquired' persons, both the particular entities which are parties to the licensing agreement and the other entities under common control with each of them are included. 'Control' has a special meaning under the Hart-Scott-Rodino regulations which does not follow the securities laws definition of 'control'.(8) Therefore, Hart-Scott-Rodino counsel should be consulted to determine the identity of the 'acquiring' and 'acquired' persons under the Hart-Scott-Rodino Act and its regulations.
Once the acquired person and acquiring person have been identified, it is possible to determine whether their respective assets or annual net sales are sufficient to satisfy the $100 million and $10 million portions of the size-of-person test. The value of a person's assets is generally as set forth in its last regularly prepared balance sheet.(9) Its annual net sales are generally as set forth on its last regularly prepared annual statement of income and expense.(10) If the balance sheets and income statements of the ultimate parent entity (or of a 'person') do not reflect the activities of all controlled entities, the assets and annual net sales of all such unconsolidated entities must be added to those of consolidated entities to determine whether the size-of-person test is satisfied.(11)
The size-of-transaction test is satisfied if "as a result of [an] acquisition, the acquiring person would hold an aggregate total amount of the voting securities and assets of the acquired person in excess of" $50 million.(12) Under the Hart-Scott-Rodino regulations, the value of assets to be acquired is the greater of the acquisition price, if determined, and the fair market value.(13)
The fair market value determination must be made in good faith by the board (or its equivalent in an unincorporated entity) of the ultimate parent entity of the licensee; alternatively, the board may delegate that function to another entity.(14) This determination must be made as of any day within 60 days prior to the filing of Hart-Scott-Rodino notification or, if no such filing is made, within 60 days prior to closing on the licence agreement.(15) There is no definitive guidance as to how the determination of fair market value should be made; any commercially reasonable approach used in good faith should suffice. The preferred approach appears to be to determine what a licensee would presently pay in cash for the licence being acquired.(16)
The acquisition price includes the value of all consideration for the assets being acquired, including the value of liabilities that the acquiring person (ie, the person receiving the licence) is assuming.(17)
This seemingly straightforward approach for determining the fair market value and the acquisition price of a transaction may lead to very different conclusions depending on the way in which the licence is structured, as the following three examples show:
- In a situation in which the consideration for the licence consists solely of one or more cash payments of a specified amount, the 'acquisition price' is deemed to be determined. The acquisition price will be the sum of the cash payments.(18) The amount so determined is not reduced by either the risk of non-payment or the time value of money (where the payments are received over time). Thus, for example, the acquisition price would be deemed to be $17 million if the licence provides for one lump-sum payment of $17 million at closing or if it provides for unsecured annual payments of $1 million for 17 years, even though the actual economic value of those two alternatives varies substantially. If the fair market value of the licence exceeds the aggregate cash payments, the value of the transaction for Hart-Scott-Rodino purposes would be the fair market value of the licence.
- In a situation (however unlikely) in which the licence calls for a specified royalty payment to be paid over a number of years at a designated interest rate, and the interest component is separately identified, the amount of interest included in the licensee's total interest payments to the licensor is not included in determining the acquisition price. For example, if the licence were to provide for the licensee to pay $500,000 per year in royalties and $500,000 per year in interest for the same 17 years discussed in the prior example, only the total royalties to be paid over the life of the licence ($8.5 million) would be included in the acquisition price if the interest component were separately stated in the licence. If the licence instead called for annual payments of "royalties and interest" of $1 million for the same 17 years, the acquisition price would be $17 million.(19) Again, if the fair market value of the licence exceeds the acquisition price, the value of the transaction for Hart-Scott-Rodino purposes would be the fair market value of the licence.
- In more likely instances in which there is a contingent element to the consideration paid for the licence (eg, the licensee agrees to pay future royalties equal to a specified percentage of future sales of the licensed product), the acquisition price will normally be deemed to be 'undetermined' so that only the fair market value of the assets is considered in determining their value.(20) However, if the royalty arrangements also included fixed annual or total minimum payments, and the amount of the contingent royalty payments can reasonably be determined by the acquiring person, the amount of the fixed payments would be added to the estimated value of the contingent payments to determine the total acquisition price of the licence being acquired.(21) Moreover, if the fixed or minimum payments alone exceed $50 million, a fair market value determination may be unnecessary to determine whether a filing is required (but could still be necessary to determine the amount of the filing fee).(22)
Once the acquisition price (if any) and/or fair market value of the licence being acquired have been determined, it may be necessary to add to this amount the value of certain other assets or voting securities which the acquiring person already holds, in order to determine whether it will hold more than $50 million's worth of voting securities and assets of the acquired person "as a result of the acquisition". The Hart-Scott-Rodino regulations generally define 'as a result of' to mean 'after'. Subject to certain exceptions, they therefore require aggregation of the value of certain voting securities or assets that the acquiring person acquired from the acquired person in the past, and holds prior to the acquisition, with the value of those assets or voting securities presently being acquired.
In summary, application of the size-of-transaction test often turns on the anticipated value of the consideration which the licensor will receive for the licence being granted and also, in some circumstances, on the value of any voting securities or assets which the acquiring person acquired from the acquired person in the past. The results of this analysis will vary substantially, depending on how the licence agreement and any prior acquisitions have been structured.
If analysis demonstrates that an exclusive IP licensing transaction satisfies the commerce, size-of-person (if applicable) and size-of-transaction tests, it is still not certain whether a Hart-Scott-Rodino filing is required. The Hart-Scott-Rodino Act and regulations set forth a number of exemptions that may apply to transactions that are otherwise subject to a filing requirement and thus obviate the need for a filing.(23) Application of these exemptions is highly technical, and many of them will not apply to licensing transactions. Accordingly, while it would be important to review them before determining that a notification is required regarding any licensing agreement that is otherwise subject to Hart-Scott-Rodino requirements, it is beyond the scope of this update to consider them here.
For further information on this topic please contact Philip C Larson at Hogan & Hartson LLP's Washington office by telephone (+1 202 637 5600) or by fax (+1 202 637 5910) or by email ([email protected]). Alternatively, contact Michele S Harrington at Hogan & Hartson's McLean office by telephone (+1 703 610 6100) or by fax (+1 703 610 6200) or by email ([email protected]).
Endnotes
(2) 16 CFR Sections 801.1 and following.
(3) American Bar Association (ABA), Pre-merger Notification Practice Manual, at 45 (Informal Interpretation 49) (1991 ed).
(5) l5 USC Section l8a(a)(1); Hart-Scott-Rodino regulations, Section 801.3.
(6) Hart-Scott-Rodino regulations, Section 801.1(l); Clayton Act Section 1, 15 USC Section 12; FTC Act Section 4, 15 USC Section 44.
(7) 15 USC Section 18a(a)(2)(B).
(8) See Hart-Scott-Rodino regulations Section 801.1(b).
(9) Hart-Scott-Rodino regulations Section 801.11(c)(2).
(10) Id, Section 801.11(c)(1).
(11) Id, Section 801.11(b)(1).
(13) Hart-Scott-Rodino regulations Section 801.10(b).
(14) Hart-Scott-Rodino regulations Section 801.10(c)(3).
(16) ABA Manual at 95-96 (Informal Interpretation 116).
(17) Hart-Scott-Rodino regulations Section 801.10(c)(2); 43 Fed Reg 33450, 33471 (July 31 1978).
(18) ABA Manual at 107-08 (Informal Interpretation 129).
(20) ABA Manual at 107-08 (Informal Interpretation 129) and at 95-96 (Informal Interpretation 116).
(21) ABA Manual at 95-96 (Informal Interpretation 116).
(22) Id at 110-111 (Informal Interpretation 133).
(23) See 15 USC Section 18a(c); Hart-Scott-Rodino regulations Sections 802.1-802.71.