March 11, 2014 Top Story

Attorney-Client Privilege Passes to Acquiring Company in Merger

Parties can contract around default rule or segregate communications to avoid waiver

Pamela Sakowicz Menaker

The Delaware Court of Chancery has held that in a merger of two companies, absent an agreement providing otherwise, privileged communications between the seller corporation and its legal counsel may not be protected in subsequent litigation between the merging companies. Great Hill Equity Partners IV v. SIG Growth Equity Fund. As part of this cautionary tale for practitioners, the court pointed out that the sold corporation had taken no steps to carve out or retrieve these communications in the merger agreement. Therefore, control over the communications passed to the buyer by operation of Delaware statutory law.

“Buyer’s Remorse” Results in Lawsuit

Great Hill Equity Partners arose out of a dispute between parties to a merger governed by Delaware law. In 2011, the plaintiffs acquired Plimus, the surviving corporation pursuant to the merger. After the merger, the acquiring company apparently had buyer’s remorse after allegedly finding some evidence of fraud in the communications it obtained following the merger. The plaintiffs brought suit against the defendants, former shareholders, and representatives of Plimus, alleging that the defendants had fraudulently induced the plaintiffs to acquire the corporation. The plaintiffs notified the defendants that they had discovered communications between the defendants and Plimus’s legal counsel regarding the transaction.

The defendant former shareholders argued that the premerger privilege survived the transaction. Citing the decision by the U.S. Supreme Court in Commodity Futures Trading Commission v. Weintraub, the Delaware court disagreed. The Great Hill Equity Partners court distinguished Tekni-Plex, Inc. v. Meyner & Landis, a decision by New York’s highest court, which concluded that “the pre-merger attorney-client communications regarding the merger negotiations did not pass to the surviving corporation for policy reasons related to its analysis of New York attorney-client privilege law.” In rejecting the defendants’ reliance on Tekni-Plex, the Delaware court said the New York court decided the case without referring to Section 259 of the Delaware General Corporation Law.

Strict Reading of State Statute

The court based its decision “on a very strict reading of the Delaware statute concerning the effect of a merger and what rights and privileges pass to the acquiring corporation in a merger,” says Irwin Warren, New York, NY, cochair of the ABA Section of Litigation’s Ethics and Professionalism Committee. That statute, Section 259 of the Delaware General Corporation Law, provides that following a merger, “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.” The court held that the statute was clear. “It would usurp the authority of our elected branches for this court to create a judicial exception to the words ‘all . . . privileges’ for pre-merger attorney-client communications regarding the merger negotiations. That sort of micro-surgery on a clear statute is not an appropriate act for a court to take,” the court said.

A Roadmap for Protecting Premerger Communications

The decision “gives counselors a road map” in what to do in this type of situation, says Warren, who adds that it is clear that the court found that “the parties, particularly the selling shareholders and the target company, can avoid this situation by negotiating and drafting to protect itself by providing for non-transfer and reservation of the privilege in the merger agreement.”

Other Section leaders agree. The former shareholders “should have made it clear in the sale documents that they were not transferring to the buyer/new entity any privileged communications that occurred prior to the sale,” says Loren Kieve, San Francisco, CA, previous cochair of the Section of Litigation’s Federal Practice Task Force. “They also should have taken steps to make sure that any file materials being transferred did not include privileged communications,” says Kieve. The court itself in Great Hill Equity Partners suggested that the parties were free to contract to get a different result.

Edna Epstein, Chicago, IL, author of “The Attorney-Client Privilege and Work Product Doctrine” and associate editor of Litigation, suggests that to protect from inadvertent waiver, attorneys should discuss the matter with competent information technology personnel to separate privileged communications through the cleaning of hard drives and other available means. Epstein warns lawyers to get very serious about dealing with the issue of privilege in corporate transactions.

Lawyers must identify upfront the matters that are of concern in a merger, including privilege, and address them in the agreement to protect one’s client contractually. “One key take-away is that it is important for transactional lawyers who are doing merger and acquisition deals to either (a) add this as a check-list item, and/or (b) have an experienced litigation practitioner look over their transactional documents to make sure they don’t miss this as well as other pitfalls,” Kieve says.

Pamela Sakowicz Menaker is a contributing editor for Litigation News.

Keywords: merger, attorney-client privilege, privileged communications, waiver

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