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Gun-Jumping Concerns for Pending Transactions When There Is No Such Thing as “Ordinary Course of Business”April 27, 2020
Many competition authorities across the world have merger control laws that mandate pre-merger notification of a proposed transaction when relevant filing thresholds are met and require the merging parties to suspend closing the transaction until clearance is received. Acquiring control over a target company without first obtaining merger control clearance from these competition authorities when the thresholds are met is viewed as a “gun-jumping” violation.
Competition authorities recognize that parties to a proposed transaction pending merger clearance need to undertake due diligence and perform some integration planning and that that work necessarily involves the sharing of sensitive information. However, the antitrust laws also seek to limit information sharing and coordination between the parties while review of a merger is pending so that competition is not harmed or restricted before closing should the deal ultimately not go forward.
While illegal gun-jumping can span a broad array of pre-close conduct, this alert focuses on how the ongoing COVID-19 pandemic could create gun-jumping-related pitfalls for parties to proposed mergers seeking to comply with interim operating covenants. For M&A transactions subject to closing conditions, including antitrust clearance, the target company generally will covenant that it must conduct its business in the “ordinary course” during the post-signing, pre-closing interim period. These covenants provide comfort to a buyer that, at closing, it will acquire the target company in essentially the same condition as when the buyer entered into the acquisition agreement and after the bulk of the buyer’s due diligence was conducted.
But the COVID-19 pandemic has forced many companies to depart from their past “ordinary course” operating practices based on both the need to comply with new legal obligations and to adjust for significant changes in supply and demand across industries. As merging companies navigate deal complexities exacerbated by COVID-19, they should carefully consider the following:
- The US and EU competition authorities have been and remain active in enforcing gun-jumping laws, while in recent years other competition authorities across the world, and notably in China, have become increasingly active.
- Merging companies should pay particular attention to covenants requiring the target company to share information with and seek approval from the buyer in order to engage in conduct outside of the ordinary course and inconsistent with past practices. Given the unprecedented steps many companies are taking in light of the COVID-19 pandemic, it is expected that there will be significantly more coordination and disclosure between merging parties than is typical—coordination that could potentially raise gun-jumping concerns.
- Although antitrust agencies acknowledge the unprecedented nature of the COVID‑19 pandemic, they also have made clear that the standard of scrutiny of potentially anticompetitive transactions and practices—like gun-jumping—will not be relaxed notwithstanding the difficult circumstances caused by the pandemic.
Too Much Influence Over the Target Company Pre-Closing
The United States. The US antitrust laws require transacting parties to remain separate and independent economic actors before closing. Both the Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice are known for persistently pursuing gun-jumping cases and have brought enforcement actions for gun‑jumping violations under the HSR Act, Section 1 of the Sherman Act, and Section 5 of the Federal Trade Commission Act. Section 1 violations most often result from parties to a pending transaction—generally when they are competitors—sharing competitively sensitive information before obtaining clearance. The US antitrust agencies have enforced the gun-jumping laws against companies that have engaged in conduct amounting to a transfer of operational control before closing and when buyers have exercised too much influence over the target company’s assets, routine business decisions, or operations. Gun-jumping enforcement actions in the US have led to both civil penalties, injunctive relief, and disgorgement of illegally gained profits.
The European Union. The EU Merger Regulation (EUMR) prohibits the closing of a notifiable transaction until the European Commission (EC) has granted merger control clearance. As such, the EUMR prohibits a company from acquiring pre-clearance “control” over another company by outright closing the transaction or by operating in a way that de facto puts the transaction “into effect.” In addition, where a transaction involves parties that are competitors, pre-closing conduct (such as the exchange of commercially sensitive information) may constitute illegal coordination between the separate companies and may fall within the scope of Article 101(1) of the Treaty on the Functioning of the European Union. The EC may impose heavy fines for each type of gun-jumping infringement.
Asia. In China, Japan, and Korea, implementing a transaction (including in part) that has been notified but not yet cleared constitutes gun-jumping. In these jurisdictions, and similar to the US and EU, competing companies that share competitively sensitive information before obtaining clearance would also risk contravening the general rules prohibiting collusion.
In China, the State Administration for Market Regulation (SAMR) is particularly active in the pursuit of gun-jumping, having issued no less than 52 decisions to date. Penalties for gun-jumping under the China Anti-Monopoly Law (AML) include an administrative fine of up to RMB 500,000 (approx. USD 71,000), and potentially the unwinding of the transaction if it restricts competition. And while current penalties may seem small, in the recent draft revisions to the AML, SAMR proposed a gun-jumping fine of 1-10% of the company’s turnover for the preceding year.
In Japan, in contrast, despite numerous investigations, and although gun-jumping may be subject to criminal fines of not more than JPY2m (approximately USD $18,372), the Japan Fair Trade Commission (JFTC) has not imposed pecuniary penalties to date.
The Korea Fair Trade Commission (KFTC) has investigated many gun-jumping cases (some 29 cases in 2018 according to the latest available data), but few have resulted in sanctions. Parties should be aware that under Korea’s Monopoly Regulation and Fair Trade Act, corporations may be subject to administrative fines for gun-jumping not exceeding KRW 100 million (approximately USD $81,000), while executives, employees, or other persons involved may also be penalized with fines not exceeding 10 million KRW (approximately USD $8,100). The KFTC also has a power to file suit against the parties seeking a declaration that any transaction implemented before clearance is void.
The Impact of COVID-19 on Conduct Covered by Interim Operating Covenants
While antitrust laws do permit buyers to place restrictions on the conduct target companies can engage in during the period between sign and close, those restrictions are generally limited to conduct that materially diverges from ordinary course business practices. On the other hand, buyers are not permitted to interfere in the day-to-day operations of the target company. As they navigate the complexities raised by COVID‑19, merging parties should carefully consider whether interim operating covenants may confer too much influence over the target company’s pre-close operational business decisions on the buyer—by virtue of the buyer having approval power over decisions inconsistent with the target company’s past practice.
As examples, we list below common interim operating covenants that may potentially raise gun-jumping considerations in the current COVID-19 environment:
- Covenant to Conduct Business in the Ordinary Course. One customary affirmative covenant in an acquisition agreement is the target company’s obligation to conduct its business in the ordinary course in the period between signing and closing. Given the unprecedented steps many companies are taking in response to the COVID-19 pandemic, companies may no longer be in a position to conduct their businesses in the ordinary course consistent with past practice. Conversely, it may not be in the buyer’s interest that the target company ignores the fundamental changes in the marketplace without adjusting its operations, as ‘business as usual’ may threaten the target company’s value.
Accordingly, a need may arise to engage in more coordination and disclosure between a buyer and a target company than is typical in order to adapt the covenant to the current environment and ensure the target company’s compliance with it. For example, there may be more instances in which a target company is required to seek the buyer’s express consent for a given action and therefore greater risk that a target company’s commercially sensitive information is disclosed. Parties should consider whether a “consistent with past practices” qualifier makes sense in the current environment and whether to draft exceptions to the covenant to provide more freedom for the target company to unilaterally make decisions in response to the pandemic.
- Covenant to Retain Employees and Maintain Benefit Plans. Many acquisition agreements contain an affirmative obligation for the target company to retain its officers and employees during the interim period, typically qualified by a “reasonableness” standard. Many acquisition agreements also require target companies to refrain from adopting or terminating employee benefit plans or making any changes to their existing plans or compensation arrangements, often qualified by materiality or dollar amount thresholds or limited to apply only to certain employees.
Because of the economic downturn triggered by the pandemic, many employers have had to reevaluate their labor costs. Large-scale layoffs or other significant changes to the composition or deployment of a target company’s labor force could technically violate the covenant depending on the scope of the changes. Target companies may also need to materially change their compensation arrangements with employees or modify existing benefit plans. Moreover, the proliferation of remote work in response to the pandemic could implicate certain changes to employee benefit plans. In order to avoid breaching its obligations under this covenant, a target company may be forced to obtain buyer’s approval for these operational changes. In short, these processes could require extensive collaboration between the buyer and the target company around what may now be day-to-day operational decisions relating to personnel and other related labor issues. This heightened collaboration may not raise only gun-jumping concerns, but the interest of antitrust regulators around the globe who have been particularly focused on preserving competition in labor markets.
- Covenant Not to Enter Into, Modify, or Waive Any Rights Under Material Contracts. Another common interim operating covenant is the target company’s covenant not to amend or waive any material right under or terminate material contracts between signing and closing. At times, this is also framed as an affirmative covenant pursuant to which a target company is obligated to comply with the terms of all material agreements. In today’s environment, many companies are waiving performance obligations, extending payment terms, and otherwise modifying commercial agreements in response to COVID-19 in ways that might ordinarily breach this type of covenant.
Parties entering into acquisition agreements in the current environment should carefully consider the materiality threshold that determines which (and how many) contracts are covered by this covenant and again consider exceptions to this covenant to permit target companies to exercise unilateral control over more of these business decisions than they otherwise would typically be granted.
- Covenant Not to Incur Debt or Make Tax-Related Changes. Secondarily, customary interim operating covenants can restrict a target company’s ability to incur debt or effect tax planning changes during the executory period. Many companies may consider incurring additional debt to address cash flow shortages due to reduced sales in the current environment. Additionally, companies may consider making changes to tax elections or structuring to take advantage of the many tax relief packages being offered by governments worldwide in response to the pandemic. Companies should consider carefully the scope of these covenants in light of the current environment to preserve the target company’s flexibility to make decisions to ensure financial stability and ensure the buyer is not exercising too much operational control of the target company pre-close in violation of gun‑jumping laws.
In Today’s Environment, Could Interim Operating Covenants Give Too Much Influence Over the Target Company to Buyers?
As outlined above, a variety of interim operating covenants may now be more likely to garner attention of merging parties and raise unique issues in the wake of the COVID-19 pandemic. Put simply, it is probable that there will be far more instances in which a buyer’s express consent is required for a given action and a greater risk that a target company’s sensitive information is disclosed than in the period prior to the COVID-19 outbreak. Could soliciting and providing consent raise gun-jumping concerns for antitrust agencies? Public statements from the antitrust agencies as well as past gun-jumping enforcement actions may provide some insight.
The United States. In a recent statement, the FTC made clear that “[n]either the legal standards that apply to transactions nor the Bureau’s investigational standards have been relaxed in light of the coronavirus pandemic.” A subsequent FTC statement added that the “antitrust laws are flexible enough to account for changing market conditions, even during uncertain times. As we saw during the 2008 financial downturn and countless other difficult periods in our nation’s history, ‘emergency’ exceptions to the antitrust laws are not needed. Now more than ever, FTC staff must continue to analyze carefully the potential effects of proposed transactions and business conduct.” In short, parties to pending or proposed transactions should not expect that the US antitrust agencies’ persistent pursuit of gun-jumping enforcement actions will wane because of the COVID‑19 pandemic. If anything, parties may find themselves navigating scenarios that implicate gun-jumping concerns with greater frequency in the current climate as they evaluate whether to seek or solicit approval of business conduct pursuant to interim operating covenants.
The US antitrust agencies acknowledge that the current COVID-19 crisis is unprecedented. As a result, past gun-jumping enforcement actions may not serve as a perfect guide. Prior actions do make clear that target companies should be particularly wary of soliciting approval of certain business decisions that touch on competitively sensitive information or may be viewed in the current environment as operational business decisions that are no longer exceptional. Similarly, buyers should be wary of providing for the approval of business decisions that go beyond protecting the value of the transaction and could be seen as exercising operational control of key business decisions pre-close, especially relating to personnel decisions and material customer contracts.
European Union. As with previous economic recessions, merging parties should expect robust enforcement of EU antitrust laws, including gun-jumping infractions when the parties engage in integration (and not just integration planning) or illegal cooperation pre‑clearance. The EC’s enforcement history on gun-jumping requires companies to be careful in scoping and implementing interim operating covenants. For example, covenants preventing target companies from appointing senior management without buyer approval could be viewed as gun-jumping if the senior management position is not relevant to the ongoing value of the business. Further, the EC has made clear that granting the buyer veto rights over commercial contracts should be limited to contracts that are “relevant to preserving the value of the target’s business“ and not ones made in the ordinary course.
Care should also be employed to avoid structuring deals that may put a transaction de facto “into effect” before antitrust clearance is granted. Some deal structures that may have increased appeal in times of crisis because they promise a swift path to closing may prove particularly risky. For example, “two-step” structures (also referred to as “warehousing agreements”), should be handled with particular vigilance in light of the EC’s recent decision in the Canon/Toshiba case. Warehousing agreements involve the purchase of the target company by an interim buyer and the parallel transfer of a purchase option to the ultimate buyer. If the first step is necessary for and contributes to the acquisition by the ultimate buyer of final control over the target company, which occurs with the second step of the transaction, the EC will consider the two steps as a single notifiable transaction. Therefore, the closing of the first step of the interrelated transactions without notifying it and/or without awaiting merger clearance is considered a partial implementation and illegal gun-jumping. As another example, illustrated by the EC’s Altice/PT Portugal decision, ancillary agreements designed to support the target company and preserve its value until closing, such as entering into joint-purchasing arrangements, may well be viewed as (full or partial) premature implementation.
To avoid gun-jumping violations for transactions where time is of the essence, parties may request the EC grant a derogation from the suspension obligation, allowing them to close the transaction before antitrust clearance. Indeed, upon reasoned request, the EC can grant the parties permission to implement a concentration before its final decision, taking into account the negative effects that a delay in implementation might have on the parties or third parties. In this respect, it is interesting to note that the EC granted the vast majority of these derogations in the wake of past economic recessions.
Asia. In China, Japan, and Korea, national regulators have not indicated that they would suspend or relax enforcement against gun-jumping in the wake of the COVID-19 pandemic. In China, SAMR’s past enthusiasm for pursuing cases of gun-jumping will likely continue unabated in today’s environment, including where buyers seek to preemptively control the target company. For example, SAMR sanctioned the implementation of one or more steps of a multistep transaction in Korean OCI/Tokuyama and Meinan /CiMing. However, parties may be able to benefit from accelerated review procedures. On April 4, 2020, SAMR announced a series of antitrust enforcement measures that include expediting merger control reviews in sectors related to the fight against COVID-19 or other sectors affected by COVID-19. Whatever else this announcement might mean, it certainly does not signal any relaxed approach to gun‑jumping.
In Japan, despite the lack of penalties imposed so far, the authorities—including at a political level—have been insisting that parties must comply with the merger-related rules of the AMA, including those that prohibit gun-jumping. One of the JFTC’s notable investigations in this area was its 2016 decision relating to the Canon/TSMC warehousing transaction structure—the same case that was sanctioned by the EC in 2019 (see above). The JFTC issued a warning that parties should not engage in similar conduct or implement comparable structures in future transactions—and there is no indication that the COVID-19 emergency has impacted matters in this respect. Faced with the consequences of the COVID-19 pandemic, parties may however consider a written request to the JFTC that it shorten the relevant merger control waiting period. In this context, the JFTC routinely agrees to shorten the waiting period for small to medium-sized deals where it is evident that they will not restrict competition.
As to Korea, we expect the KFTC will continue to pursue gun-jumping cases consistent with previous practice. Similar to Japan, parties may ask for an expedited review if they are successful in convincing the KFTC of the necessity to close by a certain date.
Parties should consult counsel in all transactions to ensure that, before closing, the parties do not engage in any conduct prohibited by the antitrust laws. Now more than ever—when it may appear to many companies that there is no such thing as “ordinary course” in the wake of COVID-19—it is critical that parties engage counsel to carefully review any proposed interim operating covenants to ensure that the activities that may be permitted or prohibited by these covenants do not amount to a transfer of pre-close operational control or the illegal exchange of competitively sensitive information. Likewise, parties should consult counsel to ensure that their contemplated deal structure will not raise gun-jumping concerns. Counsel can also advise parties on the wisdom of requesting that relevant competition authorities expedite review of a pending transaction or allow it to close prior to antitrust clearance. Put simply, companies already contending with the impacts of COVID-19 to their businesses do not also want to find themselves unnecessarily in antitrust enforcers’ crosshairs for gun-jumping.
At O’Melveny, our corporate law experts have significant experience negotiating interim operating covenants, and our antitrust law experts have the depth of knowledge required to counsel clients on the related gun-jumping concerns. Our in-depth understanding of how antitrust agencies in the US, Europe, and Asia work—and our established relationships with those regulators—enable us to help clients navigate the challenges posed by the COVID-19 pandemic. If your company is contemplating a transaction, O’Melveny’s global antitrust team can help.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Ben Bradshaw, an O'Melveny partner licensed to practice law in California and the District of Columbia, Riccardo Celli, an O'Melveny partner licensed to practice law in the Capital Region of Brussels, the Law Society England & Wales, and Roma, Courtney Dyer, an O'Melveny partner licensed to practice law in the District of Columbia and New York, Andrew Frackman, an O'Melveny partner licensed to practice law in New Jersey and New York, Yoji Maeda, an O'Melveny partner licensed to practice law in Japan and New York, Philip Monaghan, an O'Melveny partner licensed to practice law in the Capital Region of Brussels, Hong Kong, the Law Society England & Wales, and the Law Society Ireland, Bo Pearl, an O'Melveny partner licensed to practice law in California, Anna Pletcher, an O'Melveny partner licensed to practice law in California, Katrina Robson, an O'Melveny partner licensed to practice law in California and the District of Columbia, Youngwook Shin, an O'Melveny partner licensed to practice law in California, the Republic of Korea, and New York, Ian Simmons, an O'Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, Michael Tubach, an O'Melveny partner licensed to practice law in California and the District of Columbia, Christian Peeters, an O'Melveny of counsel licensed to practice law in the Capital Region of Brussels and Germany, Rechtsanwalt, Courtney C. Byrd, an O'Melveny counsel licensed to practice law in the District of Columbia and Maryland, Vince A. Ferrito, an O'Melveny counsel licensed to practice law in New Jersey and New York, Stephen McIntyre, an O'Melveny counsel licensed to practice law in California, Philippe Nogues, an O'Melveny counsel licensed to practice law in the Capital Region of Brussels and Paris, Charles Paillard, an O'Melveny counsel licensed to practice law in Paris, France, in the Capital Region of Brussels, Belgium and a registered foreign lawyer in Hong Kong, Lining Shan, an O'Melveny counsel, Onur C. Surmeli, an O'Melveny counsel licensed to practice law in California, Sergei Zaslavsky, an O'Melveny counsel licensed to practice law in the District of Columbia and Maryland, John Chong, an O'Melveny associate licensed to practice law in California, Maude Vonderau, an O'Melveny associate licensed to practice law in the Capital Region of Brussels, and Harry Ingleby, an O'Melveny trainee solicitor, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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