Shareholder Representative Services LLC v. RSI Holdco, LLC: Delaware Chancery Court Provides Guidance on Preservation of Pre-Closing Privileged Communications in Private Company M&A Transactions
May 30, 2019
In Shareholder Representative Services LLC v. RSI Holdco, LLC, C.A. No. 2018-0517-KSJM (Del. Ch. May 29, 2019), the Delaware Court of Chancery upheld a provision in a private-company merger agreement precluding a buyer from using the seller’s privileged emails against the seller in post-closing litigation. Following the guidance from the decision in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013), the RSI Court held that under the terms of the parties’ merger agreement, pre-merger communications between the target company’s owners and representatives and the target company’s counsel could not be used by the buyer in a post-closing dispute.
In September 2016, RSI Holdco, LLC (“Buyer”) acquired Radixx Solutions International, Inc. (“Radixx”). Radixx and its counsel negotiated for a so-called “Great Hill provision” in the merger agreement—i.e., one providing that certain pre-merger privileged communications would not pass to the Buyer at the effective time. In essence, the merger agreement provided that the pre-merger privileged communications between the sellers and company counsel would survive the merger and be assigned to the stockholders’ representative, and prevented the Buyer from using or relying on any such privileged communications. Despite the clear language of the merger agreement, the Buyer sought to use approximately 1,200 pre-merger emails that it had acquired by virtue of the merger in post-closing litigation. Although it acknowledged that the emails were presumably privileged at the time they were made, the Buyer argued that because the sellers did not take steps to excise or segregate the privileged communications from the email servers, the privilege had been waived.
In addressing the dispute, the Court followed the guidance in Great Hill “that absent ‘an express carve out, the privilege over all pre-merger communications—including those relating to the negotiation of the merger itself—[pass] to the surviving corporation in the merger . . . .’” The Court noted that, under Great Hill, parties are able to use their “contractual freedom . . . to exclude from the transferred assets the attorney-client communications they wish to retain as their own.” The Court held that the privilege claw-back provision of the merger agreement, “[b]y its plain and broad language,” preserved the privilege, vested control over the privilege in the stockholders’ representative, and prohibited the Buyer from using or relying on the privileged communications in any post-closing dispute among the parties.
In reaching its conclusion, the Court rejected the Buyer’s arguments to circumvent the clear terms of the merger agreement. The Buyer first argued that the merger agreement’s “no-use” provision was inapplicable, as it applied only to privileged communications—and the emails at issue were no longer privileged because, post-closing, the sellers had taken no steps to prevent the disclosure of the emails to the Buyer. The Buyer also argued that a merger agreement “carve-out” provision did not render the privilege immune from subsequent waiver due to inaction.
Rejecting the first argument, the Court held that because the merger agreement defined “Privileged Communications” to include “any privileged attorney client communications between [Radixx counsel] and [Radixx] . . . prior to the Closing Date,” and because the Buyer did not challenge the privilege as of the closing date, the plain language of the merger agreement barred the Buyer from using or relying on the emails in the post-closing litigation. As to Buyer’s second argument, the Court found that it would “undermine the guidance of Great Hill—which cautioned parties to negotiate for contractual protections.” The Court stated that “[p]ermitting [the Buyer] to both ‘use and rely on’ the [e]mails would further render the express language of [the privilege claw-back provision] meaningless.” The Court further explained that the Buyer’s arguments in support of a waiver of the privilege failed because the merger agreement required the parties to “take the steps necessary to ensure that any privilege attaching as a result of [Radixx’s counsel] representing [Radixx] . . . in connection with the transactions contemplated by this Agreement shall survive the Closing, remain in effect and be assigned to and controlled by the [Representative].” Thus, for the privilege to be waived, the Court found that it would necessarily be due in part to the Buyer’s own failure to “take the steps necessary” to preserve the privilege. The Court found that the Buyer could not argue that its own failure to preserve the privilege should now inure to its benefit.
The RSI opinion is the first opinion of the Court of Chancery following Great Hill to squarely address the scope of a privilege claw-back provision in a private company merger agreement. The Court’s opinion illustrates the importance of expressly and clearly delineating the treatment of pre-closing privileged communications that would otherwise be transferred to an acquirer upon a sale or merger. Following the guidance in RSI, target companies and their counsel are encouraged to ensure that privilege claw-back provisions not only provide for the preservation of pre-closing privileged communications, but that they also (i) provide for the express assignment of control over the privilege to the stockholders’ representative, (ii) require all parties to take steps to ensure that the privileged communications are preserved and vested in the stockholders’ representative, (iii) prohibit the buyer from making use of any such privileged communications, and (iv) define the scope of materials subject to these protections as those privileged as of the closing date. The Court’s opinion also makes clear that, if covered by such a robust privilege claw-back provision, sellers need not engage in a pre-closing document review and segregation exercise to protect the privilege and restrict the buyer’s access to pre-closing privileged communications.