Recently the Antitrust Division of the U.S. Department of Justice (DOJ) reached a $5 million settlement with Flakeboard America Limited, its parents and SierraPine to settle allegations that the parties engaged in “gun-jumping” activities while their transaction was pending review.
Gun jumping is analyzed both under the Hart-Scott-Rodino (HSR) Act and Section 1 of the Sherman Act. The HSR Act generally requires parties to file notifications, and observe mandatory waiting periods, prior to consummating transactions that meet the jurisdictional thresholds. Gun jumping can occur when the parties begin to coordinate prior to the expiration of the HSR Act waiting period. HSR Act violations can occur even if the parties to the transaction do not compete in the same markets. In transactions involving competitors, Section 1 of the Sherman Act imposes a separate basis for liability. The antitrust agencies view parties to a transaction as independent competitors until their transaction is actually completed. Coordination of competitive activities, or detailed information exchanges that can effectively enable coordination of competitive activities, between parties that are competitors can lead to a Sherman Act Section 1 challenge. Significantly, this liability can arise for pre-closing activities that occur following the expiration of any applicable HSR Act waiting period.
The recent DOJ action is another example of how the antitrust agencies will use both statutes to challenge what they view as inappropriate premerger coordination. The proposed settlement is an important reminder of the limitations on premerger activities of the parties to a transaction.
On January 13, 2014, Flakeboard and SierraPine—direct competitors in the sale of particleboard—executed an asset purchase agreement (APA) through which Flakeboard would acquire three wood-product mills, including one in Springfield, Oregon, from SierraPine. Flakeboard had no intention of operating the Springfield mill, but Flakeboard did not want to manage the shutdown and its parent did not want incur any potential reputational harm from a closure announcement. The APA thus included a provision obligating SierraPine to close the Springfield mill “five (5) days prior to the Closing,” but the APA further noted that the shutdown would not be required until “[a]ny required waiting periods and approvals … under applicable Antitrust Law shall have expired or been terminated.” This provision was apparently not publicly disclosed. The DOJ did not allege that their agreement was unlawful. The parties subsequently filed their HSR premerger notifications on January 22. The DOJ issued a Second Request to investigate the potential competitive effects of the transaction further, and the parties substantially complied with the Second Request.
Flakeboard and SierraPine’s Premerger Coordination
The DOJ’s complaint alleges that the parties later entered into a series of agreements in violation of both Section 1 and the HSR Act. Days after the deal announcement, a labor dispute arose at SierraPine that would have accelerated disclosure of the Springfield mill shutdown. The DOJ alleges the parties discussed the shutdown notice, coordinated about it and “understood” that the mill would shut down within weeks of the announcement, and agreed on a press release stating that the plant would shut down within a few weeks. SierraPine provided Flakeboard with competitively sensitive customer information; Flakeboard distributed that information to its sales team; and Flakeboard approved the content and timing of the press release, with SierraPine delaying announcement of the closure from February 3 to 4 at Flakeboard’s request so that Flakeboard’s sales personnel would be better positioned to contact the Springfield mill’s customers. Production at SierraPine’s Springfield mill ceased on March 13; the statutory HSR waiting period would not expire until August 27.
Following the announcement of the closure, SierraPine, rather than compete for Springfield’s sales from another mill, directed its customers to Flakeboard, promising, at Flakeboard’s direction, that Flakeboard would match SierraPine’s prices. As a result, Flakeboard secured new customers as well as new business from existing customers, all of which resulted in increased profits.
The parties abandoned the transaction on September 30 in response to concerns expressed by the DOJ about the transaction’s likely anticompetitive effects.
The HSR Act requires that parties to a transaction remain separate and independent prior to the expiration of the statutory waiting period. The buyer cannot exercise operational control, or “beneficial ownership,” of the target by directing how the seller conducts its business. The DOJ alleged that Flakeboard exercised operational control over SierraPine prior to the expiration of the HSR waiting period and in violation of the HSR Act by coordinating the closure of the Springfield mill and moving Springfield’s customers to Flakeboard. Each party—buy-side and sell-side—is subject to a maximum civil penalty of $16,000 for each day that party is in violation of the HSR Act.
Section 1 of the Sherman Act prohibits any “contract, combination … or conspiracy … in restraint of trade.” This prohibition includes, among other things, customer allocation and output restrictions. A pending acquisition between two competitors does not remove Section 1 restrictions prior to closing. The DOJ alleged that Flakeboard directed the closure of a competing plant, obtained competitively sensitive information from SierraPine—including customer lists with contact information and types and volumes of products purchased—and coordinated with SierraPine to move its Springfield mill customers to Flakeboard (with promises to match SierraPine’s prices). The DOJ alleged that this constituted a per se illegal agreement between competitors to restrict output and allocate customers.
For HSR violations, each side could have faced penalties of more than $3.5 million, but because of the parties’ cooperation and voluntary production evidence of their premerger conduct the DOJ only sought $1.9 million in civil penalties from each party (for a total of $3.8 million) for HSR Act violations. To remedy the Section 1 violation, the DOJ is requiring Flakeboard to disgorge $1.15 million in illegally obtained profits as a result of the output restrictions and customer allocation.
The proposed settlement enjoins Flakeboard, its parents and SierraPine from certain conduct in future pending transactions with other parties including: reaching agreements that affect price or output for competing products in the United States or that allocate markets or customers; exchanging certain competitively sensitive information; and closing a production facility that produces a competing product without prior written notice and approval from the DOJ. The parties must also implement an antitrust compliance program.
The proposed settlement outlines conduct that is permissible, which provides helpful guidance as to the kinds of conduct and information exchanges that the DOJ is not likely to find unlawful. The permitted conduct includes:
- Pre-closing conduct provisions obligating the parties to continue operating in the ordinary course of business
- Restricting a party to a transaction from taking any action that would cause a material adverse change in the value of the to-be-acquired assets
- Conducting or participating in pre-closing reasonable and customary due diligence—provided that the information is reasonably related to a party’s understanding of future earnings and prospects, and the disclosure is pursuant to a non-disclosure agreement that limits the use of the information to due diligence purposes and prohibits disclosure of the information to personnel directly responsible for the marketing, pricing or sales of competing products
Disgorgement is an unusual remedy in merger challenges, although it has been used infrequently in non-merger antitrust challenges. The antitrust agencies are more inclined to seek disgorgement now than they have been previously, with the DOJ obtaining disgorgement in its 2010 case against KeySpan Corporation, alleging KeySpan entered into an anticompetitive agreement by taking a financial interest in a competitor. In 2001, the Federal Trade Commission (FTC) obtained disgorgement of monopoly profits in a consummated merger action against Hearst Corporation where Hearst failed to provide required documents with its HSR notification, thereby hindering the FTC’s ability to adequately assess the likely competitive effects of the transaction. (The FTC also alleged that the transaction substantially lessened competition.)
More recently in 2012, the FTC withdrew its statement on disgorgement as a remedy, which had limited its use to extraordinary cases, presumably so that it could seek disgorgement in a wider variety of circumstances. Here, it appears the DOJ sought disgorgement because there was no effective injunctive remedy because the closed plant could not realistically be reopened. Disgorgement provides a deterrent effect for the parties and other firms contemplating transactions. Companies should keep this in mind with respect to other transactions, including especially non-reportable transactions raising competitive concerns, and that are subject to post-closing review.
This action is an important reminder that parties to a pending acquisition are still subject to the antitrust laws. Also, in addition to the settlement with the DOJ, the parties face the potential for complaints by private litigants.
In its Competitive Impact Statement (CIS) explaining the proposed settlement, the DOJ acknowledges that certain carefully tailored pre-closing coordination, restrictions on pre-closing conduct and information exchanges may be permissible, but the parties must not take additional actions that reduce competition pre-closing.
For example, the DOJ recognizes that closing a production facility before a transaction is consummated may be permissible under certain circumstances. However, a competitor directing the shutdown (effectively taking operational control and reducing output) and coordinating the movement of customers to the competitor (effectively allocating customers) are steps too far under the HSR and Sherman Acts.
The DOJ states that “[a]s a general rule, competitors should not obtain prospective, customer-specific price information before consummating a transaction because it could be used to harm competition if the transaction is abandoned.” However, the DOJ also recognizes the need for a potential buyer to obtain what might be competitively sensitive information from the seller. For example, a prospective buyer may need information about pending contracts to properly assess and value the business. The CIS and the proposed settlement’s outline of permitted conduct provide some contours around how competing parties to a transaction should structure due diligence activities. Parties must observe some basic rules of engagement:
- Pre-closing covenants to continue operating in the ordinary course of business are permissible.
- Pre-closing restrictions on actions that would cause a material adverse change to the to-be-acquired business or assets are permissible, but parties must be reasonable in what they consider a material adverse change and not simply use this as a shield to protect all pre-closing interactions.
- Prospective buyers cannot direct the actions of the target or take operational control of the target before the expiration of the HSR waiting period, even where the parties have executed a definitive agreement.
- Prospective buyers that compete with the target generally should not coordinate with the target or direct the actions of the target pre-closing with regard to competing products—even after the expiration of the HSR waiting period. Generally, jointly promoting the transaction is permissible (e.g., calling customers to tell them about the benefits of the transaction), but joint activity beyond this may be subject to scrutiny.
- Reasonable and customary due diligence is permissible between competitors as long as appropriate protections are employed, such as a non-disclosure agreement and firewalls to protect the use and dissemination of the information gathered. Even competitively sensitive information may be obtained provided that it is reasonably necessary to assess the potential transaction or value of the business and personnel with day-to-day responsibility over marketing, pricing, sales, R&D or other strategic functions related to competing products do not have access to the information.
Although these are some basic rules of the road, every transaction presents a unique set of circumstances and facts—including whether or not the transaction is notifiable in the United States or internationally, and whether or not the parties are actual or potential competitors. What may be permissible in some scenarios, may not be permissible in others. Parties can often meet their legitimate business objectives while managing the potential antitrust risk, but it is important to evaluate that risk early in the transaction planning process. Counsel should be closely involved in developing, implementing and monitoring appropriate procedures to manage the risk that the antitrust regulators will investigate parties’ pre-closing activities as impermissible gun jumping.