- HSR Gun-Jumping Case Results in $1.8 Million Fine
- May 31, 2006 | Author: James K. Phillips
- Law Firms: Womble Carlyle Sandridge & Rice - Atlanta Office ; Womble Carlyle Sandridge & Rice - Winston-Salem Office
On April 13, 2006, the US Department of Justice ("DOJ") charged two companies with unlawful premerger coordination in violation of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act").1 In announcing a case settlement that requires the companies to pay $1.8 million in civil penalties, Thomas O. Barnett, Assistant Attorney General in charge of the DOJ's Antitrust Division, stated that "merging parties must continue to operate independently until the end of the premerger waiting period" under the HSR Act. He added that the DOJ "will vigorously enforce this requirement" against any company that prematurely attempts to assume "operational control of a business that it is acquiring" (conduct commonly referred to as "gun-jumping").
The DOJ's complaint charged QUALCOMM Incorporated ("QUALCOMM") and Flarion Technologies Inc. ("Flarion") with gun-jumping based on the terms of their merger agreement and certain conduct by the parties prior to the closing of the transaction.2 It is noteworthy that the DOJ brought this suit even though it concluded after its HSR premerger review that the proposed merger itself did not raise competitive concerns.3
Agreement Terms and Conduct
The DOJ’s complaint against the parties sets forth a number of specifics regarding the contractual terms and the conduct of the parties to the QUALCOMM/Flarion merger that, when taken together, formed the basis for its conclusion that gun-jumping had occurred. The DOJ’s focus began with the identification of several contractual provisions included in the merger agreement and concluded with allegations regarding the conduct of the parties between the execution of the merger agreement and expiration of the waiting period under the HSR Act. Thus, the DOJ’s complaint sought to establish that QUALCOMM exercised "beneficial ownership" over Flarion’s business and assets through not only the conduct of the parties during the time period between contract execution and merger consummation, but also through the language included in the merger agreement itself.
The clauses that were subjected to scrutiny were all included in a section that is customarily found in merger and acquisition agreements – a series of negative covenants designed to ensure that the seller conducts "business as usual." Out of the twenty-one negative covenants in the merger agreement, the DOJ chose to question several specific clauses. In particular, the complaint set forth as significant the provisions in the merger agreement that Flarion would not, without QUALCOMM’s prior written consent:
- enter into any agreement to license its intellectual property to a third party;
- enter into any agreement involving the obligation to pay, or right to receive, $75,000 or more per year or $200,000 or more in the aggregate;
- enter into any agreement relating to the disposition or acquisition of intellectual property rights, except for "shrinkwrap" software licenses with purchase prices of less than $10,000.
- enter into any "material contract;"
- hire any employee except in the ordinary course of business in accordance with its standard past practice; and
- present business proposals to any customer or prospective customer.4
In focusing on the actions of the parties, the DOJ’s complaint points out that the contractual limitations on Flarion’s business were actually applied in a much more restrictive manner by the parties after the execution of the merger agreement. For example, after the merger agreement was executed:
- Essentially every employment decision by Flarion was made only with the approval of QUALCOMM;
- Many other routine decisions were made by Flarion only after consultation with QUALCOMM;
- Entire drafts of customer proposals were submitted to QUALCOMM for review.
- Flarion requested QUALCOMM’s approval of price quotes and offers of discounts to customers;
- Certain decisions regarding the matters brought to its attention by Flarion were made based upon QUALCOMM’s business metrics, not Flarion’s business metrics; and
- Flarion changed its pricing policy based upon input from QUALCOMM.
The DOJ alleged that, pursuant to the terms of the merger agreement and the conduct of the parties, QUALCOMM exercised operational control over Flarion’s business and acquired beneficial ownership of Flarion’s assets prior to the expiration of the waiting period. The DOJ, therefore, sought a penalty of $11,000 per day from the time that the merger agreement was executed (July 25, 2005) until the time the statutory waiting period expired (December 23, 2005).
Are There Now New Standards?
The timing of the QUALCOMM matter is intriguing in light of remarks made by William Blumenthal, General Counsel at the FTC, just a few months earlier in November, 2005.5 Mr. Blumenthal made it clear that the federal antitrust agencies understand that there is a tension between the importance of the planning and implementation necessary in the transition (or integration) phase to ensure the success of a merger and the prohibitions of the antitrust laws. Clearly, the federal antitrust agencies have consistently sent the message that they will act to discipline gun-jumping. However, Mr. Blumenthal’s speech was delivered as a result of his concern that “our message may have been heard by some in our audience to prohibit conduct beyond what we intended.” Accordingly, Mr. Blumenthal’s speech gave some degree of reassurance that the federal antitrust agencies would continue to strive to achieve balance. In fact, at the time of the speech, it was pointed out that only six transactions out of over 25,000 had been challenged on the basis of gun-jumping.
A careful review of the QUALCOMM matter, prior actions by the federal antitrust agencies and the commentaries of officials like Mr. Blumenthal suggests that there has been no real change to prior standards, nor has a new standard been established. Instead, QUALCOMM serves as a strong reminder that determining whether gun-jumping has occurred is a strongly factual determination and, more importantly, that actions taken by the parties early in a merger or acquisition process (like due diligence and contract negotiation) will be considered along with the conduct of the parties during the period of time between contract execution and transaction consummation. However, QUALCOMM may have introduced a new consideration in the analysis of gun-jumping.
In the QUALCOMM matter, ultimately, it was the conduct of the parties after the execution of the merger agreement that was most problematic since several of the described activities are essentially per se violations of the antitrust laws. For example, the coordination of marketing and pricing, the related exchange of information, and assumption of key decision-making by a buyer are activities long-known to be prohibited and represent no changed or new standard. However, the DOJ’s focus on the negative covenants in the merger agreement cannot be ignored. One might properly speculate that the DOJ did not initially find the contract provisions to be objectionable and only found them to be objectionable in light of the subsequent questionable activity by the parties. That being said, one must recognize the connection between the language used in negative covenants and the manner in which the parties act in response to negative covenants.
As a company’s executive acquisition team goes through the merger or acquisition process, it will be continually urged by business consultants to promptly engage in transition and integration planning, long before the transaction is consummated. At the same time, the acquisition team will be constantly reminded by counsel of the need to avoid any conduct that could be viewed as gun-jumping. These seemingly opposed concepts can be difficult to balance.
As a starting point, it is important for parties to any merger or acquisition between competitors to continue to remember that they must remain separate and independent until the consummation of the merger. This warning is first applicable early in the merger process and impacts due diligence procedures. The applicability of this warning continues during the negotiation of the agreement and until the consummation of the agreement. The critical point in the process comes when the buyer almost imperceptibly begins to shift its focus from ensuring that it "gets what it pays for" to transition and integration planning. In reality, until there is a closing, the transaction could collapse, and the other party is still your competitor.
From a practical perspective, the antitrust laws will not operate to prevent a company from "getting what it pays for" in a merger or acquisition transaction. Due diligence and transition and integration planning can continue to occur, so long as they are all handled properly. Understanding that these are sensitive areas is the first step of the process. Typically, it is not just one contractual provision or action that creates the problem, but a series of smaller things that ultimately add up to gun-jumping. By working with antitrust counsel, a company involved in a merger or acquisition transaction can develop a plan that properly balances business needs with antitrust considerations.
1 The press release is available at http://www.usdoj.gov/opa/pr/2006/April/06_at_220.html. The penalty was payable, jointly and severally, by QUALCOMM and Flarion.
2 The DOJ’s complaint is available at http://www.usdoj.gov/atr/cases/f215600/215608.htm.
3 It should also be noted that the statutory waiting period was extended by three months as a result of a request for additional information, but did expire without any action being taken by the DOJ or the Federal Trade Commission ("FTC") to block the merger and the transaction did close.
4 In a later amendment to the merger agreement, this particular section was changed to allow Flarion to present proposals "in the ordinary course of business in accordance with its standard past practice."
5 Mr. Blumenthal’s speech, "The Rhetoric of Gun-Jumping" is available at http://www.ftc.gov/speeches/blumenthal/20051110gunjumping.pdf.