Legally Armed: December 2017

By Teresa G. Ficaretta, Esq. & Johanna Reeves, Esq.

Corporate Structure Changes May Affect Federal Firearms Licenses

When the Gun Control Act was enacted in 1968, the vast majority of federal firearms licensees (“FFLs”) were sole proprietors. That is no longer the case, as even small business owners create corporations, limited liability corporations, limited liability partnerships, or general partnerships to carry on their firearms businesses. People create these entities for various reasons, including the separation of business property from personal property, limiting liability of the owners for any tortious or unlawful activities of the business, and obtaining more favorable tax treatment under state and federal law.

Corporations and other artificial legal entities are legally entitled to obtain licenses to engage in firearms businesses under the Gun Control Act. FFLs often run into problems, however, when there are changes in the structure, form, or ownership of the business that result in a change in control that must be reported to the Bureau of Alcohol, Tobacco, Firearms and Explosives (“ATF”). More significantly, such changes may result in a situation where a new federal firearms license is required.

This article addresses some of the more common types of changes in business structure and the steps FFLs should take to ensure compliance with federal law. This article does not address the registration requirements of the International Traffic in Arms Regulations, 22 C.F.R. Parts 120–130.

BACKGROUND

The Gun Control Act of 1968 (GCA), 18 U.S.C. Chapter 44, requires that persons engaging in the business of importing, manufacturing, or dealing in firearms obtain a license from ATF. The term “person” is defined in the statute to include any individual, corporation, company, association, firm, partnership, society, or joint stock company. A license must be obtained for each business and each place at which the applicant will do business. Licenses are not transferable, and in the event of the lease, sale, or other transfer of the business operations, the successor must obtain a new license before engaging in the business of importing, manufacturing or dealing in firearms.

Regulations provide a limited right for certain types of successors to operate a firearms business on behalf of a predecessor license holder. This right is limited to (1) the surviving spouse or child or executor, administrator, or other legal representative of a deceased licensee; (2) a receiver or trustee in bankruptcy; and (3) an assignee for benefit of creditors. As with changes in control, successors continuing to operate a firearms business must report the succession to the Chief of the Federal Firearms Licensing Center within 30 days from the date on which the successor begins to carry on the business.

Implementing regulations make it clear that licensees continuing to conduct business at the location shown on the license need not obtain a new license merely because of a change in trade name. Adoption of a new trade name must be reported to the Chief of ATF’s Federal Firearms Licensing Center. Regulations also provide that a “change of control” must be reported to ATF within 30 days of the change. A “change of control” consists of a change in actual or legal control over the corporation, partnership, or other licensed entity operating the firearms business. Such a change may result from a change in ownership of the stock of the company, a change in equity ownership, or a merger or acquisition where the FFL survives as a separate legal entity and is not extinguished under state law.

Change of Control Versus New License

It is essential for FFLs to determine whether changes in the firearms business amount to a change of control that must be reported to ATF or result in a new entity operating the firearms business. If the latter, a license application must be submitted by the new entity after it exists and before ownership of the firearms inventory and operation of the firearms business begins. We list a number of common scenarios and the licensing consequences below.

Change in Ownership

Whether a corporation is private or public, there may be changes in stock ownership. Changes in stock ownership may amount to a change in actual or legal control requiring notice to ATF within 30 days of the change. For example, let’s assume there are four family members each holding 25 percent of the stock of a corporate FFL. One of the family members sells his stock to another family member, so the purchaser now owns 50 percent of the stock. This change in stock ownership will give the purchaser a controlling interest in the company. The change in control must be reported to ATF within 30 days of the sale of the stock.

ATF officials have advised FFLs that sales of stock that do not result in a new or different person having a controlling interest in the business do not need to be reported. However, ATF field division personnel may have differing views on whether a particular stock sale does or does not result in a change of control. The safest course of action may be to report all changes in stock ownership to ATF to avoid any appearance an FFL has violated the reporting obligations of the regulations.

Limited liability corporations and limited liability partnerships will have equity ownership, rather than shares of stock. As with corporations, changes in equity that result in a change in actual or legal control must be reported to ATF within 30 days of the change. Again, reporting all changes in equity ownership to ATF may be the safest course of action, as the agency has no published guidance indicating which changes must be reported.

Change in Officers, Directors, or Board of Directors

Changes in the FFL corporation’s officers or directors generally do not result in a change in actual or legal control over the corporation holding the FFL. As long as these changes are not made in conjunction with changes in stock ownership or other transactions discussed in this article, they do not result in a change that must be reported to ATF. However, if the new corporate officers or directors are responsible persons for the FFL and will be dealing directly with ATF officials or signing ATF forms on behalf of the FFL, they should be reported to ATF. A “responsible person” is any individual with the power to direct or cause the direction of the management, policies, and practices of the corporation, partnership, or association insofar as they pertain to firearms. Responsible persons must be reported to ATF when the initial application is submitted and every three years when the license is renewed. New responsible persons may be reported by submitting a letter to the Chief, Federal Firearms Licensing Center, in Martinsburg, West Virginia.

Changes in the Board of Directors likewise need not be reported to ATF, as there is no change in actual or legal control of the federal firearms license holder.

Asset Purchase Transaction

An increasingly popular method of acquiring the assets of a target corporation is an asset purchase contract. These transactions allow the purchaser to acquire only specified assets of a target corporation without all or most of the liabilities. Let’s assume the target corporation is a licensed manufacturer with an inventory of firearms, an established trade name, a well-known website, and employees with significant experience in the firearms industry. An acquiring company approaches the target about purchasing the firearms inventory, trade names, website, employees, and good will of the company. The written asset purchase agreement specifies that the acquiring company will use the assets to operate a firearms business. The agreement also specifies that none of the liabilities of the company will be transferred to the purchaser.

The acquiring company MUST obtain its own federal firearms license before the firearms inventory is transferred and before it begins to operate the firearms business. This is the case whether the target company dissolves under state law or continues as a separate legal entity following the asset purchase. The acquiring company must be incorporated or created under state law, acquire any licenses required by state or local law, and then apply for the license with ATF. The entire process will likely take 90–120 days, depending on state licenses and qualifications and taking into account the 60-day timeframe for issuance of a license under the GCA.

If the firearms inventory of the target company includes firearms subject to the National Firearms Act (“NFA”), 26 U.S.C. Chapter 53, advance planning is even more crucial. The transfer of NFA firearms requires advance approval from ATF, and firearms may not be transferred tax-free unless both FFLs are licensed and have paid special (occupational) tax. Form 3 transfers are currently being processed by ATF in about 60 days. This may mean a delay in transferring registered NFA firearms between a target and an acquiring company after the asset purchase agreement has closed. The acquiring company may not lawfully possess NFA firearms registered to the target company.

Merger and Acquisition

Merger and acquisition is a general term that refers to the consolidation of companies or assets. A merger generally means a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.

Let’s start with a merger and assume that Company A holds a license as an importer of firearms while Company B holds no GCA licenses. Pursuant to a written agreement, Companies A and B merge and form Company C. Under the written merger agreement, Companies A and B will wind up their affairs at a specified date after the merger takes place and dissolve under state law and Company C will operate the businesses formerly conducted by both companies. Because Company C will be operating a firearms business, Company C must obtain its own federal firearms license before importing firearms or selling firearms previously owned by Company A. Any NFA firearms registered to Company A must be lawfully transferred to Company C before Company A dissolves.

Moving on to acquisition, let’s assume Company A holds a federal firearms license as a dealer in firearms. Company B wishes to acquire Company A and Company B will allow Company A to operate its firearms business. A written acquisition agreement states that Company B will acquire all of the assets and liabilities of Company A on a specified date. The agreement specifies that Company A will continue to exist as a wholly owned subsidiary of Company B.

In this scenario, Company B does not require its own federal firearms license, because Company A will continue to exist as a “person” under the GCA, and Company A will operate its business dealing in firearms. The acquisition of Company A by Company B is a change in control that must be reported to ATF within 30 days of the date of the closing of the acquisition agreement.

Divestiture

A divestiture is the partial or complete disposal of a business unit through sale, exchange, closure or bankruptcy. A divestiture may result from a management decision to cease operating a business unit because there are too many lines of business or if the business unit is not profitable. However, it may also occur if a business unit is deemed to be redundant after a merger or acquisition, or if disposal of a unit increases the resale value of the company.

Let’s assume that Company A has two wholly owned subsidiary companies: B and C. B holds licenses as a manufacturer of firearms and C manufactures parts and components for firearms that require no GCA license. Company A merges Companies B and C, so that only Company B survives. Company A divests itself of Company C. Because Company B survives and continues to operate the firearms manufacturing business, no additional licenses are required. There is also no change of control that must be reported to ATF.

If Company C survived the merger and intended to operate a firearms manufacturing business, then Company C must obtain its own federal firearms license prior to acquiring inventory from B and manufacturing firearms.

Spinoff

A spinoff is the creation of a new company through the sale or distribution of new shares of an existing business or division of a parent company. As an example, Company A has a firearms division licensed as a manufacturer of firearms. The division manufactures and distributes firearms in the U.S. and abroad. Company A determines the firearms division would operate more efficiently if a new business unit is charged with distributing the firearms it manufactures. Accordingly, Company A decides to spin off a new wholly owned subsidiary to distribute the firearms. Company A incorporates Company B under state law to market firearms manufactured by Company A. Company A offers its shareholders the opportunity to exchange shares in Company A for shares in Company B at a significant discount.

Company B must acquire a license as a dealer in firearms. The license must be acquired prior to Company A transferring firearms to Company B.

Conclusion

Changes in the ownership and structure of a FFL may require reports to ATF or issuance of one or more new GCA licenses. It is essential for licensees to consult qualified counsel before undertaking these changes. Failure to understand the difference between a change in control and a relicensing situation may result in disruption of the firearms business while the appropriate licenses are obtained. It may also result in ATF investigating potential violations of the GCA for engaging in the business without a license and violations of the NFA for unlawful transfers of registered firearms.

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The information in this article is for informational purposes only and is not intended to be construed or used as legal advice.

ABOUT THE AUTHORS

Johanna Reeves is the founding partner of the law firm Reeves & Dola, LLP in Washington, DC (www.reevesdola.com). For more than 10 years she has dedicated her practice to advising and representing U.S. companies on compliance matters arising under the federal firearms laws and U.S. export controls. Since 2011, Johanna also has served as Executive Director for the FireArms Import/Export Roundtable (F.A.I.R.) Trade Group (http://fairtradegroup.org). In 2016, Johanna was appointed by the U.S. Department of State, Bureau of Political-Military Affairs to serve on the 2016–18 Defense Trade Advisory Group (DTAG).

Teresa Ficaretta is an expert on ATF regulations under the Gun Control Act, the National Firearms Act, the Arms Export Control Act and Federal explosives laws. Before joining Reeves & Dola in 2013, Teresa served as legal counsel to ATF for 26 years, followed by two years as Deputy Assistant Director in Enforcement Programs and Services. Teresa was elected partner to Reeves & Dola in January 2016.

Both Johanna and Teresa can be reached at 202-683-4200 or at info@reevesdola.com.