On April 14, the Justice Department’s Antitrust Division (“Antitrust Division”) announced a $1.8 million civil settlement against merger partners Qualcomm and Flarion Technologies alleging “gun-jumping” violations of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“HSR Act”). The action underscores the Antitrust Division’s resolve to vigorously scrutinize the conduct of merging parties prior to consummation of the transaction.
On July 25, 2005, Qualcomm and Flarion entered into a merger agreement that required a premerger filing under the HSR Act. All parties to transactions that meet certain jurisdictional thresholds are required to file a premerger notifications with the Federal Trade Commission (the “FTC”) and Antitrust Division. The premerger notification filing triggers a mandatory waiting period under the HSR Act, which is normally 30 days. A “gun-jumping” violation of the HSR Act occurs when a buyer attempts to exercise “beneficial ownership” or operational control over a seller’s business prior to expiration of the HSR waiting period. Gun-jumping increasingly draws the scrutiny of the Antitrust Division and the FTC and, in several cases, leads to significant monetary penalties. The normal 30 day HSR waiting period was extended for Qualcomm and Flarion because the Antitrust Division needed more time to investigate the competitive aspects of the deal. Ultimately, the Antitrust Division, terminated the waiting period on December 23, 2005, and the merger closed in January 2006.
Antitrust Division’s Issue
The Antitrust Division’s complaint against Qualcomm and Flarion focused on the parties actual conduct as well as specific covenants in the merger agreement that required the seller, Flarion, to obtain Qualcomm’s written consent before engaging in a variety of business activities between the signing and closing of the transaction. The Antitrust Division contended that several of these covenants, together with the parties’ actual conduct prior to obtaining HSR approval, violated the HSR Act by giving Qualcomm an inappropriate amount of control over Flarion’s business activities before the HSR waiting period had expired.
Merger agreements governing transactions that must observe the HSR waiting period normally contain “conduct of business” covenants. These covenants are intended to ensure that the seller continues operating its business in the ordinary course and does not take actions that could seriously impair the value of the seller’s business. The antitrust authorities consider these goals to be reasonable and valid.
However, a “gun-jumping” problem arises when the covenants give the buyer excessive control over the target’s business during the waiting period, in violation of the HSR Act. Unfortunately, there is no bright-line test. In its complaint, the Antitrust Division singled out four out of twenty-one restrictions on Flarion’s business as problematic. These covenants prohibited Flarion, without first obtaining Qualcomm’s written consent, from: (1) presenting business proposals to any customer or prospective customer; (2) entering into any agreement to license intellectual property (the core of Flarion’s business) to a third party; (3) entering into any material contract, or certain other contracts involving the obligation to pay $75,000 or more per year or $200,000 or more in the aggregate; or (4) hiring any employee other than in the ordinary course of business in accordance with past practice.
At first glance, the prohibition on presenting business proposals and licensing intellectual property to third parties without Qualcomm’s consent seems overly restrictive. On the other hand, it is typical to see monetary or qualitative (e.g., “ordinary course of business”) thresholds on operational restrictions. That being said, the Antitrust Division did not just focus on the covenants in the merger agreement themselves, rather, it focused on the parties’ actual conduct as well. For example, Flarion on multiple occasions allegedly sought Qualcomm’s consent before it marketed products and services to customers and potential customers. Flarion sought Qualcomm’s consent even before providing pricing information to a potential customer. Allegedly, Qualcomm discouraged Flarion from certain business opportunities Flarion may have otherwise pursued. Accordingly, the Antitrust Division focused on the aggregation of the parties’ actual conduct along with the questionable covenants.
The Antitrust Division’s action underscores the federal antitrust authorities’ considerable concern about the transfer of beneficial ownership and control prior to the expiration of the HSR waiting period. The purpose of the HSR Act and the waiting period, in particular, is to give the government notice so that it has an adequate opportunity to investigate proposed mergers and take action before companies actually combine their operations. Accordingly, companies should avoid any appearance of combining their operations, by restricting the flow of confidential competitive information between them and making sure that independent business decisions are not coordinated prior to the expiration of the waiting period.
The HSR waiting period keeps the parties separate, thereby preserving their status as independent economic actors during an antitrust investigation. Consistent with this purpose, an acquiring person may not, after signing a merger agreement, exercise operational or management control of the to-be-acquired person’s business until the waiting period has expired.
Merger agreements typically contain “interim covenants” limiting the to-be-acquired person’s operations during the pre-consummation period. These covenants generally do not violate the HSR Act because the purpose of these standard provisions is to prevent a to-be-acquired person from taking actions that could seriously impair the value of what the purchaser has agreed to buy. While these customary provisions limit the seller’s ability to make certain business decisions without the buyer’s consent, these provisions are normally reasonable and necessary to protect the value of the transaction and do not constitute an HSR Act violation. The general rule to keep in mind is that the purchaser cannot begin to direct or influence important operational strategic or personnel decisions of the seller before closing.
Moreover, beneficial ownership is evaluated through the specifics of the merger agreement, the parties’ actual conduct, and the industry in which the parties operate. Qualcomm’s restriction on Flarion from presenting business proposals and licensing intellectual property to third parties was extraordinary and went to the heart of the seller’s ability to compete and grow its business. More importantly, the Antitrust Division alleged that Qualcomm actually exercised operational control over Flarion through the aggregation of its conduct along with the questionable covenants.
In summary, the Antitrust Division’s action against Qualcomm reinforces the message sent by the antitrust authorities in the past six gun-jumping cases. Conduct that is intended to facilitate procompetitive integration planning is fine and in most cases, is procompetitive, however, merging parties should not implement the plans or act as if the merger has already occurred. Merging parties and their lawyers must scrutinize covenants that go beyond the standard ordinary course provisions. In addition to examining these covenants, the parties and their lawyers should continue to monitor the parties’ actual conduct during the waiting period and, where the parties are competitors, all the way through the closing to make sure the purchaser is not exerting undue influence over the seller’s ongoing business.