Due diligence is an integral part of M&A activity. Proper due diligence regarding the acquired business allows the acquirer to become acquainted with the nature of the business being acquired, to assess its value, to evaluate the risk inherent to its acquisition and, based on all those factors, to determine the adequate consideration. Due diligence requires review of extensive and detailed information regarding the acquired business. When the parties to the transaction are competitors, tension may develop between the needs of the transaction and the general interest in maintaining competition. The determination of the proper balance between the buyer’s interest in obtaining information about the acquired business and the risk of harm to competition due to the buyer’s exposure to competitively sensitive information has not yet been addressed directly by the Israeli Antitrust Authority (the "IAA").
The Draft Guidelines Regarding Information Exchange in the Course of Due Diligence Prior to a Transaction between Competitors (the "Draft Guidelines"), which were recently published by the IAA, suggest theoretical principles and a procedural framework for conducting due diligence in transactions that require the transfer of sensitive information. The Draft Guidelines are an attempt to characterize competitively sensitive information and to provide a general outline of how to treat and conduct such transfers. However, the Draft Guidelines allow the parties to decide on the scope of information to be exchanged and the method of its transfer in accordance with their own professional discretion. The Draft Guidelines also establish a procedural framework as well as requirements for documentation, which need to be followed carefully while carrying out due diligence.
Which Transactions are the Target of the Draft Guidelines?
The Draft Guidelines are not limited to a certain kind of transactions. However, they do not apply to transactions that do not require a due diligence process (e.g., a distribution agreement or a franchise agreement). Moreover, the Draft Guidelines do not apply when the parties do not actually intend to enter a
transaction and the due diligence process is used as a cover for a "naked" information exchange between competitors.
The Draft Guidelines refer, in the first place, only to transactions carried out between competitors. However, the Draft Guidelines define the term "competitors" very broadly, based on the definition proposed in the Draft Antitrust Rules (Block Exemption for Non-Horizontal Arrangements that do not Include Price Restrictions), 2012. For example, the definition of competitors also includes parties who are not de facto competitors, but who:
- Have competed at some point during the five years preceding the transaction.
- Are potential competitors.
- Provide products that have a similar use, even if they do not operate in the same relevant market.
The significance of the broad definition of competitors is that the provisions of the Draft Guidelines and the attached limitations will be applied to a wide variety of transactions, including, in some cases, transactions in which the due diligence process raises no competitive issues.
What is "Competitively Sensitive Information"?
The Draft Guidelines’ premise – economically and empirically controversial – is that in general, competitors’ uncertainty about market conditions and about their competitors’ capabilities and plans contributes to competition; hence, any reduction in uncertainty could harm competition.
Accordingly, the Draft Guidelines define competitively sensitive information as "any information that is not public or cannot be identified or traced relatively easily, which, if found out by a business competitor of the owner of the information, including the other party to the transaction, will increase the ability of that competitor to anticipate the price and production strategy of the information owner and the information owner’s expected response to price and quantity initiatives on that competitor’s part".
Beyond the general definition, the Draft Guidelines list specific categories of information that is potentially sensitive, especially in the eyes of the Antitrust Commissioner, such as: prices, pricing policies, discounts and terms of sales; profit margins; costs of a specific product; production capacity for a specific product; market share; competitive strategy; present and future business plans in different fields; identity of existing and potential suppliers and customers; policy regarding negotiations with customers, customer recruitment and retention; policy regarding tenders; information relating to a specific client; technologies owned; mergers, acquisitions or potential joint ventures; and other confidential business information that might be used to reduce competition, including historical information.
It is worth noting that the Commissioner does not establish a sweeping categorical rule regarding the exchange of such information, and there are certainly circumstances in which the exchange of such information would not, presumably, pose a real competitive hazard.
Rules of Conduct Regarding Competitively Sensitive Information
The Draft Guidelines list a number of guidelines for due diligence that are aimed at minimizing harm to competition in a manner consistent with the provisions of the Restrictive Trade Practices Act – 1988 (the "Law"). Compliance with these rules is only required in transactions between competitors (as broadly defined in the Draft Guidelines) and only with respect to competitively sensitive information.
- Identifying the competitively sensitive information.
- Evaluating the necessity of the information disclosure – competitively sensitive information items may only be disclosed if they are essential for the purpose of the due diligence.
- Disclosing information subject to an undertaking to maintain confidentiality – the agreement creating the undertaking must prohibit the use of the information for any purpose other than the due diligence process, and prohibit the delivery of the information to a third party who is not authorized to receive it.
- Preference for aggregate, outdated, and non-concrete information – if possible, the exchanged information should be limited to aggregate information that does not allow the use of "reverse engineering" to disclose the details of which it is composed. For example, information should be provided at the division level rather than with regard to a specific product, or at the national or global level rather than at the level of regional segmentation.
- External Review – if possible, the information should be disclosed to an external evaluator who will review the information and organize it into a "bottom lines" framework, in the field of his or her expertise (lawyer, accountant, etc.).
- Review by employees who are not involved in pricing, marketing and sales in the field in which there is a competitive overlap – when the information is not within an external evaluator’s field of expertise, information can be filtered by employees who are not involved in pricing, marketing or sales of products of the kind that are in competition, or by former employees or employees on the verge of retirement. These employees will review the information, subject to their confidentiality undertakings, and will provide the "bottom lines" information to the purchaser.
- Review by employees involved in pricing, marketing and sales in the field in which there is a competitive overlap – when there is a practical need to disclose information to employees who are involved in pricing, marketing and sales in the field in which there is competition, a "clean team" shall be formed, composed of as few as possible employees; these employees will exchange the information with the purchaser at the "bottom lines" level. Given their exposure to the information, these employees will be excluded from decisions regarding pricing, marketing and sales for a period of time that is sufficient under the circumstances. The Draft Guidelines do not define what a "sufficient" period of time is, but it is clear that the exclusion obligation ends when the acquisition is legally completed.
- Documentation – the due diligence process shall be documented in detail and in real time. Among other things, the disclosed information shall be documented, along with details regarding the practical need for disclosing each item and for its level of detail, the identity of the people who reviewed the information, their roles and their connection to the entity requesting the review, the date of the information review and the review procedure. In addition, every information exchange between the direct reviewer and another person shall be documented, including exchanges of partial information or of "bottom lines". The documentation shall also include the confidentiality statements and any work protocol governing the disclosure process. The Draft Guidelines state that the IAA will view parties who fail to comply with the documentation requirements strictly as having failed to fulfill their obligations regarding the due diligence process.
As noted, the Draft Guidelines concern a field that has not been previously discussed in IAA decisions and in court rulings. They provide guidelines for assessing whether information is "sensitive" and establish a procedure for handling and evaluating such information, while minimizing the antitrust risk. However, the Draft Guidelines allow the parties to the transaction to exercise their own discretion – and leaves them legally liable with respect to their exercise of such discretion – regarding the determination of the sensitivity of each item, as well as the determination of specific review arrangements, within the framework and circumstances of each transaction. Thus, parties to a horizontal transaction should seek professional assistance before launching a due diligence process, in order to achieve its legitimate ends without incurring significant antitrust liability.