In Edward Kang’s March 2016 civil litigation column in The Legal Intelligencer and the Pennsylvania Law Weekly, he writes on the issue of M&As and Attorney-Client Privilege of Selling Corporations.
Courts have long recognized that the attorney-client privilege extends to corporations, as in Upjohn v. United States, 449 U.S. 383 (1981). Because a corporation can act only through its agents, usually officers, a corporation’s attorney-client privilege generally applies to communications between the corporation’s authorized agents and counsel. As the U.S. Supreme Court explained in Upjohn, however, it is the corporation that holds the corporate attorney-client privilege, not individual officers.
In sale of business transactions, the seller corporation either sells some or all of its business by means of a merger or a sale of assets. In these transactions, particularly when they involve small and midsized corporations, counsel may represent both the selling corporation and its shareholders in negotiating the terms of sale, participating in due diligence, and completing the transaction. Unless the sale transaction is carefully negotiated and documented, however, the selling corporation could end up unwittingly transferring to the buyer its pre-merger, privileged communications with counsel relating to the merger transaction itself. This may not sound so terrible—especially in cases involving a selling corporation that ceases to exist after the transaction—until there is litigation between the buying corporation and individual owners of the selling corporation arising from the transaction.
Litigation between a buying corporation and selling corporation (or owners of the selling corporation) over a sale of business transaction is all too common, especially when the selling corporation fails to meet the buyer’s pre-deal expectations. Such an unhappy buyer would likely claim that the selling corporation misrepresented its financials, and that the individual owners of the selling corporation, who are often also the officers, intentionally concealed the company’s true financial condition from the buyer.
In this sort of litigation, the owners’ communications with others before the sale transaction become the focus. To the selling corporation’s astonishment, the buying corporation could claim that the buying corporation, not the selling corporation, now owns all pre-merger communications between the selling corporation and others, including privileged communications between the selling corporation and its counsel. Much to the selling corporation’s dismay, the buying corporation would be right.
When there is litigation between the parties after a sale transaction, courts have concluded that the buying corporation, at least in the context of a merger, will acquire all rights to the attorney-client privileged communications of the selling corporation. Unless precautions are taken, such a development would expose all presale discussions between the selling corporation and its counsel to disclosure and use in the litigation. That’s exactly what happened in Great Hill Equity Partners IV v. SIG Growth Equity Fund I, 80 A.3d 155 (Del. Ch. 2013).
In Great Hill, a number of investors (the buyer) sued the selling corporation, Plimus Inc., its shareholders and representatives (collectively, the seller), alleging the buyer had been fraudulently induced into acquiring Plimus. A discovery dispute arose over whether the seller or the buyer controlled the privileged communications between Plimus and its counsel about the pre-merger negotiations.
The Delaware Court of Chancery concluded that under Delaware law in a sale of a corporation by means of reverse merger, the attorney-client privilege belongs to the surviving corporation, including all privileged communications of the sold corporation and its counsel concerning the merger transaction. The court viewed the question as one of statutory interpretation of Delaware General Corporation Law (DGCL) Section 259, which provides that upon a merger, “all property, rights, privileges, powers, franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation.” The court found that the plain statutory language uses the broadest possible terms to make certain that “all” assets of any kind belong to the surviving corporation after the merger. The court added that the term “privileges” has a commonly understood meaning and that “one of the most obvious examples is the attorney-client privilege.”
Chancellor Leo E. Strine Jr. authored the opinion in Great Hill and later, in 2014, was appointed chief justice of the Delaware Supreme Court. Consequently, it is likely that the Delaware Supreme Court would take the same position if presented with the same question.
As noted in the Great Hill case, which was published in 2013, the Supreme Court also addressed this issue as early as 1985: “When control of a corporation passes to new management, the authority to assert and waive the corporation’s attorney-client privilege passes as well. New managers installed as a result of a takeover, merger, loss of confidence by shareholders, or simply normal succession, may waive the attorney-client privilege with respect to communications made by former officers and directors,” as in Commodity Futures Trading Commission v. Weintraub, 471 U.S. 343, 349 (1985). Yet, as noted in the Great Hill case, some courts have taken a different approach regarding the attorney-client privilege issue. In Tekni-Plex. v. Meyner & Landis, 89 N.Y.2d 123 (1996), for example, the New York Court of Appeals adopted a more practical approach, holding that the question of whether the attorney-client relationship transfers to the buying corporation “turns on the practical consequences rather than the formalities of the particular transaction.”
In its analysis, the Tekni-Plex court grouped the selling corporation’s pre-merger attorney-client communications into two categories: general business communications and communications relating to the merger negotiations. The court held that the attorney-client privilege relating to general business communications passed to the new management. The attorney-client privileged communications relating to the merger negotiations, however, did not. The court reasoned that, since the buyer and seller naturally have an adversarial relationship—at least during the negotiations of merger—it would undermine the purpose of the attorney-client privilege to conclude otherwise.
Many courts in recent years, however, have declined to follow the Tekni-Plex approach, and have instead followed the Delaware Chancery Court’s approach as outlined in Great Hill, including U.S. District Judge Gerald McHugh of the Eastern District of Pennsylvania in NewSpring Mezzanine Capital II L.P. v. Hayes, (E.D. Pa. Dec. 9, 2014); also Novack v. Raytheon, (Mass. Super. Oct. 24, 2014). (Author’s note: I argued, unsuccessfully, in the NewSpring matter the court adopt the Tekni-Plex approach. Over my argument that the Tekni-Plex approach was more sensible than the Great Hill approach, the court decided to adopt the Great Hill approach.) Since Pennsylvania’s merger statute, 15 Pa.C.S.A. Section 336(a), uses statutory language similar to DGCL Section 259, it seems likely the result would be the same under Pennsylvania law.
- How do I ensure the attorney-client privilege of the selling corporation stays with the selling corporation?
To avoid the risk of opening a Pandora’s box of confidential information in sale of business disputes, counsel should be sure that the transaction documents specifically address the fate of privileged communications relating to pre-merger negotiations.
In Great Hill, the court acknowledged that parties to a merger can contractually exclude “pre-merger attorney-client communications regarding the negotiation of the transaction from the assets to be transferred to the surviving corporation and explicitly acknowledging that the attorney-client privilege for those documents would belong solely to the seller after the merger.” The same thing can be accomplished in an asset sale by including a provision in the asset sale agreement on “excluded assets” that explicitly indicates that the seller retains all rights to the attorney-client privilege related to any excluded assets and with respect to all communications concerning the asset sale agreement, as in Postorivo v. AG Paintball Holdings,C.A. Nos. 2991-VCP, 3111-VCP (Del. Ch. Feb. 7, 2008).
Often in a sale of business transaction, the same counsel will undertake to jointly represent the selling corporation and its shareholders, thereby creating a co-client privilege among each client and the attorney representing them jointly. If a joint representation is involved, the engagement letter should clearly address the scope and limitations of the common representation. In particular, the engagement letter should, if appropriate, clearly state that the joint representation and engagement shall end upon completion of the transaction and that all rights to the co-client privilege shall be retained solely by the selling shareholders and relinquished by the selling corporation to the other co-clients. Otherwise, the selling corporation’s interest in the co-client privilege could be conveyed by operation of law to the buyer, which may have undesirable consequences.
For example, while waiving the joint-client privilege requires the consent of all joint clients, according to the Restatement (Third) of the Law Governing Lawyers Section 75(2), under the co-client privilege, one of the co-clients “may unilaterally waive the privilege as to its own communications with a joint attorney, so long as those communications concern only the waiving client; it may not, however, unilaterally waive the privilege as to any of the other joint clients’ communications or as to any of its communications that relate to other joint clients,” as in In re Teleglobe Communications, 493 F.3d 345, 363 (3d Cir. 2007), as amended (Oct. 12, 2007).
By thinking ahead and planning carefully, counsel to sellers in merger and asset sales can put in place contractual arrangements to assure that their confidential transaction-related attorney-client communications remain in the control of the selling group and inaccessible to the buyer. •
Reprinted with permission from the March 22 edition of The Legal Intelligencer”© 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com