Understanding Privilege In M&A Transactions–Safeguarding Seller Interests

Understanding privilege in M&A transactions is crucial for protecting the seller’s interests. When we talk about privilege, we refer to the seller’s communications with their legal counsel. During an M&A deal, you will need expert and accurate legal advice to ensure it progresses without hurdles.

However, you’ll also want assurance that the information revealed to your legal advisors will not reach the buyer. Many sellers make the crucial mistake of assuming client-attorney privilege. However, considering the company you’re selling is a separate entity, you’ll need to protect that privilege.

Remember that according to the law, the company being sold owns the privilege. Once the buyer completes the sale and becomes the new owner, they assume privilege. As a result, they can access the confidential information shared with the legal counsel.

Why Privilege Ownership Can Be a Problem?

The default rule or “common-interest privilege” is that all information involving the target company belongs to the company, not the shareholders. This law is applicable unless you, the seller, enter into a contract with the legal team, specifically preventing them from sharing information.

Without this covenant in the legal contract, after the M&A deal closes, the buyer can access the data. Using the information, they can file post-closing disputes against you. This is why sellers must take the appropriate steps to safeguard their interests. Here, the Great Hill Clause comes in.

The Great Hill Clause results from a 2013 ruling the Delaware Court of Chancery made. According to this ruling, the buyer gets ownership and control over all privileged communication regarding the target company. Once the deal closes, all the data automatically reverts to the new owners.

Aside from communications with the legal team, the law can apply to other entities involved in the sale. These entities can include accountants, investment bankers, or other people. However, the seller can prevent this from happening by including a special clause in the purchase agreement.

You’ll clearly outline the rules regarding the privileges for the target company’s seller shareholders and the buyer after the closing.

Understanding Privilege in M&A Transactions – Factors to Keep in Mind

When understanding how privilege works in M&A deals, always remember that the company and its seller are separate entities. Accordingly, if you were to retain the services of a legal team jointly with the company, the privilege belongs to both.

In that case, information will pass to the buyer along with the company they purchase. Since you’ll share privilege with the company, you cannot keep any information confidential from the buyer. This factor raises the risk of possible disputes after closing the deal.

Section 259 of the Delaware General Corporation Law (DGCL) states that “all property, rights, privileges, powers and franchises” of the parties to a merger become “the property of the surviving or resulting corporation.”

The court also says that any documents showing the discussions between the seller and their legal team are “discoverable.” This means that they are not protected under privilege and should be made available to the buyer. However, the seller can redact certain sections or make line edits.

How to Safeguard Seller Privilege

Here’s what you need to do to protect seller privilege:

• When retaining the services of a legal counsel, carefully determine who the team will represent. It can be you, the seller specifically, or the company as an entity.
• Be absolutely clear on this issue and ensure that it is consistent when drafting all the relevant documents. For instance, the contract detailing legal services or a retainer agreement, the transaction agreement, invoices, and instructions given to representatives.
• Segregating privilege is crucial because it will influence how disputes are handled after the deal closes. If you don’t clearly demarcate confidentiality, the buyer can access sensitive information and raise disputes.
• When handing over the company to its new owners, you’ll ensure that all confidential and sensitive paperwork or Category 2 Documents are duly shredded or deleted. Any data left behind inadvertently becomes the property of the new owners, opening up the possibility of disputes.
• Including a covenant or clause in the purchase agreement is also an option.
• Educate your team members about the importance of maintaining confidentiality in their communications. As soon as you decide to sell the company, train them to use secure channels when discussing sensitive matters.
• Instituting a culture of IT security and prevention of data breaches should be an essential part of worker awareness in any organization. Practices like these ensure that your company is always safe.
• Restrict the number of people who have access to sensitive information. Divulge details strictly on a need-to-know basis. Limiting access lowers the risk of the data getting into the wrong hands.

How to Secure Digital Information

Don’t overlook any sensitive communications you might make with the legal counsel using the company’s servers and IT networks. Despite your best efforts, you might leave behind information that cannot be deleted and becomes accessible to the buyer.

To prevent that from happening, it’s advisable to use separate email accounts on servers that the company does not own. Further, since you’ll transfer all email accounts to the buyer, go over them carefully and remove sensitive information.

You’ll maintain a detailed record of the procedures and the due diligence you exercised. That’s how you’ll demonstrate your commitment to security, which proves to be a valuable defense tactic in case of disputes.

Remember the issue of privilege extends to any other data you don’t want to divulge to the new owners of your company. So, understanding privilege in M&A transactions is crucial. Also remember to secure any hardcopies you make of the communication.

Including covenants in the purchase agreement will ensure that even if the buyer accesses the data, they cannot use it. They cannot file disputes using the information as evidence against the seller or the company’s shareholders.

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Applicable Privilege if the Seller Stays on as a Consultant

As part of the M&A deal terms and conditions, the founder may choose to stay on with the company. You may continue working as a consultant to ensure its smooth integration with the acquirer and continuity in operations. But, be extremely cautious about using the company servers and devices.

Any information and communication you exchange belongs to the company since you’re an employee or consultant. You cannot claim privacy or confidentiality unless it’s specifically mentioned it in the company policy. Remember that this policy can be verbal or written.

Communications made using company devices are generally available to the new owners and the buyer as a rule. You cannot claim privilege, so understanding privilege in M&A transactions is crucial.

The new company owners have the right to set up policies preventing employees from personal email use. They can monitor all communications and emails employees send using the company computers and servers.

After the closing, the surviving company can have new policies about informing their workers about their monitoring practices. This monitoring could be crucial for preventing data breaches and leaks.

Privilege-Related Covenants to Include in the Purchase Agreement

When drafting the purchase agreement, work with the legal team to include certain covenants or conditions protecting privilege. Your M&A advisor can also assist in crafting strategies to create a strong legal barrier that protects your interests.

A proactive approach not only protects access to sensitive information, but also sets up a clear legal roadmap and framework. You can rely on this framework to defend yourself against disputes.

Here’s a quick overview of what to include.

• Specify who has rights over any confidential and sensitive information–the company, seller and shareholders, or buyer.
• Specify the category of documents that privilege rights apply to. For instance, documents related to the company sale or any other category.
• Conditions related to how to treat the privileged information. For instance, if the seller did not delete or destroy sensitive documents. Can the buyer assert privilege or not?
• Conditions outlining what happens to privilege in case of a post-closing dispute. Can the seller claim that they share joint privileges with the company?
• Covenants related to how the buyer can treat privilege if they find confidential information left behind in the company. For instance, can they access the data?
• Conditions outlining if the buyer can use specific privileged and non-privileged information to file a dispute after the sale.
• Conditions should specify that the seller can use their company’s historical counsel and other records when filing a dispute or for other purposes.
• Do shareholders have the right to request confidential information and examine company secrets during the transaction? Can they use that information for any disputes?

Legal teams must also safeguard both parties’ interests when drafting the purchase agreement and negotiating the terms and conditions. The objective should be to find a common middle ground that protects confidentiality concerns the seller and buyer may have.

Sample Clause to Include in the Purchase Agreement

From and after the Effective Time,

(i) the direct and indirect holders of Company Shares immediately prior to the Effective Time (the “Former Shareholders”) shall be the sole holders of the attorney-client privilege with respect to the engagement of [Seller Counsel] by the Company, and neither the Surviving Corporation nor its Affiliates shall be a holder thereof,
(ii) to the extent that files of [Seller Counsel] in respect of such engagement constitute property of the client, only the Former Shareholders and their respective Affiliates (and none of Parent, the Surviving Corporation or their respective Affiliates) shall hold such property rights and
(iii) [Seller Counsel] shall have no duty whatsoever to reveal or disclose any such attorney-client communications or files to Parent, the Surviving Corporation or any of their Affiliates by reason of any attorney-client relationship between [Seller Counsel] and the Company or any of its respective Affiliates or otherwise.

This Section is irrevocable, and no term hereof may be amended, waived or modified, without the prior written consent of [Seller Counsel].

Privilege-Related Covenants Buyers Should Include

Although privilege can secure seller rights, buyers can include their own covenants to protect them from hidden information. Any data that sellers don’t divulge can result in losses and liabilities. Here are some steps they can take and clauses they must include:

• Buyers must conduct meticulous due diligence when evaluating the target company as a viable purchase. They must examine its assets, liabilities, and any other details that can influence the company’s valuation.
• Buyers can specifically request for privileged communication that can impact their decision to finalize the M&A transaction.
• They should include a clause that gives them access to privileged communication they may need to run the company. This information may pertain to operation, and the assets and liabilities they have acquired.
• Acquirers can insist on details of ongoing lawsuits, litigation, and regulatory non-compliance issues. Since the buyer will be taking them on, they should be aware of the matters.
• Buyers can include covenants according to which sellers agree to identify and segregate any confidential communications. Once the sellers transfer sensitive information to the buyers, they should return or destroy any soft and hard copies in their possession. Since the target company now belongs to the buyer, sellers cannot keep information after the transfer.
• The purchase agreement should include a covenant according to which both parties in the M&A collaborate and safeguard privilege. They should protect pre-closing communications such as common interest or joint defense communications.

In Conclusion

Determining which information is confidential and privileged between the seller and their legal team in an M&A deal is a tricky issue. As the seller, you can secure your interests from the possibility of disputes by including covenants in the purchase agreement.

Make sure the legal counsel you retain is separate from the company you’re selling. Also, be cautious about using the company’s IT systems and servers to communicate with your attorneys. Training your workforce and setting up guidelines is another practical strategy.

Your best best is to restrict discussions and sharing information to a selected number of people you can trust implicity. And, remember to destroy the communication once its purpose is served.

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