Wisconsin 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.
by Joseph W. Boucher, Leonard S. Sosnowski
& Thomas J. Nichols
n 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:
-
Merge the Wisconsin LLC into an LLC of a state that allows
cross-species conversions or mergers (such as Delaware);
-
Use that state's laws to convert or merge the out-of-state LLC into
a corporation of that state; and finally
-
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
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).
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