Wisconsin Lawyer: Next Economy Legislation: Allowing Complex Business Reorganizations:

State Bar of Wisconsin

Sign In

Top Link Bar

News & Pubs Search

Advanced
  • Wisconsin Lawyer
    March
    31
    2008

    Next Economy Legislation: Allowing Complex Business Reorganizations

    Joseph BoucherLeonard SosnowskiThomas Nichols

    Share This:
    The Next Economy Legislation keeps Wisconsin at the forefront with its generally progressive and flexible business entity statutes. This legislation also clarifies and reforms Wisconsin's LLC Act, expands securities law provisions, and adopts several technical changes identified by the Department of Financial Institutions.

    Wisconsin LawyerWisconsin Lawyer
    Vol. 75, No. 8, August 2002

    Next Economy Legislation:
    Allowing Complex Business Reorganizations

    The Next Economy Legislation keeps Wisconsin at the forefront with its generally progressive and flexible business entity statutes. This legislation also clarifies and reforms Wisconsin's LLC Act, expands securities law provisions, and adopts several technical changes identified by the Department of Financial Institutions.

    illustration: puzzle pieces corporate 
imagesby Joseph W. Boucher, Leonard S. Sosnowski & Thomas J. Nichols

    On March 20, 2002, Gov. Scott McCallum signed into law 2001 Wisconsin Act 44 (Senate Bill 333), entitled the "Next Economy Legislation" (the NEL). The NEL becomes effective Oct. 1, 2002. The February 2002 Wisconsin Lawyer contained a brief description of this legislation and its legislative supporters.1 Among the NEL's provisions are changes to the corporate, limited liability company (LLC), and other entity statutes that the authors of this article and other State Bar Business Law Section members have worked on for the last several years. The NEL also made significant changes to Wisconsin's securities law. This article summarizes the NEL's key provisions. The securities law provisions are included in the accompanying sidebar, "The Next Economy and the Wisconsin Uniform Securities Law."

    The NEL provides the legal infrastructure necessary to allow more complex business reorganizations. The law permits a business entity to merge with or convert to a different form of entity. This will provide the flexibility to more easily accommodate many business transactions. Without this updated law, Wisconsin would be forced to use other states' laws to pursue these transactions.

    In 1993, the Wisconsin Legislature created chapter 183, the Wisconsin Limited Liability Company Law (LLC Law). Since that law became effective Jan. 1, 1994, the LLC has become the dominant form of new business entity in Wisconsin. The 1993 LLC Law did not include comprehensive provisions dealing with mergers or conversions involving other types of entities. For a more comprehensive history, please see the accompanying sidebar, "History of the LLC and NEL Laws."

    In the recent past, with the growth of start-upcompanies and companies going public in Wisconsin and other states, it became necessary to permit the flexibility this new law affords. For example, when an LLC is ready to "go public," it can simply convert into a corporation, without worrying about the issues associated with a technical dissolution of the LLC.2 Another situation in which a cross-species transaction may be appropriate is when a for-profit medical practice wishes to convert to a nonprofit chapter 181 corporation as part of a reorganization of health care entities.3

    Allowing mergers between different types of business entities also facilitates other transactions. For example, in many acquisitions taxable treatment is not a problem because the underlying transaction is subject to tax in any event. Also, multiple real estate limited partnerships can now be "rolled-up" into an LLC or corporation in a single transaction.4 Thus, practitioners will be able to offer clients a variety of ways to address the exigencies of their particular business circumstances. As shown below, however, it must be emphasized that the legislation does not change the federal and state tax treatment of these transactions. The NEL also updated the LLC Law to reflect the IRS's adoption of the new, more flexible "check-the-box" rules for entity classification and made other changes as noted below.

    Cross-species Transactions

    The NEL allows four types of Wisconsin entities - limited partnerships (LPs) (chapter 179); business corporations (chapter 180); nonstock corporations (chapter 181); and LLCs (chapter 183) - to engage in two types of "cross-species" transactions involving more than one of these types of entities: conversions and mergers. A conversion is simply the change in a single entity's classification to another form of entity.5 A cross-species merger is essentially the same as a merger between two or more business corporations, except that it involves more than one of the above types of entities.6

    General partnerships were not included as eligible entities in the NEL's cross-species transaction provisions. Many general partnerships are informal in nature, and, unless registered as limited liability partnerships, typically entail mutual general agency and unlimited liability.7 Also, the current Wisconsin partnership statutes (chapter 178) do not contain merger provisions. In light of this, the authors were concerned that inclusion of general partnerships in the NEL might impede enactment of the other, more immediately necessary, cross-species transaction provisions. Cross-species conversion and merger provisions may very well be included in the pending State Bar project to update the Wisconsin partnership statutes generally.

    Conversions

    Prior to the NEL, the operations of a Wisconsin LLC could be transferred to a Wisconsin corporation, but the transfer usually involved a multistep process, such as the following:

    1. Merge the Wisconsin LLC into an LLC of a state that allows cross-species conversions or mergers (such as Delaware);
    2. Use that state's laws to convert or merge the out-of-state LLC into a corporation of that state; and finally
    3. Merge the out-of-state corporation into a newly formed Wisconsin corporation.

    An action that should take one step took three steps. Under the NEL, a business now can be formed as a Wisconsin LLC to take advantage of the structural flexibility and tax advantages offered by that form of business entity, and at the appropriate time simply convert into a Wisconsin corporation to take advantage of the benefits of that structure. The new conversion provisions for each type of entity contain the same protections, including specific voting requirements8 and dissenters' rights,9 as previously applied to conventional mergers for such entities.

    Under the NEL, the business entity that is to be converted must submit to the Department of Financial Institutions (DFI) a certificate of conversion, including a plan of conversion, a statement that the plan was approved in accordance with the applicable law of the jurisdiction that governs the preconversion form of business entity, and a statement identifying the registered agent and office, or its equivalent, of the business entity, both before and after conversion. The Certificate of Conversion form is available online from DFI, at www.wdfi.org/corporations.10

    The plan of conversion must contain certain information, including the following: the name, form of business entity, and jurisdiction governing the business entity before and after conversion; the terms and conditions of the conversion; the manner and basis of converting the shares or other ownership interests of the business entity that is to be converted into shares or other ownership interests of the new form of business entity; and a copy of the post-conversion articles of incorporation or other governing document.11 The plan also may contain a subsequent effective date and a different effective time for the conversion if the default effective date and time provided by the relevant statute are not acceptable.12 These plan requirements are based upon the corresponding plan of merger requirements for regular business corporations.13

    The results of a conversion are as follows:

    1. Under the new law, when a conversion becomes effective, the business entity that was converted no longer is subject to the law of the jurisdiction that governed the organization prior to the conversion, but rather is subject to the law of the jurisdiction that governs the new form of business entity.14

    2. Entity owners that are generally liable for the liabilities of a form of business entity, such as general partners in a limited partnership, are subject to a special rule. They continue to be subject to such liabilities, but only those liabilities that were accrued during the period when the entity was of the type that entailed such pass-through liability.15

    3. In any event, the business entity continues to be subject to all its liabilities incurred by it in its prior form.16

    4. The business entity continues to be vested with title to all of its prior properties, provided it records instruments of conveyance reflecting the conversion for all Wisconsin real estate owned at the time of conversion.17 The conveyance is not subject to a transfer fee18 and there is no tax penalty if the new business entity fails to satisfy this requirement with respect to one or more pieces of real estate.

    5. Upon conversion, the articles of incorporation or other similar governing document of the new business entity becomes that provided for in the plan of conversion.19

    6. Under the NEL, any civil, criminal, administrative, or investigatory proceedings that are pending by or against the prior business entity may be continued by or against the new business entity after the effective date of conversion.20

    Mergers

    Prior law authorized business corporations and nonstock corporations to merge into other foreign or domestic business corporations and nonstock corporations,21 and LLCs to merge into other foreign or domestic LLCs.22 The NEL significantly expands these merger provisions to allow one or more limited partnerships, business corporations, nonstock corporations, and LLCs to merge with any one or more other foreign or domestic such entities, not just the same form of business entity.23

    Gov. McCallum signing legislation

    On March 20, Gov. Scott McCallum (seated) signed the Next Economy Legislation into law as supporters looked on (from left): Rep. Suzanne Jeskewitz; Atty. Joseph Hildebrandt; Sen. Mark Meyer; Atty. Joseph Boucher; and John Kundert, Secretary, Department of Financial Institutions; and Atty. Tom Nichols.

    The surviving business entity of the merger must submit to the DFI the plan of merger and a statement that the plan was approved by each participating business entity in accordance with the applicable law of the jurisdiction that governed that entity prior to the merger. The articles of merger also may contain a subsequent effective date and a different effective time for the merger if the default effective date and time provided by the relevant statutes are different than what the parties would prefer. The Articles of Merger form is available online from DFI, at www.wdfi.org/corporations.24 The plan of merger must contain information similar to what is required for a plan of conversion, as described above. It must set forth the name, form of business entity, and jurisdiction for each business entity that is a party to the merger, as well as for the surviving business entity, and the manner and basis of converting the interests in each such business entity into shares, interests, obligations, or other securities of the surviving business entity or any other business entity or into cash or other property, in whole or in part.25 In addition, the plan of merger may set forth any desired amendments to the governing document of the surviving business entity, as well as any other provisions relating to the merger.26

    The results of a merger are similar to those for mergers of regular business corporations under prior law, including:

    1. Every other business entity that is a party to the merger merges into the surviving business entity, and the separate existence of each such entity, except the surviving business entity, ceases.27

    2. Because mergers now may involve an entity subject to laws imposing general liability on one or more of its owners, such as a general partner of a limited partnership, the NEL provides that such general liability laws continue to be applicable after the merger (for example, if a limited partnership merges into a corporation) or commence being applicable upon the merger (for example, if the surviving entity is a limited partnership), but only for liabilities that are accrued while such laws are applicable to the business entity.28

    3. Title to all property owned by each participating business entity is vested in the surviving business entity without reversion or impairment, provided the surviving business entity records instruments of conveyance to itself for all Wisconsin real estate.29 These recordings are not subject to a transfer fee30 and there is no tax penalty for failing to file a transfer return.

    4. The surviving business entity is responsible for all of the liabilities of each business entity that is a party to the merger.31

    5. Civil, criminal, administrative, or investigatory proceedings pending by or against any business entity that is a party to the merger may be continued as if the merger did not occur, or the surviving business entity may be substituted in the proceeding.32

    6. The articles of incorporation or other similar governing document of the surviving business entity is amended to the extent provided in the plan of merger.33

    7. Shares or other interests of each business entity that is a party to the merger that are to be converted into shares, interests, obligations, or other securities of the surviving business entity or any other business entity, or into cash or other property, are to be so converted, and the former holders of such shares or other interests are entitled only to the rights as provided in the articles of merger or under the laws applicable to their respective business entity.34

    8. If the surviving business entity is a foreign business entity, the DFI is its agent for service of process in any proceeding to enforce dissenters' and other rights of shareholders or other owners.35 Any surviving foreign business entity must promptly pay amounts owed to dissenting shareholders or other owners of a participating domestic business entity as required under applicable Wisconsin law.

    Tax Issues

    A critical point to remember is that, while the NEL permits cross-species mergers and conversions, it does not change the income tax consequences to the entities involved and their owners.36 Tax issues must be carefully reviewed in the context of any proposed transaction. A full discussion of potential tax consequences is beyond the scope of this article. However, some general comments can be made. In general, business entities are treated as either "corporations" or "partnerships" for income tax purposes, and state law corporations (and certain comparable types of entities organized under the laws of other jurisdictions) are automatically treated as "corporations." However, other entities can generally choose to be taxed as either "corporations" or "partnerships" under the "check-the-box" regulations first promulgated in the late 1990s.37

    The rules regarding the merger and conversion of business entities are quite complicated. However, certain generalizations can be made, though these are subject to exceptions that also are beyond the scope of this article. In general, mergers and conversions among entities that are treated as "corporations" can be tax free, but such transactions are subject to well-developed, and often counter-intuitive, rules and requirements.38 Similarly, mergers and conversions among tax "partnerships" are generally tax free, but the partnership tax rules are subject to a number of "tax abuse" rules that can trigger taxability, even in nonabusive transactions.39 Reorganizations of nonprofit charitable organizations also are subject to their own detailed set of rules.40

    Although the NEL substantially increases flexibility in corporate acquisition and reorganization transactions by allowing all three of the above types of tax entities to merge or convert with one another, this also introduces a whole new set of tax complexities. Probably the most significant potential tax consequence is the fact that a merger or conversion of a tax "corporation" into a tax "partnership" (including most LLCs) is a fully taxable transaction, potentially triggering tax both inside the corporation and to its shareholders.41 Also, conversions and mergers of nonprofit eligible charitable organizations into noncharitable entities are subject to both state restrictions and potential tax penalties and other consequences.42 Other transactions, such as a conversion or merger of an LLC into a corporation when the LLC owners own at least 80 percent of the surviving corporation, can be tax free, but there still are potential basis, holding period, recapture, and other ramifications.43

    The NEL specifies that mergers and conversions shall be treated for Wisconsin tax purposes the same as they are treated for federal tax purposes.44 In addition, amendments to the sales tax statutes apply the traditional exemptions (and their limitations) to conversions, as well as mergers.45

    Other NEL Amendments

    The NEL made other updating, technical, and procedural amendments.

    Check-the-Box LLC Changes. Because the LLC statutes originally were designed to allow limited liability entities to qualify for partnership tax treatment, they contained certain provisions based on the partnership statutes which were critical for partnership classification under the prior regulations.

    Dissolution of LLCs. Under prior section 183.0901 of the Wisconsin Statutes, an LLC automatically dissolved when certain events occurred, including any event of dissociation by a member (by withdrawal, assignment, removal, bankruptcy, and so on). With the advent of the "check-the-box" regulations, this statutory language no longer was necessary. Section 183.0901, as changed, eliminates the automatic dissolution upon these events for LLCs organized after the effective date of the NEL.

    Withdrawal of Members. The NEL provides that the members of an LLC may, by provision in the operating agreement, actually prohibit a member from withdrawing.46 Under prior law, an operating agreement could provide that a member could not withdraw without breaching the agreement, but the member would, nonetheless, still have the power to withdraw.47 Now the members may agree among themselves to eliminate any power of a member to withdraw.48 A voluntary withdrawal right continues as the default in most circumstances, absent contrary provisions in the operating agreement.49

    Current law continues to bar withdrawal if the member acquired the LLC interest for no, or nominal, consideration, unless the operating agreement provides otherwise.50 As under prior law, for LLCs organized for a definite term or a particular undertaking, a member may not withdraw prior to the expiration of that term or the completion of that undertaking, unless otherwise provided in the operating agreement.51 Practitioners, therefore, should exercise caution in drafting the "purpose" section of the operating agreement.

    Ownership Interests. The statutes in some states have specifically permitted the use of multiple types of ownership interests in LLCs, including different series or classes of members, or interests that have different preferences, limitations, rights, or duties. While the authors of the NEL believe that Wisconsin chapter 183 has always permitted such multiple interests, there was no explicit provision to that effect. Section 183.0504 now explicitly permits these types of LLC ownership interests.

    Filing and Procedural Issues. A number of minor, technical changes pertaining to electronic filing, registration of foreign LLCs, and fee changes were included in the NEL at the request of the DFI.

    Merger and Conversion Fees. Under prior law, the fee for filing documents of merger varied depending upon the type of entity executing the merger. The fee for filing articles of merger for a corporation was $50 per corporation. For a nonstock corporation, the fee was $30 per corporation. For an LLC, the fee was $50 per company. The NEL sets these filing fees uniformly at $150 for both mergers and conversions, except that the fee applicable to a cooperative under the law is still $30.52

    Electronic Filing. Prior law allowed documents required to be filed by corporations with the DFI to be filed in electronic format. The NEL specifies that documents required to be filed by limited partnerships, limited liability partnerships, nonstock corporations, and LLCs also may be filed in electronic format. The NEL permits the DFI, by rule, to establish a higher fee applicable to filing any documents in paper format.53

    Registered Agents. Current law requires every limited partnership, corporation, nonstock corporation, and LLC to appoint a registered agent to receive certain communications on behalf of the entity and to receive service of process (for example, service of a summons and complaint).54 Prior law permitted these entities to appoint another business entity, rather than an individual, as registered agent. However, the types of business entities authorized to serve as registered agent were not uniform across all of the laws governing the entities. For example, prior law did not authorize any of these entities to appoint a limited partnership or limited liability partnership as registered agent. Under the NEL, all business entities may appoint a limited partnership, limited liability partnership, corporation, nonstock corporation, or LLC as registered agent.55

    Prior law also specified a procedure for a registered agent of a corporation, nonstock corporation, or LLC to resign.56 The NEL created a similar procedure applicable to the registered agent of a limited partnership or limited liability partnership.57 The NEL, by adopting Wis. Stats. section 179.12(1) applicable to limited partnerships, ensures that no business entity will ever be charged a fee for filing a document only to change a registered agent.

    Amended Foreign Certificates of Authority. Under current law, a foreign corporation or foreign nonstock corporation has to obtain a certificate of authority from the DFI to transact business in Wisconsin.58 Similarly, a foreign LLC must obtain a certificate of registration from the DFI.59 Prior law also specified certain conditions under which a foreign corporation, foreign nonstock corporation, or foreign LLC needed to obtain an amended certificate (for example, if the entity changed the jurisdiction under which it was organized).60 The NEL retains these requirements and adds the additional requirement that a foreign corporation, foreign nonstock corporation, or foreign LLC obtain an amended certificate if the entity changes the date of its incorporation or organization.61 This would presumably apply, for example, if a business entity doing business in Wisconsin merged into another entity with a different organizational date and continued to do business in Wisconsin.

    Conclusion

    The NEL keeps Wisconsin at the forefront with its generally progressive and flexible business entity statutes. The challenge to practitioners is to think creatively in applying these new provisions to best meet the business demands of their clients. Given the relatively recent vintage of cross-species merger/conversion laws, both in Wisconsin and elsewhere, many issues and questions undoubtedly will arise. Future technical amendments may be required. The authors would appreciate hearing from practitioners on problems encountered in using the new provisions.

    Endnotes

    1 75 Wis. Law. 16 (February 2002).

    2 See Wis. Stat. §§ 179.76, 180.1161, 181.1161, 183.1207.

    3 Wis. Stat. § 180.1161.

    4 Wis. Stat. §§ 179.77, 180.1101, 183.1201(2).

    5 See Wis. Stat. §§ 179.76, 180.1161, 181.1161, 183.1207.

    6 See Wis. Stat. §§ 179.77, 180.1101, 181.1101, 183.1201.

    7 See Wis. Stat. §§ 178.06, .12.

    8 See Wis. Stat. §§ 180.1103, 181.1103, 183.1202.

    9 See Wis. Stat. §§ 180.1320, 183.1206.

    10 See Wis. Stat. §§ 179.76(5), 180.1161(5), 181.1161(5), 183.1207(5). The Certificate of Conversion form is available in .pdf format from the DFI-Division of Corporate & Consumer Services, www.wdfi.org/corporations. Readers may download the form to their own computers, print the form, fill in the blanks, and return the completed form by mail to the DFI.

    11 See Wis. Stat. §§ 179.76(3), 180.1161(3), 181.1161(3), 183.1207(3).

    12 See Wis. Stat. §§ 179.76(3), 180.1161(3), 181.1161(3), 183.1207(3).

    13 See Wis. Stat. § 180.1101(2) (1999-2000).

    14 See Wis. Stat. §§ 179.76(4)(a)1, 180.1161(4)(a)1, 181.1161(4)(a)1, 183.1207(4)(a)1.

    15 See Wis. Stat. §§ 179.76(4)(a)2, 180.1161(4)(a)2, 181.1161(4)(a)2, 183.1207(4)(a)2.

    16 See Wis. Stat. §§ 179.76(4)(b), 180.1161(4)(b), 181.1161(4)(b), 183.1207(4)(b).

    17 See Wis. Stat. §§ 179.76(4)(c), 180.1161(4)(c), 181.1161(4)(c), 183.1207(4)(c).

    18 See Wis. Stat. § 77.25(bm).

    19 See Wis. Stat. §§ 179.76(4)(d), 180.1161(4)(d), 181.1161(4)(d), 183.1207(4)(d).

    20 See Wis. Stat. §§ 179.76(6), 180.1161(6), 181.1161(6), 183.1207(6).

    21 See Wis. Stat. §§ 180.1101, 181.1101 (1999-2000).

    22 See Wis. Stat. § 183.1201 (1999-2000).

    23 Wis. Stat. §§ 179.77 et. seq., 180.1100 et. seq., 181.1100 et. seq., 183.1200 et. seq.

    24 See Wis. Stat. §§ 179.77(5)(c), 180.1105(1)(c), 181.1105(5), 183.1204(1)(b). The Articles of Merger form is available in .pdf format from the DFI-Division of Corporate & Consumer Services, www.wdfi.org/corporations. Readers may download the form to their own computers, print the form, fill in the blanks, and return the completed form by mail to the DFI.

    25 See Wis. Stat. §§ 179.77(2), 180.1101(2), 181.1101(2), 183.1203.

    26 See Wis. Stat. §§ 179.77(3), 180.1101(3), 181.1101(3), 183.1203(3)(d), (e).

    27 See Wis. Stat. §§ 179.77(6)(a), 180.1106(1)(a), 181.1106(1), 183.1205(1).

    28 See Wis. Stat. §§ 179.77(6)(b), 180.1106(1)(am), 181.1106(1m), 183.1205(1m)(a).

    29 See Wis. Stat. §§ 179.77(6)(c), 180.1106(1)(b), 181.1106(2), 183.1205(2).

    30 See Wis. Stat. §§ 77.21(1e), .25(6).

    31 See Wis. Stat. §§ 179.77(6)(d), 180.1106(1)(c), 181.1106(3), 183.1205(3).

    32 See Wis. Stat. §§ 179.77(6)(e), 180.1106(1)(d), 181.1106(4), 183.1205(4).

    33 See Wis. Stat. §§ 179.77(6)(f), 180.1106(1)(e), 181.1106(5), 183.1205(5).

    34 See Wis. Stat. §§ 179.77(6)(g), 180.1106(1)(f), 181.1101(6), 183.1205(6).

    35 See Wis. Stat. §§ 179.77(6)(h), 180.1106(3)(a), 181.1107(2), 183.1205(7).

    36 See Wis. Stat. §§ 71.80(21), (22), 73.03(58).

    37 See Treas. Reg. §§ 301.7701-2, -3.

    38 See I.R.C. ch. 1, subch. C.

    39 See I.R.C. ch. 1, subch. J.

    40 See I.R.C. ch. 1, subch. F; ch. 42, subch. A.

    41 See Treas. Reg. § 301.7701-3(g)(ii); I.R.C. §§ 331, 336.

    42 See, e.g., Wis. Stat. § 181.0304; I.R.C. § 507.

    43 See Treas. Reg. § 301.7701-3(g)(1)(i); I.R.C. § 351.

    44 See Wis. Stat. §§ 71.80(21), (22), 73.03(58).

    45 See Wis. Stat. § 77.61(15).

    46 See Wis. Stat. § 183.0802(3).

    47 See Wis. Stat. § 183.0802(3)(a) (1999-2000).

    48 See Wis. Stat. § 183.0802(3)(b).

    49 See Wis. Stat. § 183.0802(3)(a).

    50 See Wis. Stat. § 182.0802(3)(b).

    51 See Wis. Stat. § 183.0802(b).

    52 See Wis. Stat. §§ 179.77(5m), 180.0122(1)(o), 181.0122(1)(o), 183.0114(1)(n), 185.83(1)(b)(m).

    53 See Wis. Stat. §§ 179.03(2), .11(1), .12(1), .13, .185(1), .24(1)(b), .76(7), .77(5m), .82, .86(1), 180.0122(5), 183.0114(3), 184.10(4), 185.48(4), (6), .83(1m).

    54 See Wis. Stat. §§ 179.82(4), 180.0501(2), (3), 181.0501(2), (3), 183.0105(1)(b), (c).

    55 See Wis. Stat. §§ 179.82(4), 180.0501(2), (3), 181.0501(2), (3), 183.0105(1)(b), (c).

    56 See Wis. Stat. §§ 180.0503(1), 181.0503(1), 183.0105(5).

    57 See Wis. Stat. §§ 179.045, 178.43(2m).

    58 See Wis. Stat. §§ 180.1501(1), 181.1501(1).

    59 See Wis. Stat. § 183.1002(1).

    60 See Wis. Stat. §§ 180.1504(1), 181.1504(1), 183.1006(1).

    61 See Wis. Stat. §§ 180.1504(1)(b), 181.1504(1)(b), 183.1006(1)(b).