When an acquisition is completed through a merger, the general rule in most jurisdictions is that the target’s property passes to the surviving company by operation of law. But what about privileged communications about the transaction between the target and its lawyers? In a recent case, the Delaware Court of Chancery held that, absent an agreement between the parties providing otherwise, communications between the target’s stockholders and the target’s lawyers transferred to the buyer upon closing. Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, Civ. A. No. 7906-CS, 2013 Del. Ch. LEXIS 280 (Del. Ch. Nov. 15, 2013) (not released for publication).
The case arose from a merger in which the target company was the survivor. A year after closing the buyer sued the seller for fraudulent inducement. The buyer discovered privileged communications between the seller’s stockholders and its outside counsel. The seller had not removed those documents from its computer system before the closing and the stockholders had not taken any measures since the closing to retrieve the records back from the buyer. The stockholders claimed that they held the privilege and, therefore, the buyer could not use the communications in the litigation.
The court rejected the stockholders’ claim, citing the clear rule in the Delaware General Corporation Law that “all property, rights, privileges, powers and franchises” of the seller pass to the surviving corporation.
In a refreshing example of judicial helpfulness, the court explained how future sellers could avoid losing the privilege. According to the court, the parties can negotiate special agreements providing for the seller to retain the privilege after the closing. The court pointed to a 2008 Delaware decision approving a purchase transaction provision specifically excluding from the sale all the seller’s rights under the transaction documents. The court reiterated that the problem would be avoided in future transactions if the parties agreed to “exclude from the transferred assets the attorney-client communications they wish to retain as their own.”
In order to avoid the problem of privilege passing to the buyer in a merger, we recommend the following. The same principles likely apply in a stock acquisition where, like in a merger, the rights of the target pass to the buyer by operation of law.
- Negotiate Agreements Covering the Ownership of Privileged Communications: Parties to a merger can negotiate agreements addressing ownership, post-closing, of the attorney-client privilege, privileged communications and other matters regarding the transaction. These agreements should coordinate with remedy survivability and other similar agreements in the transaction documents. (This may be less of a concern in public transactions, where claims for breach of representations and warranties typically do not survive the closing.)
- Protect Privileged Communications: The court noted that, because the buyer owned the privileged communications, it did not need to address the issue of whether the seller waived the privilege. The court nevertheless indicated that the stockholders’ failure to take reasonable steps to prevent the buyer from accessing the privileged information may have resulted in a waiver. Therefore, if the parties intend for the seller to retain the privilege, the seller should take measures to keep privileged communications from the buyer (for example, by clearing information from computers, retaining records created in transaction negotiations and the like).
Transactional lawyers should remember the potentially disastrous default rule and how to avoid it.