The importance of acquiring companies refraining from the exercise of control over target companies before the government has completed its mandatory review pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act) was reinforced recently by a Department of Justice’s Antitrust Division complaint filed against Smithfield Foods, Inc.
On January 21, 2010, the Antitrust Division alleged that Smithfield violated the HSR waiting period requirements during its 2007 merger with Premium Standard Farms, LLC. United States v. Smithfield Foods, Inc., No. 1:10-cv-00120 (D.D.C. Jan. 21, 2010). Smithfield entered into a consent decree, which was filed simultaneously with the complaint, and agreed to pay a fine of $900,000 to settle the case.
The HSR Act requires parties to transactions that meet certain monetary thresholds to notify both the Antitrust Division and the Federal Trade Commission of the transaction and to observe a waiting period — usually 30 days — before closing the transaction. The 30-day waiting period provides the antitrust agencies time to evaluate the competitive effects of a transaction before the parties combine their operations and potentially change the competitive dynamics of the marketplace. The HSR Act not only prohibits the parties from combining their operations during the waiting period, but also prohibits the parties from exercising control over each other. Violations of the HSR waiting period are known as “gun jumping” and can result in fines of up to $11,000 per day.
According to the complaint, Smithfield, the country’s largest pork packer, entered into an agreement on September 17, 2006, to acquire Premium Standard, a competing pork packer. The parties filed HSR Notification and Report Forms on October 6, 2006, with the Antitrust Division and FTC. The Antitrust Division undertook an extensive investigation of the merger and extended the waiting period by issuing a request for additional information (a “Second Request”) on November 6, 2006. The Antitrust Division eventually closed its investigation without taking any action. The HSR waiting period expired on March 7, 2007, and the parties completed the transaction on May 7, 2007.
As is typical in a transaction of this kind, the Smithfield-Premium Standard merger agreement contained a customary “conduct of business” clause. This clause limited Premium Standard’s ability, among other things, to assume new debt, issue voting securities and sell assets, and also required Premium Standard to conduct its business “consistent with past practices.” In its complaint, the Antitrust Division did not object to these provisions: referring to “Smithfield’s legitimate interest in maintaining Premium Standard’s value without impairing Premium Standard’s independence.”
The Antitrust Division did object, however, to the way in which Premium Standard prematurely ceded control of its hog procuring operations to Smithfield. The Antitrust Division alleged that as early as September 20, 2006, Premium Standard began submitting for Smithfield’s consent contracts for the purchase of hogs from independent hog producers. In all, there were three contracts that arose prior to the expiration of the HSR waiting period. These multi-year contracts were for the purchase of up to 475,000 hogs per year at a cost of between $57 million and $67 million. In each instance, Premium Standard provided Smithfield with the terms of the contracts, including the “price to be paid, quantity to be purchased, and length of the contract.”
Smithfield, the complaint stated, “exercised operational control over a significant segment of Premium Standard’s business prior to the expiration” of the HSR waiting period. It had, in effect, acquired “beneficial ownership” of that part of Premium Standard’s business, and “thus acquired and held those assets” in violation of the HSR Act. Hog procurement was a sensitive area of the business because the Antitrust Division was investigating the effect the transaction would have on competition for the purchase of hogs.
There are several important points to be learned from this case concerning how parties to a merger or acquisition conduct their businesses during an HSR review:
- Even if a transaction does not raise competitive issues, the parties must comply fully with the HSR Act. The antitrust authorities take HSR Act compliance seriously and will prosecute violations regardless of whether they challenge the underlying transaction.
- Customary “conduct of business” clauses aimed at preserving the value of the target’s business are legitimate and ordinarily do not raise gun jumping issues. The key is to allow the target to operate its business in the ordinary course of its business consistent with past practices.
- When drafting “conduct of business” clauses, make sure that they reflect business realities and allow the target to operate its business independently. For example, reasonable limitations on capital expenditures are legitimate as long as they are not so low that the target cannot operate in the ordinary course of business, e.g., it cannot buy necessary inputs without seeking the approval of the acquiring party.
- Also, “conduct of business” clauses should not encourage or require the target to frequently seek approvals from the acquiring company. While it is legitimate to require the acquiring company’s approval for the target to engage in conduct outside of its ordinary course of business (e.g., sale of a plant or issuing stock), a merger agreement that requires the target to continually seek the acquiring company’s approval to operate within the target’s ordinary course of business can raise gun jumping issues.
- Parties should avoid coordinating their competitive activities until the transaction is closed. Improper coordination can arise not only through direct control of one party’s business, but also by providing competitively sensitive information to the other party. For instance, in this case, Smithfield and Premium Standard were competitors in the hog procurement market — the market the Antitrust Division was investigating. When it sought Smithfield’s consent for its hog procurement contracts, not only was Premium Standard transferring control over that segment of its business, but it also was providing Smithfield with competitively sensitive information that Smithfield could use when procuring hogs for its own business.
The complaint and proposed final judgment can be found at www.justice.gov/atr/cases/smith2.htm.