As dramatically illustrated by a recent enforcement action against two wood products manufacturers, the merging parties in any transaction reportable under the Hart-Scott-Rodino (HSR) Act1 must take great care that they keep their operations entirely separate and do not coordinate their conduct in the market during the HSR waiting period. Failure to do so may result in very substantial penalties.
On November 7, 2014, the Antitrust Division of the United States Department of Justice (DOJ), announced a settlement with two particleboard manufacturers, Flakeboard America Limited and SierraPine, to resolve claims that they illegally coordinated their competing businesses while Flakeboard's acquisition of SierraPine assets was under HSR Act review.2 DOJ alleged that Flakeboard and SierraPine agreed to shutter a SierraPine mill prior to closing the acquisition and to steer SierraPine customers to Flakeboard in violation of both the HSR Act and Section 1 of the Sherman Act.3 Flakeboard and SierraPine each agreed to pay $1.9 million in civil penalties for the "gun-jumping" violation under the HSR Act, and Flakeboard agreed to pay an additional $1.15 million to disgorge allegedly ill-gotten profits from former SierraPine customers under Section 1 of the Sherman Act.
This case and its settlement serves as a reminder to companies that dealings with a competitor in the M&A context are not exempt from the antitrust laws prior to closing. All parties in a transaction, whether it be a merger, acquisition or joint venture, need to be diligent in their efforts not to act as one business prior to regulatory approval. Even exchanges of competitively sensitive information prior to closing should be avoided unless the parties use "clean teams" or similar procedures to protect against the coordination of behavior among actual or potential competitors.
Flakeboard's Pre-Closing Conduct
On January 13, 2014, Flakeboard agreed to buy three mills from SierraPine for a total value of approximately $107 million. The parties filed the required premerger notification with the Federal Trade Commission (FTC) and the DOJ pursuant to the HSR Act. The DOJ investigated the competitive effects of the transaction, issuing a "Second Request" for documents and information that extended the initial 30-day waiting period under the Act. Ultimately, the parties abandoned the transaction on September 30, 2014, in response to DOJ's concerns about potential anticompetitive effects of the transaction.
According to the asset purchase agreement, SierraPine agreed to take steps to prepare for the shutdown of its Springfield, Oregon facility-one of the facilities to be purchased by Flakeboard-after HSR Act approval but no later than 5 days prior to close. However, just after the deal was announced in January, SierraPine experienced a labor issue that necessitated either that Flakeboard agree to waive the provision requiring the Springfield mill closure or that SierraPine close the Springfield mill sooner and prior to HSR Act approval of the transaction. Flakeboard refused to waive the provision and SierraPine shut down the Springfield mill effective March 13, 2014, in consultation with Flakeboard.
In anticipation of the early Springfield mill closure, Flakeboard and SierraPine worked together to transition SierraPine's customers to Flakeboard's competing mill in Albany, Oregon. SierraPine reportedly provided Flakeboard "competitively sensitive information about Springfield's customers-including the name, contact information, and types and volume of products purchased by each Springfield customer" -and also agreed to delay announcement of the closure "so that Flakeboard could better position its sales personnel to contact Springfield's customers."4 Also, "at Flakeboard's request, SierraPine instructed its own sales employees to inform Springfield customers . . . that Flakeboard wanted to serve their business and would match SierraPine's prices" and furnished assurances of employment to key SierraPine sales employees to create an incentive for them to steer sales to Flakeboard.5 This conduct allegedly had the desired effect and "significantly increased Flakeboard's profits."6
According to the DOJ, coordination of the Springfield closure and the steering of customers to Flakeboard violated both the HSR Act as well as Section 1 of the Sherman Act because the parties had not received HSR clearance and were direct competitors. The maximum civil penalty for HSR Act violations such as gun-jumping is currently $16,000 per day.7 DOJ stated that it was prepared to seek the full $3.568 million HSR penalty against each party but accepted a settlement of just $1.9 million each because of the parties' cooperation with DOJ's gun-jumping investigation, including producing documents and entering into a timing agreement despite the daily accruing fine.8
The $1.15 million disgorgement paid by Flakeboard equals the amount of illegal profits Flakeboard was alleged to have earned during the six month period prior to the settlement as a result of the coordinated customer steering. DOJ pointed out that "no special circumstances justified the unlawful agreement or exempted it from per se treatment" as unlawful under Section 1 of the Sherman Act.9 For example, the coordination was "not reasonably necessary to achieve any procompetitive benefits of the transaction, and therefore does not qualify as an ancillary restraint." By contrast, agreements to divest assets if faced with an agency challenge would be permissible, because in that context the agreement is undertaken with an assurance that the transaction will be consummated. According to DOJ, disgorgement was particularly appropriate in this case because reopening the Springfield mill was impractical given it had been closed for several months and all employees had left or been terminated.
Lastly, the parties are also subject to certain behavioral restrictions for a period of ten years. During any transaction negotiations and continuing until a transaction is abandoned or closed, both parties must refrain from any agreements to fix or stabilize prices or restrict output of competing products and from disclosing or seeking disclosure of "information about customers, prices or output." Each of the parties also must implement an antitrust compliance program, designate an Antitrust Compliance Officer, make annual compliance reports to DOJ and afford DOJ access to documents, information and employees upon request.
Certain Pre-Closing Agreements & Information Exchanges Are Permissible
The doctrine of "gun jumping" prohibits an acquiring party from exercising operational control over the business or assets of a target prior to receiving HSR Act clearance because this is considered to be prematurely taking beneficial ownership of the acquired company or assets. Taking beneficial ownership prior to HSR Act approval constitutes a violation of the Act and can result in costly penalties for the parties given the daily accrual of civil fines.
When parties to a transaction are direct competitors, as was the case here in Flakeboard/SierraPine, they also need to be concerned that premerger coordination could constitute an agreement that unreasonably restrains trade in violation of Section 1 of the Sherman Act. Agreements to fix or stabilize prices, restrict output, rig bids, or to allocate markets or customers are all per se violations of Section 1, notwithstanding any pending but unconsummated merger between the parties. While DOJ sought civil disgorgement penalties in this case, the same conduct could also in theory give rise to criminal prosecution and could also result in costly follow-on civil litigation where private plaintiffs can seek trebled damages.
The DOJ's case against Flakeboard and SierraPine is just the latest in a series of cases brought by the DOJ and FTC challenging unlawful premerger coordination.10 For example, in a somewhat analogous case in 1996, Titan Wheel International settled an FTC gun-jumping investigation brought in connection with its acquisition of assets from Pirelli S.p.A. where Titan took immediate control of a Pirelli factory and even began manufacturing there prior to HSR Act clearance.11 There, early termination of the HSR Act waiting period was granted with respect to the transaction, but Titan had to pay $130,000 in civil penalties for its gun-jumping conduct.
While the HSR Act and Section 1 of the Sherman Act restrict certain pre-closing conduct, there are certain widely-accepted measures parties can take to protect the acquirer's legitimate interests prior to closing without incurring an undue risk of gun jumping problems. Indeed, DOJ specifically recognized these practices as exceptions to the prohibited conduct in the Flakeboard/SierraPine settlement:
- Parties to a transaction may agree that the target will continue to operate as it has in the ordinary course of its business;
- Parties may agree to forego conduct that would have a material adverse effect on the value of the to-be-acquired business or assets; and
- The parties may engage in due diligence information exchanges where (1) the information is reasonably necessary to understanding future earnings and prospects of the target business and (2) its disclosure is subject to a non-disclosure agreement (i) restricting use of the information to due diligence purposes and (ii) prohibiting dissemination to any employee of a party engaged in marketing, pricing or sales of a competing product.
One way to accomplish the restriction on information sharing embodied in the last point above is the use of a "clean team" for the exchange of potentially competitively sensitive information. A clean team should consist of only persons who have been removed from any involvement with competitive decision-making, and team members must be under strict instructions not to share the information outside the team. While in the Flakeboard case DOJ only made an explicit allowance for the use of clean teams in the due diligence process, parties also are well advised to continue the use of clean teams in conducting integration planning during the pre-closing period as well, because potential Section 1 concerns continue to apply after negotiations and due diligence are completed and until closing when the parties cease to be competitors.