Soon after someone settles “gun jumping” charges, client alerts and blog posts with informative titles like “DOJ Settlement Resolves ‘Gun Jumping’ Charges” start flying around. These “alerts” and “posts” usually recite facts alleged in a DOJ complaint and then say certain conduct is fine (pre-closing integration planning under the watchful eye of an antitrust lawyer, of course), while other conduct (jointly setting prices before closing) is not. But few (if any) actually say what should be considered when negotiating the actual provisions of the transactional agreement to minimize risk of a “gun jumping” investigation.
First, what is gun jumping? Put simply, for transactions that require a merger filing, a seller cannot simply give the keys to the business to the buyer before the designated waiting period expires and the deal finally closes. The idea is to maintain the seller as an independent business in case the transaction is blocked by the antitrust enforcement agency reviewing the transaction, so that competition does not suffer. Jumping the gun, so to speak, can delay closing and lead to an investigation and fines. (As an aside, for transactions that do not require a merger filing, turning over the keys to the business before closing poses most of the same risks.)
What is clear is that the seller needs to be free to operate its business independently and in the ordinary course, while the buyer needs assurances that the seller’s conduct between signing the purchase agreement and closing does not diminish the value of what is being bought. This is why transaction agreements frequently contain provisions specifying that the seller must operate “its business in the ordinary course consistent with past practice prior to” closing the deal. Such agreements also frequently list things the seller cannot do—to preserve the value of the deal for the buyer—by saying, to quote an actual example, that the seller cannot “directly or indirectly acquire…assets, rights or properties except…purchases of inventory, raw materials or supplies, and other assets up to $2,000,000 in the aggregate, in the ordinary course of business consistent with past practice.” These types of provisions usually go on to direct the seller to seek the buyer’s consent (not to be withheld or delayed, of course) before doing what is prohibited.
The language quoted above is straight out of a merger agreement signed in connection with an $800 million-plus deal that closed but saw the parties investigated for “gun jumping” and ultimately paying a nearly $1 million fine. In that case, the seller routinely purchased needed inventory in amounts of much more than the $2 million threshold noted above. While the deal’s competitive significance was being investigated by the DOJ, the seller shipped a number of multiyear contracts to the buyer for approval. Those contracts obligated the seller to purchase, on an annual basis, inventory at a total cost ranging from approximately $57 million to $67 million. The DOJ said these types of inventory purchases were necessary for the operation of the seller’s ongoing business in the ordinary course.
So, what does this all mean for you? What you should not do is rely on whatever has been done in past agreements as a justification for what to put in your agreement. Just because someone agreed to a threshold of $250,000, $500,000 or more does not mean it is right for you. Whatever threshold you arrive at, it should be above what is done in the ordinary course and at a level that would be considered a material change in the business. One possible way to make this determination is to examine the seller’s purchasing or contracting history and ask what is in the pipeline. Although not necessarily determinative, company policies on purchasing and contracting authority may be helpful, too, in terms of providing an upward boundary. Considering these factors and others instead of blindly following past practice can help minimize risk of a “gun jumping” investigation.
A more recent example involving a $5 million “gun jumping” settlement highlights how a provision in a transactional agreement as implemented by the parties can prematurely transfer operational control from the buyer to the seller without preserving the value of what is being bought. During the negotiations of that deal, the buyer expressed its desire to shut down a mill after closing but wanted the buyer to manage the shutdown because the buyer was concerned that its reputation might take a hit if it announced the closure. (The seller wanted to continue operating the mill if the deal did not happen as planned but knew that its employees and customers would start leaving as soon as news of the planned closure hit the street.) What did the parties do? They wrote into the asset purchase agreement a requirement that the seller “take such actions as are reasonably necessary to shut down and close all business operation at its [mill] five (5) days prior to the Closing” and that “in no event shall [the seller] be required to be shut down or close its business operations at its [mill]” until “[a]ny required waiting periods and approvals…under applicable Antitrust Law shall have expired or been terminated.”
Things did not go as planned. Within days of announcing the deal, a labor issue arose at the mill that the seller believed required it to publicly disclose the seller’s plan to close the mill post-closing. The seller asked the buyer to waive the provision in the asset purchase agreement requiring the disclosure. Doing so would have averted the need to announce the seller’s intention to close the mill during the HSR waiting period. The buyer refused that request, and the seller announced the closure. Within weeks the mill closed and the buyer and seller worked together to transfer the buyer’s customers to the seller. In the wake of opposition from the DOJ regarding the competitive merits of the underlying deal, the parties eventually abandoned their proposed transaction. By then, the mill was gone and the damage done.
So what does this mean for you? A former FTC official offered the following guidance in relation to a seller’s decision on whether to proceed with a significant capital project pre-closing, which is applicable here. Among the questions he suggests asking are:
- What is the magnitude of the efficiencies that would be realized from deferral of the project?
- How reversible is the decision not to proceed if the merger ultimately does not close?
- To what degree would the seller’s competitiveness be harmed by the deferral (or abandonment) of the project if the merger ultimately does not close?
- To what degree would the overall level of market competition be harmed if the seller’s competitiveness were harmed?
- To what extent would the project represent a material change in the operation of the seller?
In the end, you need to ask whether the provision is necessary to preserving the value of what is being bought during the interim period between signing and closing. If it is not, think twice before contractually committing yourself to the will of the buyer.
*“Needle and the Damage Done” by Neil Young