In a matter of first impression, the Delaware Court of Chancery recently considered whether the attorney-client privilege over pre-merger communications between a target company and its counsel passes to the surviving corporation in a merger governed by Delaware law. In Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013), the court concluded that, absent language in the merger agreement to the contrary, the privilege does in fact pass to the survivor as a matter of law pursuant to Section 259 of the General Corporation Law of the State of Delaware (the “DGCL”). The court’s decision in Great Hill highlights the possibility that pre-merger communications made with the expectation that they would be privileged could wind up in the hands of an adverse party, and provides guidance on how to avoid this unintended consequence of a merger.
The Great Hill Decision
In September 2011, a group led by Great Hill Equity Partners IV, LP (collectively, the “Buyer”) acquired Plimus, Inc. (Plimus) pursuant to a merger in which Plimus was the surviving corporation. One year later, the Buyer brought suit against the former shareholders and representatives of Plimus (collectively, the “Seller”), alleging that the Seller fraudulently induced the Buyer to acquire Plimus. In connection with that claim, the Buyer notified the Seller that it had discovered communications between the Seller and Plimus’s then-legal counsel regarding the transaction. Before the merger, the Seller had not undertaken any steps to extract these communications, and likewise failed to retrieve them from Plimus following the merger. Upon learning that the Buyer had located these communications, the Seller asserted the attorney-client privilege over such communications on the grounds that the Seller, and not the surviving corporation, retained control of the attorney-client privilege with respect to pre-merger communications relating to the negotiation of the merger agreement.
The court’s decision arose out of the Buyer’s motion seeking to resolve the privilege dispute and to determine whether the surviving corporation owned the pre-merger privileges of Plimus or, in the alternative, whether the Seller waived the privilege otherwise attaching to the communications in question. The question before the court was an issue of statutory interpretation. Although Plimus was a California corporation, the acquiring entity was a Delaware corporation and the merger agreement provided that the merger would have the effects set forth in the applicable provisions of the DGCL and the California General Corporation Law. Section 259 of the DGCL provides, in pertinent part, that “all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation. . . .” 8 Del. C. § 259.
The Seller contended that the phrase “all . . . privileges” was not intended to encompass the attorney-client privilege, and as a result, the Seller retained control over communications subject to such privilege. The Seller was not, however, able to point to any legislative history supporting its interpretation of Section 259, and the Court of Chancery likewise was unable to locate evidence supporting that interpretation. The court concluded that the Seller’s interpretation of Section 259 was not a plausible reading of the statute’s plain language and held that the only reasonable interpretation was that “all means all . . . and that this includes all privileges, including the attorney-client privilege.” (Emphasis in original.)
The court also rejected the Seller’s assertion that the New York Court of Appeals’ decision in Tekni-Plex, Inc. v. Meyner & Landis, 674 N.E.2d 663 (N.Y. 1996), and the Court of Chancery’s prior decision in Postorivo v. AG Paintball Holdings, Inc., 2008 WL 343856 (Del. Ch. Feb. 7, 2008), stood for the proposition that the former stockholders of a selling corporation retain privileges attaching to attorney-client communications pertaining to the negotiation of the merger agreement. Although the court of appeals ultimately concluded that the attorney-client privilege with respect to pre-merger communications did not pass to the surviving corporation, it did so without citing to Section 259 of the DGCL and based its holding on policy reasons relating to its analysis of New York law regarding the attorney-client privilege. See Tekni-Plex, 674 N.E.2d at 670-72. In Postorivo, the Court of Chancery applied Tekni-Plex, but did not determine whether the New York decision would be correct under Delaware law. The Court of Chancery also distinguished its decision in Postorivo by noting that in that case, the Court of Chancery was applying New York law to an asset purchase agreement and not a merger transaction governed by Delaware law.
The court concluded its analysis by noting that the parties could have negotiated a provision within the merger agreement specifically excluding the transfer of the attorney-client privilege to the surviving corporation. In support of its position, the Buyer had submitted excerpts from private company merger agreements wherein the parties carved out pre-merger attorney-client communications regarding the negotiation of the transaction from the assets being transferred to the surviving corporation and acknowledged that the privilege over such documents would belong exclusively to the seller following the merger. The court also observed that the asset purchase agreement in Postorivo – the very case cited by the Seller in support of its arguments – included within the definition of “excluded assets” “all rights of the [selling parties] under [the asset purchase agreement] and all agreements and other documentation relating to the transactions contemplated [t]hereby.” Having determined that the attorney-client privilege over pre-merger communications passed to the surviving corporation upon the consummation of the merger as a matter of law, the Court of Chancery did not address whether the Seller had waived the privilege through its failure to ensure that the Buyer would not have access to the allegedly privileged communications. Notably, however, the court referred to the possible waiver of the privilege resulting from the Seller’s “lengthy failure to take any reasonable steps” to preclude the Buyer from accessing the privileged communications as a “substantial issue.”
In light of the Great Hill decision, where a merger transaction involves a Delaware corporation, practitioners should consider whether it would be prudent to include in the merger agreement language that excludes pre-merger attorney client communications from the assets being transferred to the surviving corporation. Moreover, counsel for the target company in a merger also should consider incorporating an express acknowledgement of the parties that the target company’s pre-merger stockholders retain the attorney-client privilege over these documents.
Merely including such protective provisions in the merger agreement likely will not, however, be sufficient to ensure that the target company stockholders retain the attorney-client privilege. Selling parties must also consider the affirmative steps necessary to avoid an inadvertent waiver of the privilege. Although the court did not address whether the selling parties in Great Hill had waived the attorney-client privilege, it was critical of the Seller’s failure to either segregate the privileged communications before the merger or retrieve those communications after the merger. As a result, practitioners should consider whether to include in the transaction agreements provisions that affirmatively permit the target company to remove communications and other documents subject to the attorney-client privilege (whether tangible or stored electronically) prior to the merger, including any necessary carveouts from covenants obligating the target company to operate in the ordinary course of business pending the consummation of the merger. In addition, at the outset of a transaction, the target company and its representatives should consider the best practices for the segregation of privileged communications to facilitate removal of the same, including whether to establish separate folders or servers for storing privileged communications.