M&A Safe Harbor Policy bolsters deal certainty

On Oct. 4, Deputy Attorney General (DAG) Lisa Monaco announced a new U.S. Department of Justice (DOJ) Mergers & Acquisitions Safe Harbor Policy (the Safe Harbor) for companies that voluntarily and timely self-report misconduct discovered during the due diligence of an acquisition target or the integration of the acquired entity. The Safe Harbor is designed to offer substantial benefits, including the presumption of a declination of prosecution and the avoidance of successor liability, to acquiring companies that timely self-report, investigate and remediate misconduct at an acquired entity. Since the announcement, the new policy has faced considerable political criticism, with some groups arguing that it gives a free pass to corporate wrongdoers and may accelerate market concentration. But critics have failed to acknowledge the valuable impact the policy can have on M&A transactions, particularly during the diligence and negotiation process by allowing both buyers and sellers to more precisely quantify and allocate liability costs or uncertainties upfront. Specifically, the Safe Harbor provides both buyers and sellers in M&A transactions compelling incentives to ‘clean house’, as it were, in the course of M&A diligence and deal negotiations, in order to avail themselves of the liability-limiting benefits of the Safe Harbor, thus providing more deal certainty for both parties with respect to the potential financial impacts, scope and allocation of responsibility with respect to any remediation, restitution, and disgorgement required as a result of such misconduct.

Acquiring companies that promptly and voluntarily disclose misconduct within six months of the consummation of an acquisition, cooperate with the ensuing DOJ investigation, and engage in appropriate remediation, restitution, and disgorgement within one year of such consummation will receive the following liability-limiting benefits:

(1) Presumption of Declination of Prosecution:

The buyer will receive the presumption of a declination of prosecution from DOJ (rather than assuming potential successor liability for the misconduct). This provides substantial relief from the DOJ’s standard position that when a “company merges with or acquires another company, the successor company assumes the predecessor company’s liabilities” including criminal and civil liabilities;

(2) Relief Amidst Aggravating Factors

Even though there may be aggravating factors or circumstances at the acquired entity (including, for example, involvement of company executives in the misconduct, significant profits to the company from the misconduct, misconduct that is egregious or pervasive within the company, or repeated misconduct), the buyer will still be eligible for the Safe Harbor’s relief; and

(3) No Effect on Recidivist Analysis

Any misconduct disclosed under this Safe Harbor will not be factored into future recidivist analysis for the acquiring company, which means that an acquiring company that self-discloses misconduct at the acquired company will not be considered a “recidivist” in future enforcement actions.

The above benefits can significantly cut off and limit a buyer’s future liability for a seller’s misconduct. However, it’s not just buyers that stand the chance to benefit here. Sellers should consider that the above benefits could, in turn, effectively limit their own vulnerability and liability to buyers under the purchase agreement with the buyer. In private transactions, M&A agreements often allocate responsibility for damages resulting from any misconduct at the seller, either through general indemnification provisions relating to breaches of representations and warranties that cover such matters which have not previously been discovered by the seller and/or disclosed to the buyer, or through specifically negotiated indemnity, escrow and purchase price adjustment provisions when such matters have been discovered and/or disclosed. Even in public transactions where general indemnification provisions are much less common, M&A agreements nevertheless provide for potential termination or other remedies available to buyers due to significant breaches of representations and warranties, as well as material adverse effects at the seller, between signing and closing, and can include escrowed or held back funds allocated toward post-closing costs associated with misconduct that is discovered or disclosed. In both cases, uncovering, disclosing and limiting the potential near term costs and long-term impacts to a buyer from misconduct early on in the process can aid sellers in providing both closing and overall price certainty. Thus, even though the Safe Harbor allows for self-reporting up to 6 months post-closing, the Safe Harbor may provide compelling incentives for both buyers and sellers in mergers and acquisitions to engage in a robust diligence process early on in transaction negotiations in order to maximize the benefits available under the Safe Harbor by enabling them to negotiate a deal with tailor made M&A agreement provisions that provide such certainty for both parties.

While the DOJ has previously encouraged companies to perform preacquisition diligence to identify prior illegal conduct, reduce the risk that an acquired company continues to engage in illegal conduct post-closing, and permit the parties to negotiate costs and responsibilities of potential violations of law identified during an acquisition, the Safe Harbor now provides concrete benefits to parties that facilitate this process early on. In effect, the Safe Harbor incentivizes transaction parties to put a little extra work in upfront in order to substantially limit their mutual risk with respect to possible violations.

Though the Safe Harbor arms buyers and sellers with more clarity on DOJ’s posture toward successor liability, the decision to self-report will remain fact intensive and require a case by case assessment of the risks and potential benefits. Regardless of whether a company chooses to avail itself of the Safe Harbor, it serves as a reminder that acquiring companies should have in place a robust pre-closing due diligence and post-closing integration process reasonably designed to detect potential violations of law. It also should serve as a reminder to target companies that failure to implement compliance controls could lead to liability that will be uncovered and disclosed by an acquirer before or even after a transaction closes.