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    The Conveyance Glitch in the Next Economy Law

    Recent changes to the Wisconsin Business Corporation Law impose three new requirements on Wisconsin businesses before property of a merging entity is vested in the surviving entity. Read about the interpretive difficulties that businesses will experience when attempting to comply with the statute due to drafting ambiguities and the consequences of noncompliance to businesses conducting mergers and acquisitions in Wisconsin.

    Jennifer Boatwright

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    Wisconsin Lawyer
    Vol. 76, No. 7, July 2003

    The Conveyance Glitch in the Next Economy Law

    Recent changes to the Wisconsin Business Corporation Law impose three new requirements on Wisconsin businesses before property of a merging entity is vested in the surviving entity. Read about the interpretive difficulties that businesses will experience when attempting to comply with the statute due to drafting ambiguities and the consequences of noncompliance to businesses conducting mergers and acquisitions in Wisconsin.

    merge signby Jennifer L. Boatwright

    The recently enacted Next Economy Legislation (the NEL) was intended to provide Wisconsin attorneys with the legal infrastructure necessary to execute complex business reorganizations, but has instead made executing business reorganizations in compliance with Wisconsin law a confusing and complicated task. The NEL, effective since Oct. 1, 2002, permits cross-species conversions and mergers. Specifically, it permits corporations, nonstock corporations, limited liability companies (LLCs), and limited partnerships (LPs) to convert into or merge with another form of business entity through what was intended to be a simple filing.1 While in most respects, the NEL is one of the more progressive cross-species statutes in the United States, a seemingly minor clause will at the very least create confusion and difficulty and also may result in several other unintended consequences.

    The difficulty of complying with the NEL may result in a marked decrease in the number of mergers undertaken by Wisconsin business entities. This decrease will be amplified even further because newly formed business entities will be less likely to incorporate in Wisconsin, and because Wisconsin business entities that do decide to engage in a merger transaction may find it beneficial to reincorporate in a different state before doing so. Additionally, for reasons discussed below, the NEL may make lenders more hesitant to loan funds to surviving entities. This will make securing funds to finance a merger transaction or postmerger operations more difficult.

    The Conveyance Glitch

    Prior to the NEL effective date, when two or more entities merged, the property of the merging entity vested in the surviving entity by operation of law upon the filing of articles of merger with the Wisconsin Department of Financial Institutions. Since the NEL effective date, however, if the NEL is read literally, there are three requirements that must be met before title to the merging entity's property is vested in the surviving entity:

    1) the merging entity must "transfer" its "interests" in Wisconsin real estate to the surviving entity;

    2) the merging entity must execute any required real estate transfer tax returns; and

    3) the surviving entity must record the transferring instrument at the appropriate county register of deeds:

    "The title to all property owned by each business entity that is party to the merger is vested in the surviving business entity without reversion or impairment, provided that, if a merging business entity has an interest in real estate in Wisconsin on the date of the merger, the merging business entity shall transfer that interest to the business entity surviving the merger and shall execute any real estate transfer return required under s. 77.22. The business entity surviving the merger shall promptly record the instrument of conveyance under s. 59.43 in the office of the register of deeds for each county in which the real estate is located."2

    These new requirements impose substantial filing obligations on business entities to accomplish the same result that previously was accomplished by filing articles of merger. The benefit of this administrative burden is unclear. One might speculate that the purpose is to make tracking conveyances for property tax assessments and transfer fee audits somewhat easier. The purpose of the provision does not, however, appear to be the generation of additional tax revenues, because the NEL elsewhere provides that transfers pursuant to a merger or combination between or among corporations, nonstock corporations, LLCs, or LPs are exempted from the statutory fees normally imposed upon real estate transfers.3

    This NEL provision raises two overarching issues. First, what constitutes an "interest in real estate"? The answer affects which items of property the merging entity must "transfer" and thus, for which items of property the surviving entity must record the conveyance instrument at the appropriate register of deeds. Second, what are the consequences of failing to meet one or more of the three requirements?

    Identifying an Interest in Real Estate

    The NEL does not define an "interest in real estate," and the remainder of the Wisconsin Business Corporation Law (WBCL) provides conflicting guidance. There are three potentially relevant WBCL provisions, none of which clearly delineates the scope of an "interest in real estate" for purposes of the NEL.

    1) WBCL section 700.01. Section 700.01 is the definition section of the WBCL chapter addressing interests in property, including such topics as the classification of interests, the legality of remainder interests, and forms of tenancy. For purposes of chapter 700, "interest" is defined as "any interest in property."4 This broad definition presumably includes interests such as leases and easements, in addition to standard ownership interests.

    2) WBCL section 706.001. Chapter 706 governs conveyances of real property, recording, and title. Section 706.01, the chapter's scope and construction section, states that chapter 706 governs "every transaction by which any interest in land is created, aliened, mortgaged, assigned or may be otherwise affected," but explicitly excludes from its application both leases for a term of less than one year and assignments, modifications, or terminations of leases made when the unexpired term of such lease is less than one year.5

    3) WBCL section 77.22. This section requires the filing of real estate transfer tax returns for conveyances of real estate. Excluded from the definition of "conveyances," found in section 77.21, are transfers of leases of less than 99 years, transfers of easements, or property transfers pursuant to a will.6

    These three possible sources of guidance leave attorneys in the unenviable position of having to speculate as to: 1) whether section 700.01 governs, in which case all interests in real estate, including easements and all leases, must be "transferred" and recorded; 2) whether section 706.01 governs and items that need to be "transferred" and recorded are all real estate interests other than those arising from leases of less than one year or assignments, modifications, or terminations of leases made when less than one year of such lease remains; or 3) whether section 77.22 governs and the only interests that must be "transferred," and thus recorded, are those that also require the filing of a real estate transfer tax return (that is, "conveyances"). If none of these provisions govern, attorneys are left with no guidance.

    Potential Consequences of Noncompliance

    Given the difficulty of determining the definition of an interest in real estate, it is probable that some merging entities will fail to comply fully with the statute. Additionally, many entities will simply be unaware of the new requirements. What impact will a failure to comply have on merging entities? There are two arguable consequences: loss of title under Wisconsin's race-notice statute, or nullification of the merger, whether express or constructive.

    Before discussing the possible consequences of failing to comply with the NEL, a threshold issue must be addressed: Do the possible negative consequences impact all property or only real estate? A literal reading of the NEL suggests that the vesting of all property is contingent on whether three requirements related only to interests in real estate in Wisconsin are fulfilled. It seems particularly harsh, however, to condition the vesting of all property on what could be one or two interests in Wisconsin real estate. The statutory language referring to "all property" is carried over from prior versions of the law, while the language beginning with "provided that" is the addition under NEL. It appears likely that the new language affecting only real estate in Wisconsin was added without anyone fully considering the ramifications that such language would have on the overall meaning of the statute. In discussing the possible consequences of noncompliance, this article uses language set forth in the statute, but readers should understand that there is a lingering question as to whether noncompliance affects all property or only real estate in Wisconsin.

    Loss of title. The first possible consequence of noncompliance is found in Wisconsin's race-notice statute. This statute provides that a person who purchases an item of real estate in good faith and for valuable consideration and who records it with the register of deeds is the legal titleholder as against a previous owner of the same real estate who did not record her interest at the register of deeds: "every conveyance that is not recorded as provided by law shall be void as against any subsequent purchaser, in good faith and for a valuable consideration, of the same real estate or any portion of the same real estate whose conveyance is recorded first."7

    If the surviving entity failed to record its interest in, for example, a building in which the merging entity's manufacturing operations were housed, application of the race-notice statute would mean that the surviving entity could be stripped of its ownership interest in that building by a subsequent good faith purchaser who does record its interest. The possibility of such a scenario occurring is minimal, however, because if the merging entity properly recorded its interest in the building, there cannot be a subsequent good faith purchaser even if the surviving entity fails to record. Potential purchasers checking the chain of title would be on notice that the building was once owned by the merging entity and thus would be on notice that whomever the purchaser was negotiating with did not in fact have the authority to sell the building.

    Nullification of the merger. The second possible consequence of noncompliance is that the merger will be nullified, either expressly or constructively. In regard to possible express nullification, nothing in the NEL or the remainder of the WBCL indicates that such a result will occur. But, in regard to possible constructive nullification, although the merger still would be effective, if the NEL is read literally, the end result is that all property fails to vest and the surviving entity ends up with much less than it bargained for, thus resulting in a constructive nullification of the merger. The NEL states that title to all property is vested "provided that the merging business entity transfers its interests in real estate to the business entity surviving the merger and executes any real estate transfer return required under s. 77.22."8 This clause can be interpreted in two ways (or, accounting for the threshold issue raised above, in four ways): 1) all of the property from both entities divests; or 2) none of the property of the merging entity vests in the surviving entity.

    Jennifer L. 

BoatwrightJennifer L. Boatwright, Michigan 2002, is a business law associate in the Milwaukee office of Foley & Lardner. Her practice is primarily focused on transactional and securities work.

    The first interpretation - that all of the property from both entities divests - comes from the statutory language that "all property owned by each business entity" is vested "provided that" the statute is complied with. By implication, it may mean that no property is vested in the postmerger entity unless the statute is complied with. There are three reasons why this is an illogical result. First, property already owned by the surviving entity does not need to vest anywhere because it is already vested and thus should not be affected by the merger. Second, the merging entity ceases to exist and its property must vest somewhere. If the property does not vest in the surviving entity, the alternative would appear to be that the property vests in the state, an unlikely scenario given that it raises complicated constitutional takings issues. Third, this would be a particularly severe result. For example, under this interpretation, if Entity B merges into Entity A, but the entities fail to transfer, record, or file a transfer tax return for a small building owned by Entity B, then, disregarding the question of in whom the building would vest, none of B's property would be transferred to A. Courts are generally reluctant to impose such harsh measures in the absence of clear legislative intent.

    The second interpretation - that property owned by the merging entity fails to vest in the surviving entity - is also illogical for the same reasons identified above, specifically that it raises constitutional takings issues and concerns regarding imposing such a harsh measure in the absence of clear legislative intent. The only difference between this and the previous interpretation is that, under this interpretation, the premerger property of the surviving firm is not affected.

    The possibility of either of these two interpretations has consequences for potential lenders and for entities attempting to secure loan funds to finance a merger transaction or postmerger operations. Under either interpretation, the transfer of assets to the surviving entity is legally uncertain. Creditors, whether secured or unsecured, are less likely to lend funds if there is an open question regarding the amount of assets in which the surviving entity has an ownership interest. This is because, as the total value of the surviving entity's assets decreases, the creditor assumes more risk that it will not be paid in the event of default. For secured creditors, a security agreement entered into between a creditor and a surviving entity may be essentially worthless if property fails to vest in the surviving entity. Therefore, creditors will be disinclined to loan funds to business entities with plans to undertake a merger or to business entities that recently completed a merger transaction.

    Conclusion

    Wisconsin's new business reorganization statute makes executing mergers a complicated, confusing, and speculative task. The NEL leaves several important questions unanswered. First, what is an "interest in real estate"? Because the NEL does not clearly delineate the scope of an "interest in real estate," merging entities must speculate as to which items of real estate the three requirements apply. Second, what are the consequences of failing to comply with the NEL? The first possible consequence - loss of title by virtue of Wisconsin's race-notice statute - is unlikely because there cannot be a subsequent, good faith purchaser of real estate if the merging entity properly recorded its interest. The second possible consequence - express or constructive nullification - is a particularly harsh result and is unlikely to be enforced by a court in the absence of a clear legislative mandate. In addition, it raises issues regarding constitutional takings.

    At a minimum, the NEL needs to undergo substantial revisions, including a clarification of both the definition of an "interest in real estate" and the consequences of failing to meet one or more of the three new requirements. The Wisconsin Legislature should go beyond that, however, and seriously contemplate repealing these new requirements by considering the advantages that the requirements provide to the Department of Revenue as compared to the increased difficulty and burden that the requirements impose upon business entities in Wisconsin. One of the NEL's main purposes is to accommodate business transactions that have, in the past, been accomplished only through a multi-step process that required, for example, a Wisconsin entity to merge with an out-of-state entity, use the law of that other state to accomplish a cross-species merger, and then merge the out-of-state entity into a newly formed Wisconsin entity.9 This use of the law of other states is an inefficient use of resources, adding considerable time and expense to a merger transaction, and making incorporation in Wisconsin a less attractive proposition. The NEL was intended to address this problem, but has instead resulted in merger transactions becoming more difficult and confusing and their effectiveness speculative. It would be an unpleasant irony if the NEL, a statute designed to make Wisconsin more attractive to business, instead has the effect of driving business away.

    Endnotes

    1A general overview of the NEL can be found in the August 2002 Wisconsin Lawyer.

    2Wis. Stat. § 180.1106(1)(b).

    3Wis. Stat. § 77.25(6) (West 2002).

    4Wis. Stat. § 700.01.

    5Wis. Stat. § 706.001.

    6Wis. Stat. § 77.22(1).

    7Wis. Stat. § 706.08(1)(a).

    8Wis. Stat. § 180.1106(1)(b) (West 2002) (emphasis added).

    9Supra note 1, at 21.




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