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Delaware Chancery Court Provides Useful Guidance for Protecting Pre-Merger Privileges in Post-Closing Litigation Between Buyers and Sellers

In Shareholder Representative Services LLC v. RSI Holdco, LLC, No. 2018-0517-KSJM, 2019 WL 2290916 (Del. Ch. May 29, 2019), the Delaware Court of Chancery reaffirmed that a target company may protect its pre-merger privileged communications in a post-closing dispute with the acquirer by including clear and unambiguous language in the merger agreement that seeks to protect the privilege. This decision provides additional guidance to sellers intent upon protecting their rights in potential post-closing litigation with buyers.

Section 259 of the Delaware General Corporation Law provides in pertinent part that “all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation.” 8 Del. C. § 259(a). Pursuant to this statute, following the closing of a merger, the acquiring company would acquire and hold the target company’s attorney-client privilege. In the event of post-closing litigation between the seller and buyer, this would potentially put the seller at a disadvantage, as the buyer would have access to the seller’s privileged communications. For example, in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013), the Delaware Court of Chancery held that the sellers waived the pre-merger privilege because they did not take any affirmative steps to prevent the transfer of privileges; i.e., the sellers neither wrote language into the merger agreement preserving the privilege nor did they stop the buyer from physically taking possession of the communications.

In Shareholder Representative Services, the selling stockholders of Radixx Solutions International, Inc. (“Radixx”) sued the acquirer, RSI Holdco, LLC (“Holdco”), alleging that Holdco and its affiliate improperly failed to pay the “holdback amount” withheld from the purchase price agreed upon in the merger. During the litigation, Holdco informed the sellers that it had located pre-closing emails sent between Radixx and its counsel and asserted that Radixx waived any claims of attorney-client privilege over those emails. Motion practice ensued.

The sellers argued that Radixx did, in fact, take affirmative measures necessary to protect the privilege. They pointed to a provision in the merger agreement (Section 13.12), which provided:

Any privilege attaching as a result of [counsel] representing [Radixx] . . . in connection with the transactions contemplated by this Agreement [1] shall survive the [merger’s] Closing and shall remain in effect; provided, that such privilege from and after the Closing [2] shall be assigned to and controlled by [the selling stockholders’ representative]. [3] In furtherance of the foregoing, each of the parties hereto agrees to take the steps necessary to ensure that any privilege attaching as a result of [counsel] representing [Radixx] . . . in connection with the transactions contemplated by this Agreement shall survive the Closing, remain in effect and be assigned to and controlled by [the selling stockholders’ representative]. [4] As to any privileged attorney client communications between [counsel] and [Radixx] . . . prior to the Closing Date (collectively, the “Privileged Communications”), [Holdco], the Merger Subsidiary and [Radixx] (including, after the Closing, the Surviving Corporation), together with any of their respective Affiliates, successors or assigns, agree that no such party may use or rely on any of the Privileged Communications in any action or claim against or involving any of the parties hereto after the Closing.

This section had four main objectives. It preserved any privilege that would have been attached to pre-merger communications; assigned control over those privileges to the designated representative of Radixx’s selling stockholders; required both the sellers and buyers to take steps to ensure the privileges remain in effect; and prevented Holdco or their affiliates from using any privileged communication in any Post-Closing litigation.

The Court held that Section 13.12 was sufficient to preserve the privilege under Great Hill. Holdco argued that the “no-use” clause in in Section 13.12 referred only to communications that were still privileged at that point in time following the closing of the merger, and asserted that the privilege was waived by Radixx’s post-closing conduct. The Court rejected this argument. It held that Section 13.12 specifically defined “Privileged Communications” as including any attorney-client communications between Radixx and its counsel that occurred prior to the closing.

Holdco argued further that Radixx should have taken steps to segregate the attorney-client pre-closing communications in its computer systems before Holdco acquired those systems, as was suggested in Great Hill. The Court indicated that Holdco’s argument undermined the advice given in Great Hill, which urged parties to negotiate for contractual protections. The Court reasoned that if it allowed Holdco to use the otherwise privileged emails, doing so would render Radixx’s negotiated contractual protections meaningless. In addition, Section 13.12 required that all parties involved take the steps necessary to ensure that the pre-merger privileges remained in effect and be assigned to and controlled by the selling stockholder representative after the closing. The Court observed that any waiver was partially due to Holdco’s own failure to “take the steps necessary” to preserve the privilege, therefore violating its own contract.

This decision provides a useful reminder to sellers when negotiating the terms of a merger agreement to include language that would effectively preserve their rights and privileges in potential disputes with buyers.

Copyright © 2021, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume IX, Number 156
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About this Author

John Stigi securities law  corporate attorney Sheppard Mulli, law firm
Partner

John Stigi is a partner in the Business Trial Practice Group in the firm's Century City and New York offices, and leader of the firm's Corporate/Securities Litigation Team.

Mr. Stigi's practice focuses on securities class action and shareholder derivative action defense, SEC investigation defense, internal corporate investigations, complex contract and commercial litigation, and M&A and corporate governance litigation.  He has extensive experience representing issuers, officers, directors and auditors in all areas of securities, corporate...

310-228-3717
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