The United States District Court for the District of Massachusetts has denied a motion to dismiss a class action claiming that certain private equity firms illegally colluded in the purchase of target companies in leveraged buyout transactions. The decision could have significant implications for private equity firms that have or are considering participating in “club deals” whereby two or more firms join together to consummate a leveraged buyout or similar acquisition transaction.

In Dahl v. Bain Capital Partners, LLC1 the plaintiffs do not contest the legality of club deals but rather allege that the defendants participated in an “Overarching Conspiracy” to allocate the leveraged buyout market in violation of the antitrust provisions of § 1 of the Sherman Act and §§ 4 and 16 of the Clayton Act. The plaintiffs’ complaint alleges that the defendants, which presently include 13 private equity firms or affiliates, conspired to pay less than fair value for target companies by, among other things, “(1) submitting sham bids, (2) agreeing not to submit bids, (3) granting management certain incentives and (4) including “losing” bidders in the final transaction.” The complaint focused on nine specific transactions which occurred between 2003 and 2008, but could potentially be expanded to include up to 36 transactions.

The defendants asserted two grounds for dismissal of the complaint. First, the defendants argued that the plaintiffs’ claims were preempted from consideration under antitrust laws because the conduct at issue is regulated by the Securities and Exchange Commission (“SEC”). Second, the defendants argued that the plaintiffs failed to properly plead a claim under § 1 of the Sherman Act. The Court denied the motion to dismiss on both grounds.

With respect to preemption, the defendants argued that the plaintiffs had no legal remedy to pursue an antitrust claim under the Supreme Court’s decision in Credit Suisse Securities (USA) LLC v. Billings 2 which supports preemption of antitrust laws by securities laws when the conduct in question is regulated by the SEC. In Billings, the Supreme Court ruled that with regard to the sale of securities by underwriters as part of initial public offerings preemption was appropriate because the conduct in question was regulated by the securities laws and the SEC and found that the securities and antitrust laws were “clearly incompatible” with one another. The Supreme Court reached its conclusion by applying a four factor test to determine “clear incompatibility.” In applying the “clear incompatibility” test, the Dahl Court found that none of the factors were satisfied and that the case could proceed under the antitrust laws. In finding that the securities and antitrust laws were not incompatible, the Court noted in particular that the securities laws do not regulate private equity leveraged buyout transactions and that the SEC does not substantively regulate private equity firms or the transactions in question.

With respect to the defendants’ argument as to the sufficiency of the plaintiffs’ claim, the Court ruled that the circumstances of the case “plausibly suggest” that an illegal agreement existed in violation of § 1 of the Sherman Act, thus satisfying the pleading requirements established by the Supreme Court in Bell Atlantic Corp. v. Twombly.3 The presence of the same private equity firms in multiple transactions was an important factor for the Court in determining that the plaintiffs had provided enough facts to “plausibly suggest” an illegal agreement to prevent open and competitive binding for target companies in leveraged buyout transactions.

Following entry of the Court’s ruling, the defendants filed a motion for interlocutory appeal which was denied on February 12, 2009. The case has now moved to the first stage of discovery and we will continue to carefully monitor its progress.

The Dahl case is one of a number of actions filed since the announcement by the United States Department of Justice in 2006 of its antitrust investigation of private equity club deals. One such case was Pennsylvania Avenue Funds v. Borey 4 in which a United States District Court in the State of Washington dismissed an antitrust class action challenging the joint bidding activities of two private equity firms in their purchase of a target company. The Borey court found that joint bidding was not per se unlawful under the Sherman Act and that the joint bidding conduct in question was not unlawful under a Sherman Act rule of reason analysis. To date no formal action has been taken by the United States Department of Justice with respect to the investigation, which when coupled with the Borey ruling appeared to indicate that antitrust claims with respect to club deals would be difficult for the plaintiff’s bar. However, the ruling in the Dahl case has again raised a question as to the likelihood and merits of such claims.

The exponential growth in the size of transactions over the past few years resulted in club deals becoming an attractive way for private equity firms to raise large amounts of capital while reducing risk and maintaining portfolio diversification. The current market environment has resulted in a decrease in the size of transactions but club deals are likely to remain attractive primarily as a result of illiquidity in the debt markets. If private equity firms intend to participate in club deals they need to carefully weigh the possibility of an antitrust challenge and be prepared to defend against claims of collusive or anticompetitive activities.