Gun-Jumping and Due Diligence: Reducing Merger Risks 


Spring 2006 - ( Lang Michener Competition & Antitrust Brief )

Lang Michener Competition & Antitrust Brief and Federated Press, 2006, Vol Xi, No. 1
In light of the current level of merger and acquisition activity, it is timely to re-examine the question of pre-merger coordination of conduct among parties negotiating such transactions. While this kind of conduct can be problematic, not all efforts by merging parties to coordinate their affairs in advance of a merger are unlawful. This conservative view may make mergers less successful than they might otherwise be, because of an over-reaction to high-profile cases over the past decade where parties faced large fines for engaging in inappropriate pre-merger conduct. The most common case referred to arose in 2003 (USA v. Gemstar-TV Guide, U.S. Dist Ct., DC). 

Recently, the U.S. Federal Trade Commission addressed this subject by saying "we are mindful that many forms of pre-merger coordination are reasonable and even necessary and that care needs to be taken not unduly to jeopardize the ability of merging firms to implement the transaction and achieve available efficiencies." (William Blumenthal, General Counsel, November 2005). 

Frequently, the purchaser will wish to compel the target to conduct its business before closing in a way that is beneficial to the post-merger interests of the acquiring party. The reason competition (anti-trust) officials are concerned about coordination before a deal is finalized is two-fold. The first is a desire to prevent combining parties from actually merging their activities before the merger has been reviewed in accordance with the requirements of the Competition Act. This kind of conduct (called "gun-jumping") can also be the subject of an investigation under the criminal conspiracy provisions of the Competition Act, where the allegation may be that the parties – not yet affiliated – have conspired to lessen competition. 

While there is no new jurisprudence on the subject in Canada, there is a good basis for looking closely at U.S. jurisprudence and to conduct a proposed merger in a manner that avoids both the long-arm reach of American antitrust authorities, as well as challenges by our own Competition Bureau. 

In Canada, all acquisitions of control over, or a significant interest in, all or part of a business, regardless of size, are subject to review by the Bureau, even if it is the case that certain mergers (those exceeding statutory monetary thresholds) are more likely to attract attention. The Bureau can, in the middle of a merger review, while the merging parties are engaged in due diligence, switch gears and conduct a conspiracy investigation. 

The Bureau is on record in respect of gun-jumping conduct. The Merger Enforcement Guidelines (1991) provide as follows:

Information exchanged during merger negotiations which do not ultimately lead to a merger could raise questions which may require examination pursuant to the conspiracy provisions of section 45 of the Act. This risk can be reduced by limiting the information exchanged to that which is reasonably necessary to make a decision to merge, and by ensuring to the extent possible that such information is restricted to persons involved in negotiating the transaction, e.g., lawyers, accountants, chief executive officers or merger counsellors. Unless there are legitimate reasons why commercially sensitive information needs to be shared in both directions, such risk can also be reduced by ensuring that the information flow is one way.

Although the revised Guidelines omit this discussion, there is no question that the Bureau expects parties to carry on their affairs in a way that does not violate the conspiracy provisions of the Act. That said, the law does not seek to make mergers unsuccessful by restraining the parties' abilities to provide for an appropriate evaluation of the benefits of a merger or for an orderly transition to a merged entity. 

In addition to concerns that the parties will behave as though they were merged, and coordinate their activities inappropriately before they become a single firm, there is also a concern that the parties may disclose to each other information which, upon a decision not to close a transaction for whatever reason, will essentially teach them how to coordinate future conduct so as to minimize competition. Therefore, parties should confine the information exchanged to that necessary to evaluate the merger, prepare regulatory filings and prepare for transition, within the context of a proposed transaction. Accordingly, the merging parties should avoid discussions of the continuing party's future plans and projections, and both parties should minimize discussions about costs, output, distribution channels and, especially, price. 

Practically, merging parties will find restraints on sharing such information, and particularly unit cost and revenue information, terribly annoying when trying to evaluate a proposed transaction, so it is not uncommon to try to establish some safe zones. There are various ways of doing this, not all of them without risk, including the following:

  • Enter into a confidentiality agreement to preserve confidentiality in case the merger doesn't proceed.
  • Keep negotiating teams small (professionals and the most senior manager(s)).
  • Consider a "clean team" that keeps all sensitive information in a black box, the contents of which are never disclosed to others within their organizations. The creation and makeup of such teams and the rules by which they are bound require professional review and advice, and even then, views range considerably.
  • Confine certain information to third parties such as advisors and counsel.
  • Keep the information flowing one way (seller to buyer and not the other way around) and document it accordingly.
  • Avoid discussions about customer pricing and unit purchases, and often even the identity of customers and suppliers in cases where that is not known.
  • If sensitive information must be disclosed, use aggregated data rather than specific and detailed information.

In conclusion, while there is an ongoing need for guidance by counsel to merging parties to prevent inappropriate conduct, purchasers should not be so concerned about these risks as to prohibit all transition and post-merger planning, joint courtesy calls to important customers and suppliers, and announcements and joint promotion of the benefits of the transaction itself. The goal should be to take sufficient care to minimize risks from competition or antitrust enforcement in each relevant jurisdiction, while maximizing the likelihood of achieving the desired results for the parties.