In light of potentially substantial civil penalties from government enforcement agencies and increased risk of litigation from competitors or customers over pre-merger coordination between merging parties, questions regarding appropriate pre-merger activity continue to grow in importance. For example, antitrust regulators are increasingly focused on the ways in which a buyer may be involved in the activities of the target firm prior to the closing of a transaction without violating antitrust laws, as well as what restrictions, if any, a buyer may place on the pre-closing activities of the target.
Improper pre-merger coordination (also known as “gun jumping”) is analyzed under both 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 valued in excess of $63.1 million (indexed to inflation). Gun jumping can occur when the parties coordinate prior to the expiration of the HSR Act waiting period to a degree that the regulators may view the buyer as having obtained beneficial ownership of the target’s operations. 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. Parties to a transaction are viewed by the antitrust agencies as independent competitors until their transaction is completed. Coordination of competitive activities between merging parties that are competitors, or detailed information exchanges that allow the parties to coordinate pricing (for example) can lead to a Sherman Act Section 1 challenge. Section 1 liability can arise for pre-closing activities that occur following the expiration of any applicable HSR Act waiting period.
The U.S. Department of Justice and the Federal Trade Commission have secured substantial fines for gun jumping violations. The Department of Justice levied a $5.7 million fine each against two joint venture participants in United States v. Gemstar-TV Guide International, Inc., Case No. 03-0198 (D.D.C. July 11, 2003) for pre-closing coordination, in which the parties altered their independent business practices so as not to compete with the contemplated joint venture, prior to its formation.
Also, in other situations, companies have faced allegations in private civil litigation of unlawful gun jumping for exercising rights under an interim conduct clause that is part of a larger transaction agreement. Such clauses are common and give the buyer a mechanism that protects the value of the business being purchased. Those clauses usually give the buyer the right to review transactions a seller could engage in outside the ordinary course of business that have a high value. Yet even with these commonly occurring clauses, parties should be careful not to use the clause in such a way as to create even the appearance of unlawful business coordination prior to closing the transaction.
Principles Regarding Pre-Merger Coordination
For the vast majority of transactions that do not raise substantive antitrust issues, pre-merger coordination that is reasonably necessary to protect the value of the transaction will not raise significant antitrust issues. Certain conduct, such as coordination on pricing and combining significant day-to-day operations or management pre-closing, is almost always unlawful and almost never reasonably necessary in the government’s view to protect the merger.
Every transaction raises unique issues that must be evaluated on a case-by-case basis. Nonetheless, several principles should be observed.
1. Avoid improper information exchange during due diligence and transition planning.
Antitrust regulators have concerns when competitors contemplating a transaction engage in information exchange or planning discussions for legitimate purposes that “spill over” into competitive activities and may affect ongoing competition between the merging parties. Therefore, parties should use lagged or aggregated information, where possible, during the due diligence process. Also, transition planning personnel should be different from the personnel involved in the day-to-day business operations (e.g., development of post-merger pricing should be walled off from the sales and marketing personnel who continue pricing during the pre-merger period). Better yet, parties may consider outsourcing pre-closing planning functions to consulting and accounting firms, or dedicated groups of employees operating as part of a “clean team.” A “clean team” can be formed using personnel who are not in a position to influence or direct their employer’s core competitive activities, so disclosure of sensitive target data to them should not give rise to significant antitrust issues. Care must be taken to ensure that the information they are receiving is reasonably needed for a legitimate due diligence or transition planning purpose, and that the detailed information received by the “clean team” is not disseminated more broadly within the organization.
2. Minimize coordination on significant pre-closing projects or contracts.
- The antitrust regulators recognize that planning activities with regard to capital projects and significant business improvements are sometimes necessary to allow the transaction to achieve efficiencies. However, certain significant activities, such as deciding whether to pursue a major capital project, raise antitrust concerns. Often, merging parties need to take preliminary steps related to those activities prior to closing. While the regulators are skeptical about whether a buyer’s participation in a seller’s decision to engage in a capital project are necessary, the regulators will typically balance the need for the parties to realize efficiencies post-closing against the concern that a decision not to proceed with the project would reduce the seller’s competitiveness if the merger did not close. Specifically, the regulators will evaluate the activities in light of the following factors: Whether the decision not to proceed with a project is reversible if the merger does not close and whether the target’s competitiveness is harmed by the deferral or abandonment of the project. To the extent the target can easily restart or finish the project, the regulators are likely to have fewer concerns about the planning discussions.
- How the decision on the project was made. If the decision was reached unilaterally by the target, there should be few issues. If the buyer mandated the target make the decision or if it was a joint decision, the regulators are likely to have significant questions.
- The magnitude of the efficiencies achieved and the harm to competition. The regulators will balance the potential efficiencies achieved by the activities against the need to undertake those activities pre-closing and the potential harm to competition.
- The timing of the project. To the extent the buyer was aware of the project at the time of signing, then it is more difficult to justify the need to stop the project pre-closing.
3. All pre-closing conduct covenants in any merger or acquisition agreement must be reviewed to ensure that they comply with applicable antitrust rules.
Merger agreements commonly contain pre-closing restrictions on the seller’s conduct so as to protect the value of the seller’s business to the buyer. By way of example, merger agreements often include provisions that require the buyer’s prior approval of any proposed contracts, other than those made in the ordinary course of business, above certain dollar amounts prior to the closing of the transaction. Through these clauses, the buyer can ensure that the seller does not strike a deal that the buyer believes might damage the target business or otherwise diminish its value. However, at least one case indicates that the enforcement of such a clause by two merging competitors has the potential to violate the antitrust laws, exposing the surviving company to potential treble damages.
As a baseline requirement, the target must be able to operate freely within its ordinary course of business and consistent with past practices. A clause requiring the target to operate within its ordinary course of business should be permissible. Acceptable restrictions include covenants in which a seller limits its ability to declare or pay dividends or distributions of its stock; issue, sell, pledge or encumber its securities; amend its organizational documents; acquire or agree to acquire other businesses; mortgage or encumber its intellectual property or other material assets outside the ordinary course; make or agree to make large new capital expenditures; make material tax elections or compromise material tax liability; pay, discharge or satisfy any claims or liabilities outside the ordinary course; and commence lawsuits other than the routine collection of bills.
However, even if the contractual language allows for ordinary course of business freedom, implementing that provision in a way that requires the buyer’s consent and involves the buyer in the target’s ordinary-course decision-making process can raise substantial antitrust risks. The buyer must use caution to avoid implementing that clause in such a way as to become unnecessarily involved in the target’s business decisions prior to closing. The substance of any conduct restrictions and the manner in which they are enforced and monitored will take precedence over the language of the contractual commitments themselves. Counsel drafting contractual provisions that place limits on the seller’s independent activities must be sensitive to overreaching that may create gun jumping problems.
4. Merging parties should seek, whenever possible, to minimize the time that elapses between execution of a merger agreement and the closing of the transaction.
The longer the time period between signing and closing, there is a greater chance that coordination issues may arise.
5. Joint marketing of the transaction is permissible accompanied by strict guidelines that ensure independent ongoing competition until the transaction closes. With appropriate guidance and controls, joint advertisements promoting the transaction and controlled joint customer or supplier calls to tout the benefits of the merger are generally permissible. The regulators would have concerns if the buyer tried to redirect the seller’s ordinary-course advertising program or dictate the contents of the seller’s advertisements for products in which the buyer and seller compete. With respect to joint customer calls, the parties should not discuss ordinary-course competitive selling, and the buyer clearly cannot direct or control the seller’s sales force or function prior to closing.
Given the serious risks associated with pre-closing coordination activities, merging parties should consult with counsel early in the process to establish antitrust guidelines that govern all integration planning and related pre-closing activities. If followed, such guidelines can significantly lower antitrust risks.