Preserving privilege with respect to pre-closing communications between a selling corporation’s counsel and its management is an important negotiation point in many transactions, so that the seller can prevent the buyer from using such communications against the seller in disputes between the buyer and the seller, but the buyer can continue to assert that privilege in disputes with third parties. The default rule under Delaware law is that the privilege passes to the buyer post-closing. More specifically, section 259 of the Delaware General Corporation Law provides, in part, that “all property, rights, privileges, powers and franchises” shall pass to the surviving corporation. However, the parties may negotiate around this provision in the transaction documents according to the Delaware Court of Chancery’s decision in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP.[1]
The transaction documents in Great Hill did not include a carve-out from section 259, and so the court concluded that the privilege passed to the buyer. Following Great Hill, most stock/merger transactions have included provisions addressing who owns the privilege post-closing. The court’s recent Shareholder Representative Services, LLC v. RSI Holdco, LLC[2] decision is the first post-Great Hill ruling to address a challenge to a section 259 carve-out provision.
The carve-out provision in RSI Holdco included four key elements: (1) preservation of pre-closing privileged communications; (2) assignment of the privilege to a representative of the seller’s shareholders; (3) agreement among the parties to take necessary steps to preserve the privilege and to vest the privilege with the shareholder representative; and (4) agreement from the buyer not to use pre-closing privileged communications in post-closing litigation. The buyer attacked this provision on two related fronts. First, the buyer argued that the no-use provision applied only to communications that remained privileged following the closing, and that the seller had waived privilege with respect to pre-closing communications. The court rejected this argument because the parties’ agreement specifically defined “privileged communications” to include any pre-closing attorney-client communications between the seller and its counsel. Second, the buyer argued that the seller waived privilege because it did not take steps to segregate the privileged communications from its computer servers before transferring them to the buyer. The court also rejected this argument because it would render the seller’s contractual rights meaningless. The court was also strongly persuaded by the contractual obligation for all parties to take necessary steps to preserve privilege for the seller. Hence, the buyer could not rely upon its own failure to segregate the privileged communications to support its waiver argument against the seller. The court also acknowledged [implicitly] that requiring the seller to isolate all pre-closing privileged communications would be impracticable and could serve to unnecessarily delay transaction closings so that the communications could be so segregated.
RSI Holdco provides useful guidance for drafting effective terms for preserving privilege with the seller with respect to pre-closing communications so that pre-closing attorney-client communications regarding the negotiation of the transaction cannot be unilaterally used against the seller in a post-closing dispute with the buyer. Key among these terms is a mandate that all parties take steps necessary to preserve the privilege and “no-use clause” to restrict use of the privileged communications by the buyer in any post-closing litigation. It is also important to carefully define what constitutes a privileged communication so as not to inadvertently leave communications outside of the preservation clause. Finally, the “privilege clause” should provide for the assignment of the right to assert the negotiated privilege to the applicable seller’s representatives that are responsible for handling litigation between the buyer and the sellers.
[1] 80 A.3d 155 (Del. Ch. 2013).
[2] C.A. No. I 2018-0517-KSJM (Del. Ch. May 29, 2019).
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