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Illegal Pre-Merger Coordination Challenged by the US Department of Justice

January 1, 0001

 

 On January 21, 2010, the Antitrust Division of the Department of Justice ("DOJ") announced a civil penalty action against Smithfield Foods, Inc. ("Smithfield") and Premium Standard Farms, LLC ("Premium") for "gun-jumping" violations of the Hart-Scott-Rodino Act (the "HSR Act" or "Act"). DOJ's charges grew out of its investigation of the merger between Smithfield and Premium in 2007; during that investigation, the DOJ found that Smithfield — the buyer — had engaged in conduct that constituted premature assumption of operational control of some of Premium's ordinary course of business activities. This action provides additional guidance on the joint activity parties to a merger can and cannot engage in before expiration of the HSR waiting period.

The HSR Act requires parties to file notifications and observe a waiting period before they consummate certain mergers or acquisitions. The purpose of the Act is to provide the federal antitrust agencies the opportunity to consider whether the transaction will "substantially... lessen competition." While the waiting period is pending, the parties remain separate companies and, generally speaking, may not "jump the gun" and coordinate business activities.

In this case, the parties' merger agreement contained customary interim conduct of business provisions placing certain standard limitations on Premium's operations during the HSR waiting period to "protect Smithfield's legitimate interests in maintaining Premium's value without impairing Premium's independence." These legitimate provisions included limitations on Premium's right to assume new debt or financing, issue new voting securities or sell assets, as well as a requirement that Premium carry on its business in the "ordinary course consistent with past practice." The parties closed their merger in May 2007, after the DOJ completed its investigation and the HSR waiting period had expired. However, during the merger investigation the DOJ identified three instances where the parties went beyond the legitimate provisions in their agreement and engaged in gun-jumping. In these three cases, the seller, Premium, had actually submitted proposed supply contracts to Smithfield management for its approval. The total value of these contracts — which were for the purchase of hogs from independent hog producers — ranged between US$57 and US$67 million. Each time Premium sought consent, it provided Smithfield with the proposed contract terms, including the price to be paid for the hogs, the quantity of hogs to be purchased, and the length of the contract. The DOJ alleged that through this review and approval process, Smithfield inappropriately was exercising actual operational control over a "significant segment" of Premium's business in violation of the HSR Act. To settle the DOJ's complaint, Smithfield agreed to pay a civil penalty of US$900,000.

This case is the fourth "gun-jumping" case the DOJ has brought in recent years. In 2006, the DOJ alleged that Qualcomm Incorporated violated the HSR Act when Flarion Technologies ceded control of many of its management and operational decisions to Qualcomm prior to the expiration of the HSR waiting period. The Qualcomm/Flarion Merger Agreement prohibited Flarion, without Qualcomm's consent, from entering into agreements with third parties, entering into any agreement to pay or receive US$75,000 (later amended to US$250,000), present business proposals to customers or prospective customers, and, in practice, to hire new employees. In settlement of the DOJ's complaint, the parties paid a civil penalty of US$1,800,000. In 2003, the DOJ alleged that Gemstar International Group, Ltd. engaged in improper pre-merger conduct when it required merger partner TV Guide Inc. to submit, for Gemstar's review and approval, numerous decisions relating to TV Guide's marketing of its interactive programming guides. In settlement of its complaint, Gemstar was required to pay a US$5,676,000 civil penalty. In 2001, the DOJ alleged that Computer Associates, which was acquiring Platinum Technology, "jumped-the-gun" by, among other things, installing its employees at Platinum's headquarters to review and approve customer contacts, by restricting Platinum's right to negotiate discounts for its products and services without approval, and by collecting from Platinum, and disseminating within Computer Associates, competitively sensitive information. The DOJ obtained a civil penalty of US$638,000 from Computer Associates in settlement of its complaint.

The DOJ's recent gun-jumping actions should remind firms and their counsel that the antitrust agencies and the antitrust laws require merging parties to operate as independent firms during the period between the signing of a merger agreement and the closing of the transaction, notwithstanding the acquiring firm's interest in protecting its investment. In addition to the possibility of substantial civil penalties, an antitrust agency investigation into gun-jumping conduct can delay clearance of the underlying merger transaction, and, if the conduct runs afoul of the Sherman Act, may support a Sherman Act Section 1 complaint by either an antitrust agency or a private plaintiff. Not all (or even most) pre-closing conduct is prohibited; merging parties can protect against gun-jumping violations through fairly simple and straightforward procedures and close coordination between in-house and antitrust counsel and the merging parties' business teams.