There are three U.S. antitrust laws that regulate the diligence process, transition planning, and overall conduct between parties during deal negotiations and due diligence prior to closing: Section 7A of the Clayton Act (better known as the Hart-Scott-Rodino Antitrust Improvements Act (HSR Act), Section 1 of the Sherman Act, and Section 5 of the Federal Trade Commission Act. There are two binding principles common to these statutes.
First, competitors must remain competitors until after closing. This is rooted in an acknowledgment that not every transaction will successfully close. As a result, the sharing of information between competitors during the entire pre-closing period needs to be carefully monitored and scripted so as to ensure that if the transaction fails to close, competition in the marketplace is not lessened because of the information learned. For example, if a buyer learned of the specific prices the target charges to specific customers, and the deal failed to close, the buyer could make improper use of that detailed information by adjusting its own prices in an attempt to steal that customer after the deal is abandoned. This is exactly the outcome the antitrust laws protect against.
Second, the exercise of beneficial ownership by the buyer over the target prior to expiration of the HSR Act waiting period is similarly prohibited. Again, competitors must continue to act as competitors until after closing. That means, for example, that a buyer cannot begin ordering a target to alter certain business practices in anticipation of closing. Rather, the seller must continue to operate freely as if no deal was pending. In the event the parties begin acting as one prior to closing of the transaction, they could be found liable for “jumping the gun” or “gun jumping,” as it is colloquially referred. Either type of violation can lead to antitrust liability and the consequences can be serious.
The consequences of a violation are serious; civil penalties for gun jumping can be substantial, with maximum fines up to $16,000 per day per violation, which can be applied to both the buyer and the seller. Separate penalties for a violation of the Sherman Act are also significant, including behavioral injunctive relief as well as potential disgorgement of illegally obtained profits. In addition to enforcement of these laws by the DOJ and the Federal Trade Commission (FTC), private parties may bring civil suits under Section 1 of the Sherman Act to recover treble damages for premerger violations of Section 1. Also please note that other jurisdictions worldwide (e.g., Europe, China, Brazil) are also aggressively increasing their enforcement focus on this topic.
To avoid gun-jumping liability, merging parties should abide by this simple principle: the parties are and must remain independent companies until closing. Thus, it is important for merging parties to adhere to the following general principles:
Merging parties must continue to compete, develop, and market their respective products and services independently as if no potential transaction is pending. Although the two companies may intend to merge, under the antitrust laws, the companies are still independent, and until any potential transaction actually closes, competition must be just as vigorous as it was before the parties engaged in negotiations.
- While integration planning is allowed, actual integration is not. Merging parties must not give customers, partners, or anyone else the impression that they are acting jointly or have indeed combined their operations prior to closing. Merging parties should avoid even the appearance of actual pre-closing integration.
- Merging parties must not use any competitively sensitive information received during negotiations for any commercial purpose. The only reason for discrete and cabined usage of competitively sensitive information in the pre-closing period is to assess valuation and/or assist in legitimate integration planning. Alert counsel immediately if you come across competitively sensitive information that is being used by the parties for competitive or other commercial purposes prior to closing.
However, within these general guidelines, there are legitimate business justifications for the coordination of certain conduct, particularly the need to share information and coordinate activities during due diligence and integration planning. The antitrust agencies have recognized the importance of these legitimate activities. With appropriate safeguards, the parties can achieve both successful deal negotiations and integration planning. Consulting with your antitrust counsel to develop a targeted and tailored plan, replete with such safeguards, is advised.
There are two equally important levels of safeguards when sharing information. First, merging parties should construct an appropriate structure and procedure for sharing information. Namely, the parties should limit the scope of sharing competitively sensitive information on a “need to know” basis. That is, it should be limited to those particular individuals who are responsible for carrying out the deal’s development or legitimate integration planning activities. In addition, the parties should implement appropriate safeguards to ensure that competitively sensitive information does not flow from diligence personnel to those who have responsibilities in the ordinary course of business for product development, pricing, sales, or marketing. In the event additional safeguards are deemed necessary, exploring use of a confidential virtual data room and “clean teams” also may be appropriate.
Second, merging parties should limit the types of information that are shared. Below are guidelines for the types of information that buyer and seller may share when engaged in due diligence and planning for integration. These guidelines apply to product areas in which the parties compete, or may compete in the future Note that the concept of “compete” is broad, and the parties’ products do not have to be exactly the same in order for the antitrust agencies to consider them to be competing products. Data regarding non-competing products and services can be shared more freely (although there may be non-antitrust reasons to withhold such information), as long as the sharing of “non-competitive” information does not lead to the improper exercise of beneficial ownership by buyer over the seller. As questions arise, or where flexibility is requested, please contact antitrust counsel before deviating from these guidelines.
Product Roadmaps and R&D Plans: The parties can share high-level product roadmap information. General, aggregated R&D information can also be shared. As the level of detail increases, particularly for specific products, please consult counsel.
- Pricing Data: The parties should not share current or future pricing information, especially prices that can be attributed to specific customers or products. The parties can share historical prices, particularly if the data is aggregated and noncustomer/product specific (e.g., average selling prices for a product family). Note that “price” is a broad term, and can include, e.g., margins, discounts, and rebates. Thus, while one party, in theory, could share public list prices, it could not share specific discount and rebate information that will allow the other party to determine the final price for a specific customer or a specific product (or vice versa).
- Cost Data: The parties can share aggregated cost data, but should not share information that will enable either company to identify current costs for specific products or components.
- Employee Data: The parties can share information relating to headcount and benefits/salaries of employees, especially in order to evaluate strategies to retain or establish key personnel for the post-closing team, including senior level management. Note that there are often non-antitrust, HR-related restrictions applicable to such data.
- Customer Data: Unless first cleared by counsel, customer-specific data should not be shared, such as revenues associated with specific customers and information regarding new opportunities and potential customers (especially sales leads). Neither party should request customer-related information such as top customer lists or future revenue projections, but this information could be redacted so as to prevent the other side from identifying the specific customers.
- General Corporate and Financial Data: Most general corporate and financial data can be shared, such as incorporation documents, financial reports, and budgets, as long as the parties follow the guidelines above regarding pricing, cost, and customer data.
- Contracts and Material Terms: Standard form contracts can be shared. However, executed contracts should be redacted before they are shared. Specific pricing information, material nonstandard contract terms, and customer names should be redacted.
- Legal Privilege: Privileged materials should be redacted.
Coordination of Activities
Buyer and seller must still unilaterally direct their own actual sales, marketing, and other commercial activities prior to closing, so as not to face liability for gun jumping. For example:
Buyer cannot agree with its sales counterparts at seller to refrain from pursuing customer prospects or divide new customer prospects between the companies. Buyer cannot refrain from competing for a customer because it knows that seller is competing for that customer as well. The same holds true vice-versa.
- The parties cannot agree on current or future prices for existing products or products to be released in the future (pricing decisions for each party’s products and services must remain unilateral, and set only by that party).
- The parties may plan for specific sales and marketing activities that are effective once the parties merge, but these plans must not be implemented until the transaction actually closes. In the meantime, the parties cannot agree to suspend or redirect competitive marketing activities prior to closing.
- Merging parties cannot make specific representations to customers as to what the combined entity may do in the future relating to discounts, pricing, services, product developments, or other competitively sensitive terms or conditions of sale. While the parties may plan for product integration or future development, specific plans may not be made public, and all decisions regarding current products and services must be unilateral until after closing.
As questions arise, or where flexibility is requested, please contact antitrust counsel before deviating from these guidelines.
Merger Agreement Operating Covenants
Generally it is acceptable for the parties to execute operating covenants in the merger agreement that restrict the seller’s pre-closing activities in order to protect the benefit of the bargain for the buyer. However it is critical that those restrictions, individually or collectively, do not transfer operational control by unduly restricting seller’s ordinary-course business activities or otherwise hinder the seller’s ability to compete pre-closing or after abandonment if the deal does not close for some reason. One approach to reducing the risk from merger agreement operating covenants is to rely on general provisions simply requiring the seller to operate the business in the ordinary course and/or not undertake actions that would or could result in a material adverse effect on seller’s business.
More specific covenants limiting the seller may be acceptable but the parties should first ask: (1) are such provisions reasonably necessary to preserve the buyer’s bargain; (2) will the provisions allow the seller to continue to compete pre-closing in the ordinary course of business or after abandonment should the deal fail to close; and (3) will the restrictions allow activities commonly undertaken by seller or contemplated in seller’s recent business plans? If so, counsel likely can assist in fashioning specific covenants acceptable to both parties. Restrictions on seller’s ability to make independent pricing, discounting, and bidding/sales decisions prior to closing, however, are highly suspect and should be avoided without further discussing in advance with counsel.
The Goodwin Antitrust & Competition Law Group is available to assist if you have any questions or require other guidance.
—————————————— There are certain limited exceptions where the seller cannot make wholesale changes to its business model and/or operations without notifying the buyer first. Please consult antitrust counsel to determine if your specific event is significant enough to give rise to this exception.
 This is not a theoretical risk. Recently, the Antitrust Division of the Department of Justice (DOJ) brought a significant gun-jumping enforcement action: U.S. v. Flakeboard America Limited, et al. The DOJ alleged that the conduct of two merging parties prior to the expiration of the HSR waiting period constituted a premature transfer of "beneficial ownership" in violation of the antitrust laws. The DOJ’s most serious allegation was that the parties conspired during the HSR waiting period to restrain trade by coordinating the closure of one of the seller’s mills and allocating customers of that mill to the buyer. This unlawful coordination led to the permanent shutdown of the seller’s mill and enabled the buyer to profit by securing a significant number of the seller’s customers for its own competing operations. The defendants’ conduct allegedly constituted a per se unlawful agreement to restrain trade in violation of Section 1 of the Sherman Act, and prematurely transferred operational control, and therefore beneficial ownership, of the seller’s particleboard business to the buyer in violation of the HSR Act. A DOJ settlement required each merging party to pay $1.9 million in civil penalties, as well as disgorgement of $1.15 million in profits by the buyer. Ultimately, the parties abandoned the transaction and it was never consummated.