Privilege issues to consider when negotiating M&A transactions
Sophisticated buyers and sellers in M&A transactions should consider what rules will govern the target company’s and the seller’s legal privilege post-closing. For instance, should privilege belong to the seller or remain with the target company (and therefore the buyer)? Should privilege over some matters be transferred but not others? Do different considerations apply to asset transactions? This article provides important takeaways on such questions, informed by recent Canadian litigation.
The privilege issue in Dente
Dente et al v Delta Plus Group et al. concerns a post-closing dispute over earn outs and other issues between individuals who sold shares of a private company and the buyer of those shares. The sellers became consultants of the target company post-closing until the dispute. During the ensuing litigation, the sellers asserted privilege over documents on the target company’s servers relating to the M&A transaction. The share purchase agreement (SPA) did not address how privileged documents should be treated post-closing and deemed all books and records of the target company to be the buyer’s property.
Key principles governing post-closing privilege in M&A transactions
The Court in Dente applied the following principles:
- The default rule is that privilege held by a target company belongs to that company (not its shareholders). As such, the buyer will own the target company (and its privilege) post-closing. This rule applies to privileged communications with and involving third parties (such as investment bankers, accountants, etc.).
- Parties can contract out of the default rule by stipulating that a selling shareholder retains sole possession of the target company’s privilege prior to closing.
- The selling shareholders and the target company may be in a joint retainer relating to the M&A transaction. In such a scenario, the privilege belongs to both the selling shareholders and the target company (owned by the buyer when the dispute arises). Neither can maintain confidentiality from the other. They continue to maintain privilege as against third parties.
- The selling shareholder’s privilege is not waived when documents are inadvertently left behind at the target company post-closing, especially if the sellers made reasonable efforts pre-closing to delete such documents.
- A selling shareholder who continues to use the company’s server/device to communicate (for instance, because they remain as an employee or consultant) does not waive privilege provided the seller has a reasonable expectation of privacy. Such an expectation may not be supported if there is a verbal or written corporate policy permitting the company to access communications on company servers/devices, or stating that use of its servers/devices would result in the loss of any applicable privilege.
- In the pre-transaction phase, the seller and the target company should carefully consider who deal counsel will represent. Once that determination is made, it should be consistent with the transaction documents, retainer agreement, invoices, and instructing representatives. This issue has significant implications for how any applicable privilege will be treated in a post-closing dispute. If the target company and seller share deal counsel, then they will share the privilege and it will be difficult to justify confidentiality between the joint clients in a post-closing dispute. As a practical consequence, the seller and the buyer will both have access to privileged documents relating to the transaction.
- The M&A agreement should address matters relating to privilege. Parties can contract out of the default rules applicable to privilege. The principles applied in Dente are similar to those applied in NEP, a 2013 decision from Alberta’s Court of Appeal concerning privilege in a post-closing dispute. They are consistent with Delaware law which, unlike Canada, has considered and approved the use of a contract to preserve a seller’s right to privilege in the context of an asset purchase.
The M&A agreement may specify:
- who will retain any applicable privilege (seller, buyer, and/or target company);
- the category of privileged documents to which the agreement applies (e.g. only transaction-related privilege documents or other categories, etc.);
- covenants about the seller’s conduct relating to privileged documents (e.g.: seller did not delete any privileged documents, seller will not assert it has joint privilege with the target company in any post-closing dispute, etc.)
- covenants about the buyer’s conduct relating to privileged documents (e.g.: buyer will not assert the target company has joint privilege with the seller in any post-closing dispute, buyer will not access or use any privileged documents left behind at the target company, buyer will not argue privilege has been waived if it finds any privileged documents, buyer will not use certain privileged and non-privileged documents in any post-closing dispute, buyer will not object to seller using the target company’s historical counsel in any post-closing dispute or in other matters, etc.).
- Sellers should take reasonable steps to protect their privilege. They should delete privileged documents stored on the company’s servers or devices, contemporaneously document such steps, and inform the buyer that such steps are being taken to protect the seller’s privilege. If documents cannot be deleted (for instance, due to IT policies), then the seller should consider whether alternative means of communication with its deal counsel should be used (for instance, separate email accounts that can be deleted or storing documents on servers not owned by the company). If such precautions are not practical, the seller should negotiate a covenant for the buyer to not access and use such documents.
- A seller should avoid engaging in any post-closing privileged communications that may be accessible to the target company (i.e., the buyer). Many corporate policies expressly specify that users of a company’s resources should have no expectation of privacy and their communications may be unilaterally accessed or monitored. As such, sellers should verify whether such policies may apply before using company servers and/or devices for privileged communications.