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Merging Parties May Face Antitrust Enforcement If "Conduct of Business" Provisions Are Not Carefully Crafted and Followed

January 27, 2010

Merging parties take note: the antitrust agencies will take action where "conduct of business" provisions are drafted too broadly, or where the buyer goes further than the provisions allow to manage or influence the seller’s actions before the parties obtain clearance under the Hart-Scott-Rodino Antitrust Improvements Act ("HSR Act"). 

In a recent complaint, the Department of Justice ("DOJ") alleged that Premium Standard Farms ("Premium"), a pork packer and processor and hog producer, sought approval from Smithfield Foods ("Smithfield"), the largest pork packer and processor and hog producer in the United States, for its business decisions made in the "ordinary course" during the HSR Act waiting period. Although the merger documents apparently included appropriate provisions requiring Premium only to obtain approval for decisions outside of the "ordinary course," DOJ alleged that the Smithfield executives in practice reviewed and approved supply agreements that were "ordinary course." Concurrent with the filing of the lawsuit, the parties filed a settlement agreement in which Smithfield agreed to pay a $900,000 penalty. The Smithfield example serves as a reminder that parties should not only draft merger agreement language carefully; they must also ensure that executives are educated and trained as to what that language means and the antitrust ramifications of failing to abide by it.

Smithfield and Premium filed for HSR approval of Smithfield's acquisition of Premium with the agencies in October 2006. Following the initial HSR waiting period, the DOJ issued requests for additional information and documents ("second requests"). According to the DOJ's complaint, the parties' merger agreement contained customary "conduct of business" provisions limiting Premium's operations during the waiting period, including a requirement that Premium operate its business in the "ordinary course" consistent with past practice. In practice, however, instead of "exercising independent business judgment" during the waiting period, Premium sought Smithfield's approval on three supply contracts the DOJ characterized as "ordinary course." For each of the three contracts, Premium shared with Smithfield the proposed contract terms, including pricing, quantity and length of contract information. As a result, the DOJ alleged that Smithfield controlled a significant segment of Premium's business operations and therefore acquired beneficial ownership of Premium's business in violation of the HSR Act. During the waiting period, the HSR Act forbids the parties from transferring beneficial ownership (i.e. operational control) of any aspect of the target's business to the acquiring party. Formal guidance provided by the agencies explains that "the existence of beneficial ownership is determined in the context of the particular case with reference to the person or persons that enjoy the indicia of beneficial ownership."

In order to protect the buyer's investment during the period prior to closing, merger agreements almost always contain "conduct of business" provisions. These provisions often include restrictions on actions the seller may take, such as forbidding the assumption of new debt or financing, or the issuance of voting securities or the sale of assets, as well as language requiring the seller to continue to operate its business in the ordinary course consistent with past practice during the period prior to closing. Parties to merger agreements must be very careful as to how "ordinary course" is both defined and interpreted. Although the antitrust agencies recognize the importance of protecting the buyer's investment, they also recognize the need to preserve competition between the parties and the seller as an independent company in case the proposed merger is not consummated. Thus, "conduct of business" provisions, and in particular, "ordinary course" language or limitations should be considered in light of the facts and circumstances of a particular business and industry. The parties should make certain that the relevant definitions are properly drafted to ensure the seller retains the ability to use its independent business judgment for all decisions necessary to the seller's day-to-day ongoing operations. 

Perhaps even more importantly, all personnel must understand the importance of fulfilling the merger agreement obligations, and stopping short of exceeding those obligations. Executives of merging parties often have a natural tendency to want to establish a rapport with their counterparts, and that tendency, combined with a fear of running afoul of the merger agreement provisions, can lead to well-intentioned "gun-jumping" violations like the Premium disclosure and Smithfield review of the supply agreements described by the DOJ. 

Allegations of "gun jumping" violations can be extraordinarily costly, and not simply because of a fine or penalty paid by a company facing enforcement action. Even the suggestion that the parties are not carefully following antitrust safeguards can complicate an otherwise straightforward HSR process. The Smithfield example shows that parties can find themselves in a multi-year investigation that will distract the companies and detract resources away from both the merger process and business operations. These effects are preventable, however. Antitrust counsel can help to properly draft merger agreement language and establish integration planning processes to assure compliance with "gun-jumping" prohibitions.