Change-in-control transactions can present complicated questions concerning the attorney-client privilege, should litigation arise.  Does any privilege protect post-signing, pre-closing communications between the acquirer’s and the target’s respective counsel, or are those communications subject to discovery?  And what happens post-closing to pre-closing privileged communications – does the acquiring company also acquire the pre-merger privileged communications of the target?  Recent decisions by courts in New York and Delaware help shed light on these questions and provide useful guidance on how to ensure that all available privileges are preserved.

Post-Signing and Pre-Closing Communications Between the Acquirer’s and Target’s Counsel

In Ambac Assurance Corp. v. Countrywide Home Loans, Inc., [1]  the New York Supreme Court, Appellate Division, First Department addressed whether New York’s common interest doctrine shields from discovery post-signing, pre-closing communications between counsel for a target company and its acquirer, even if neither party contemplated litigation at the time of the communications.  After reviewing federal precedents and Delaware evidentiary law, the First Department held, contrary to recent authority from other New York appellate courts, that the common interest doctrine protects these communications from disclosure even if litigation was not contemplated.

The case arose out of Ambac Assurance Corporation’s agreement to insure payment on residential mortgage-backed securities issued by Countrywide Home Loans, Inc. and its affiliates between 2004 and 2006.  Ambac alleged, among other things, that Countrywide had fraudulently induced Ambac to insure the mortgage-backed securities.  Ambac likewise sought to hold Bank of America Corp. (“BAC”) liable as Countrywide’s successor-in-interest, based on BAC’s having acquired Countrywide in July 2008.  The First Department reversed the lower court’s grant of Ambac’s motion to compel disclosure of communications between Countrywide, BAC and their respective counsel, dating from the period beginning January 11, 2008, when Countrywide and BAC signed their merger agreement, and ending July 1, 2008, when the merger was consummated.  Ambac sought discovery of these documents in support of its successor-liability claim against BAC.  For its part, BAC argued that its counsel’s communications with Countrywide and its counsel between the signing of the merger agreement and the closing were protected by the attorney-client privilege and thus immune from discovery.

The First Department began by describing the common interest doctrine as “a limited exception to the waiver of the attorney-client privilege,” whereby otherwise-privileged communications between client and counsel do not lose their privileged status notwithstanding their disclosure to a third party.The court identified two prerequisites for the common interest doctrine to apply: “(1) the communication qualif[ies] for protection under the attorney-client privilege, and (2) the communication [was] made for the purpose of furthering a legal interest or strategy common to the parties” (Ambac, at *2, citing Kelly v. Handy & Hartman, 2009 WL 2222712, *2 (S.D.N.Y. July 23, 2009)).  Ambac argued, and the lower court agreed, that for the common interest doctrine to apply, New York law also requires that the communications at issue pertain to pending or reasonably anticipated litigation, and thus because neither BAC nor Countrywide contemplated litigation when the merger agreement was signed, the communications between BAC’s and Countrywide’s respective counsel were not privileged (Ambac, at *5).

In reversing the lower court’s decision, the First Department conceded that other New York courts, including the Second Department as recently as in 2013, “have taken a narrow view of the common-interest privilege, holding that it applies only with respect to legal advice in pending or reasonably anticipated litigation” (Ambac, at *1; see also Ambac at *4, citing Hyatt v. State of Cal. Franchise Tax Bd., 105 A.D.3d 186, 205 (2d Dep’t 2013)).  Nonetheless, the First Department held that “in today’s business environment, pending or reasonably anticipated litigation is not a necessary element of the common interest privilege,” noting that “business entities often have important legal interests to protect even without the looming specter of litigation” (Ambac at *2).  Thus, “[s]o long as the primary or predominant purpose for the communication with counsel is for the parties to obtain legal advice or to further a legal interest common to the parties, and not to obtain advice of a predominantly business nature, the communication will remain privileged” (Ambac, at *4).

In its reasoning, the Court observed that the common interest doctrine is derived from the attorney-client privilege which, unlike the work product doctrine, “is not tied to the contemplation of litigation” because “advice is often sought, and rendered, precisely to avoid litigation, or to facilitate compliance with the law, or simply to guide a client’s course of conduct” (Ambac, at *3).  Accordingly, it “extend[ed] logically” from the doctrine’s origins that “litigation need not be actual or imminent for communications to be within the common interest doctrine” (Ambac at *4, citing Dura Global Tech., Inc. v. Magna Donnelly Corp., No. 07-cv-10945-DT, 2008 WL 2217682, *3 (E.D. Mich. May 27, 2008)).  The court also catalogued a variety of authorities supporting its conclusion: the federal courts, which have “overwhelmingly rejected” the argument that the common interest doctrine requires pending litigation (Ambac, at *3, citing United States v. Schwimmer, 892 F.2d 237 (2d Cir. 1989)); the Restatement of the Law Governing Lawyers, which takes the same position (Ambac, at *3); and Rule 502(b) of the Uniform Delaware Rules of Evidence, which codifies the common interest doctrine but does not require pending or anticipated litigation (Ambac, at *6).   The court likewise described its conclusion as “the better policy,” as it would encourage the parties to a merger agreement to seek the advice of counsel together, thereby potentially reducing follow-on litigation as the companies navigate complicated integration and regulatory issues (Ambac, at *5).

Ambac provides helpful guidance as to the privilege status of post-signing, pre-closing communications, but many questions remain unresolved.  Most obviously, Ambac conflicts with recent authority from New York’s Second Department (see Ambac, at *4, noting disagreement with Hyatt v. State of Cal. Franchise Tax Bd., 105 A.D.3d 186, 205 (2d Dep’t 2013)), a dispute which will remain unresolved unless the Court of Appeals weighs in.  Moreover, the Ambac court highlighted the “complex legal and regulatory process” involved in consummating the Countrywide/BAC merger (Ambac, at *5).  While one would imagine that most, if not all, mergers would present complex legal and regulatory problems, future litigants could seek to distinguish Ambac on this ground, particularly in transactions involving less heavily-regulated entities.  Finally, Countrywide and BAC had signed a confidentiality agreement (Ambac, at *5); while such agreements are hardly unusual in an M&A context, it is unclear whether Ambac would apply in the absence of such an agreement.

The Post-Closing Status of Pre-Merger Privileged Communications

Another increasingly common intersection between attorney-client privilege and M&A concerns the privileged status post-closing of pre-merger communications.  Suppose a company sells a wholly-owned subsidiary to a buyer.  Later, the buyer discovers that the company is subject to an unknown legal liability, and comes to regret its purchase.  The buyer sues the seller, claiming the seller fraudulently induced the sale.  Can the defendant seller claim that its pre-sale communications with its counsel, which may contain privileged advice regarding the liability giving rise to the dispute, retain their privileged status post-closing and are not discoverable by the buyer?

Chancellor (now Chief Justice) Strine faced similar questions in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013).  There, the plaintiffs (“Buyer”) sued the former shareholders and representatives (“Seller”) of Plimus, Inc., claiming that Seller had fraudulently induced Buyer into buying Plimus.  After the complaint was filed in September 2012, Buyer discovered that it could access Seller’s pre-transaction communications with Plimus’s then-counsel that were stored on Plimus’s computer systems.  Buyer notified Seller that it had access to these communications, which Seller claimed were privileged, but Seller did not try to claw back the documents for over a year (a fact which, while not necessary to the opinion’s reasoning, is nonetheless noted twice) (Great Hill Equity Partners IV, LP, 80 A.3d at 156, 162).  Buyer then sought the Court’s intervention to determine the documents’ privilege status.  The questions before the Chancery Court in Great Hill Equity Partners were (1) whether, notwithstanding the merger, Seller could continue to assert the attorney-client privilege over its pre-transaction communications with counsel, and (2) whether the privilege had been waived, either (i) by Seller’s failure during the pre-merger period to guard against the privileged communications being handed over to Buyer post-merger, or (ii) by Seller’s failing to ask for the return of the documents immediately after learning that Buyer could access them.  Based on the “plain operation of clear Delaware statutory law,” in particular § 259 of the Delaware General Corporation Law (“DGCL”) (Great Hill Equity Partners IV, LP, 80 A.3d at 162), the court ruled that the privilege governing Seller’s pre-merger communications now belonged to Buyer, without reaching either waiver question.

The Chancery Court’s opinion rests heavily on the text of DGCL § 259, which provides that, post-merger, “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. . . .” (Ambac, at 156)  In arguing for a narrow interpretation of section 259, Seller contended that “privileges” as used in the statute was intended to cover only property rights such as easements or uses of copyright, rather evidentiary privileges (Ambac, at 157; see also at *1 and at *4, citing Hyatt v. State of Cal. Franchise Tax Bd., 105 A.D.3d 186, 205 (2d Dep’t 2013)).  The court, however, brushed this argument aside, stating that it “conflict[ed] with the only reasonable interpretation of the statute, which is that all means all as to the enumerated categories, and that this includes all privileges, including the attorney-client privilege” (Ambac, at 158).  The court also stated that, because the statutory language is unambiguous, “[w]hatever the case may be in other states, members of the Delaware judiciary have no authority to invent a judicially-created exception to the plain words ‘all . . . privileges’ and usurp the [Delaware] General Assembly’s statutory authority.”[2]

The court also squarely addressed the appearance of prejudice to Seller if its pre-merger privileged communications were disclosed to Buyer, stating that “the answer to any parties worried about facing this predicament in the future is to use their contractual freedom . . . to exclude from the transferred assets the attorney-client communications they wish to retain as their own” (Ambac, at 161).  Indeed, the court approvingly noted that many private-company merger agreements (several of which Buyer had submitted to the court) specifically excluded attorney-client communications regarding the merger negotiations from the assets passing to the surviving company by operation of law (Ambac, at 160). Not having bargained for and obtained such a provision, Seller’s privileged communications passed to Buyer with the merger.

Lessons From Ambac and Great Hill Equity Partners

Among the lessons to be learned from these rulings are the following:

• Ambac provides strong support for the proposition that post-signing, pre-closing privileged communications between a target and an acquirer are protected by the common interest doctrine, but does not represent authoritative New York law. Other New York courts may still require the expectation of litigation for the common interest doctrine to apply.

• Great Hill Equity Partners approves the use of contractual provisions in merger agreements to exclude privileged communications from the assets passing to the acquiring company in the merger, and such provisions have become common in private-company merger agreements. A standard-form version of such a clause might read substantially as follows:

From and after the Effective Time, (i) the direct and indirect holders of Company Shares immediately prior to the Effective Time (the “Former Shareholders”) shall be the sole holders of the attorney-client privilege with respect to the engagement of [Seller Counsel] by the Company, and neither the Surviving Corporation nor its Affiliates shall be a holder thereof, (ii) to the extent that files of [Seller Counsel] in respect of such engagement constitute property of the client, only the Former Shareholders and their respective Affiliates (and none of Parent, the Surviving Corporation or their respective Affiliates) shall hold such property rights and (iii) [Seller Counsel] shall have no duty whatsoever to reveal or disclose any such attorney-client communications or files to Parent, the Surviving Corporation or any of their Affiliates by reason of any attorney-client relationship between [Seller Counsel] and the Company or any of its respective Affiliates or otherwise. This Section is irrevocable, and no term hereof may be amended, waived or modified, without the prior written consent of [Seller Counsel].

• Finally, Ambac and Great Hill Equity Partners purport to express the law of New York and Delaware, respectively, and may provide added grounds for choosing New York or Delaware law to govern a merger agreement.

Endnotes

[1] Ambac Assur. Corp. v. Countrywide Home Loans, Inc., 124 A.D.3d 129, 130, 998 N.Y.S.2d 329, 330 (2014).

[2] Ambac, at 159.  Seller fared no better in arguing that, even if some privileged communications would pass to Buyer by operation of  section 259, public policy concerns counseled in favor of a narrower ruling that merger-related communications with counsel should not pass to the surviving corporation.  According to the court, “[i]t would usurp the authority of our elected branches for this court to create a judicial exception to the words ‘all . . . privileges’ for pre-merger attorney-client communications regarding the merger negotiations.  This sort of micro-surgery on a clear statute is not an appropriate act for a court to take.”  Ambac. at 160.