Hart-Scott-Rodino "Gun-Jumping" Penalties for Alleged Abuse of "Ordinary Course of Business" Provisions of Merger Agreement
On January 21, 2010, the U.S. Department of Justice (DOJ) filed in federal court in Washington, D.C. a complaint and consent decree requiring two merging companies (Smithfield Foods (Smithfield) and Premium Standard Farms LLC (Premium Standard)) to pay $900,000 in civil penalties for violations of the "file and wait" provisions of the Hart‑Scott‑Rodino Antitrust Improvements Act of 1976 (the Act).
Case Summary
The companies were direct competitors in the pork products market. The merger agreement included traditional "conduct of business" provisions that required Smithfield's consent to material changes in Premium Standards' operations during the Act's waiting period.
The complaint alleges that after signing the merger agreement, but before filing their premerger notifications and waiting the mandatory 30 days, Smithfield (the acquiring company) began to exercise operational control over a core element of Premium Standard's business, its hog procurement contracting. Significantly, DOJ did not allege that the merger itself violated antitrust law, nor did DOJ allege that the "conduct of business" provisions themselves were unlawful. To the contrary, the complaint recognized Smithfield's legitimate interests in preserving Premium Standard's value during the Act's waiting period:
"The Merger Agreement contained certain customary interim "conduct of business" provisions limiting Premium Standard's operations during the Section 7A waiting period to protect Smithfield's legitimate interests in maintaining Premium Standard's value without impairing Premium Standard's independence. These included provisions regarding Premium Standard's rights to assume new debt or financing, issue new voting securities and sell assets, as well as requirements that Premium Standard "carry on its business in the ordinary course consistent with past practice. The Merger Agreement also conditioned the closing of the transaction on the absence of any material adverse effect, as such agreements customarily do."
It was Smithfield's premature exercise of operational control over Premium Standard's ordinary course contracts to control the price, quantity and duration of Premium Standard's hog procurement contracts, which are central to the firm's business, that violated the Act.
For this reason, neither the Smithfield complaint nor the related consent decree provides guidance on the more difficult issueof whether the terms of "conduct of business" provisions alone may constitute unlawful gun-jumping. How far buyers and sellers may go in negotiating and implementing such provisions may pose one of the most difficult issues merger partners have to address in the course of a transaction.
The DOJ provided some guidance on this issue in its 2006 complaint and consent decree in United States v. QUALCOMM Inc. and Flarion Technologies, Inc. There, the DOJ alleged that unlawful gun-jumping occurred through "conduct of business" provisions that, among other things, provided the buyer with the right to approve (a) all agreements by the seller to license its intellectual property, (b) all agreements involving the obligation of pay or receive $75,000 or more, and (c) the seller's business presentations to customers or prospective customers.
Practical Take-Aways
Taken together, Smithfield and QUALCOMM are consistent with the government's long-held view that although merging companies may during the Act's waiting period plan for their post‑consummation operations as a consolidated entity, a target firm cannot surrender its independence, especially with respect to critical competitively sensitive operations. Doing so based on nominally standard "conduct of business" provisions in the merger agreement does not shield the parties from liability for "gun-jumping."
In addition to approving bids and contracts, the companies should not, without prior consultation with counsel:
- Engage in joint sales or marketing activities;
- Abandon product lines;
- Shut down or substantially curtail manufacturing or research and development operations;
Implement major reductions in force; or - Assign employees of one company responsibility for operations of the other company.
Observing these guidelines during the Act's waiting period may be less than ideal for the merger partners, who may have spent substantial time and effort negotiating the transaction. Failing to observe the guidelines, however, may subject both of the companies to the legal costs entailed by a compliance investigation under the Act, and, ultimately, to the prospect of civil penalties of up to $16,000 per day, notwithstanding the fact the merger itself may be entirely lawful. Because daily penalties continue to accrue from the date the parties begin engaging in gun-jumping until 30 days after they make all necessary corrective filings under the Act (a period that can encompass many months), penalties can easily exceed $1 million.
New HSR Thresholds Announced
The Federal Trade Commission (the FTC) recently announced that the reporting thresholds under Section 7 of the Clayton Act, known as the Hart‑Scott-Rodino Antitrust Improvements Act of 1976 (the Act), will be decreased.
The Act requires all parties to certain transactions, including mergers and acquisitions that meet or exceed the Act's jurisdictional thresholds, to notify the FTC and the Antitrust Division of the Department of Justice and wait a designated period of time before consummating those transactions. The 2000 amendments to the Act require the FTC to revise the Act's jurisdictional and filing fee thresholds annually, based on the change in gross national product. Certain related thresholds and limitation values in the Hart-Scott-Rodino (H‑S‑R) rules will also be adjusted. The decreased thresholds will apply to all transactions that close on or after February 22, 2010.
Reporting Thresholds
Current Reporting Thresholds. Certain transactions, including acquisitions of voting securities or assets, acquisitions of non-corporate interests, or the formation of joint venture corporations or other entities, are subject to the reporting requirements of the Act if the transaction meets a two-part test based on the size of the transaction and the size of the parties.
The size-of-transaction test is met if the transaction is valued at more than $65.2 million.
The size-of-parties test is met if the ultimate parent entity of one of the parties to the transaction has $13 million in total assets or annual net sales and the ultimate parent entity of another party to the transaction has $130.3 million in total assets or annual net sales. However, the size-of-parties test does not apply to transactions valued at more than $260.7 million.
Decreased Reporting Thresholds. Under the new thresholds:
- The size-of-transaction test is met if the transaction is valued at more than $63.4 million.
- The size-of-parties test is met if the ultimate parent entity of one of the parties to the transaction has $12.7 million in total assets or annual net sales and the ultimate parent entity of another party to the transaction has $126.9 million in total assets or annual net sales.
- The threshold at which the size-of-parties test does not apply is decreased to transactions valued in excess of $253.7 million.
Additional Information
Discussions of other recent laws, regulations and rule proposals of interest to public companies are available on our Web site.
This post is intended for general guidance. Parties contemplating a transaction should consult antitrust counsel to determine whether any particular transaction is reportable under the Act and evaluate any antitrust concerns raised by the transaction. Parties should also keep in mind that a transaction that is not reportable because it does not meet the Act's reporting thresholds is not exempt from agency scrutiny of the potential anticompetitive effects of the transaction. The FTC, the Department of Justice and State Attorneys General (as well as private parties) may challenge a transaction as anticompetitive even when no H-S-R filing was required for the transaction. Therefore, all transactions should be reviewed for compliance with Section 7 of the Clayton Act prior to closing.
