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.
by 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. 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.
Wisconsin
Lawyer