Case background
In DLO Enterprises, a seller brought claims against a buyer for breach of an asset purchase agreement (the Agreement), by which the buyer purchased substantially all of the seller’s assets. The seller’s allegations included that the buyer failed to follow contractual indemnification procedures and took other improper actions. The buyer filed counterclaims, including for breach of contract and fraudulent inducement.
Section 1.1 of the Agreement stated the seller would transfer, and the buyer would acquire, all of the seller’s “right, title and interest” in all of the seller’s assets, including “all files” and “all inventory.” Section 1.1 further provided the seller’s transfer excluded the “Excluded Assets,” defined to include the seller’s “rights under or pursuant to this Agreement and agreements entered into pursuant to this Agreement.” Section 8.9 of the Agreement stated “[t]he parties intend that, at all times after the Closing, [the buyer] will have the right in its discretion to assert or waive any attorney work-product protections, attorney-client privileges and similar protections and privileges relating to the Assets and Assumed Liabilities.”
The seller’s owners prior to the asset sale (the Seller Owners) worked for the buyer following the closing of the transaction. During discovery proceedings, a dispute arose between the parties regarding the privilege associated with various documents responsive to discovery requests, as well as emails between the sellers, the Seller Owners, and counsel on email accounts that the buyers acquired through the asset purchase. Specifically, the parties disputed whether the seller and the Seller Owners could claim attorney-client privilege over three categories of documents.
The buyer argued, under Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. Nov. 15, 2013), any privilege over the seller’s pre-transaction communications passed to the buyer in the sale, and Section 8.9 of the Agreement waived privilege. The seller argued Great Hill was inapplicable and that its privilege fell within the Agreement’s Excluded Assets definition and, therefore, did not transfer. The buyer filed a “Motion for Disposition of Privilege Dispute,” seeking an order compelling production of the disputed materials.
The court’s decision
The Court of Chancery denied the buyer’s motion to compel the seller to produce attorney-client privileged materials concerning negotiation of the buyer’s purchase of the seller’s assets. The court concluded the seller retained the privilege as a matter of law absent a clear waiver agreement, which the parties did not form.
The court discussed Great Hill, which decided as a matter of first impression that, under 8 Del. C. Section 259, attorney-client privilege regarding merger negotiations belonging to a merger target passes to the surviving corporation, absent an express contractual carve out. The court’s ruling also relied on a prior decision of the court that applied Great Hill and found that merger parties expressly agreed to such a carve out (therefore, precluding the acquiring party from also acquiring the pre-closing privileged communications):
“In the asset purchase context, the seller will retain pre-closing privilege regarding the agreement and negotiations unless the buyer clearly bargains for waiver or a waiver right. Here, Buyers failed to explicitly secure pre-closing privilege waiver rights relating to the negotiation of the Purchase Agreement. Where Buyers did not clearly secure in the Purchase Agreement itself the rights they seek this Court to enforce, the Court will not unilaterally read such rights into existence. Accordingly, Sellers retain privilege with respect to such communications.”
See DLO Enters., 2020 WL 2844497, at *5.
The court held a seller’s attorney-client privilege with respect to an asset purchase agreement and its negotiation remain with the seller post-closing unless the parties contract for a different result. The court relied on (and distinguished) its prior ruling in Great Hill, which concluded that, under 8 Del. C. Section 259, attorney-client privilege regarding merger negotiations belonging to a merger target passes to the surviving corporation absent an express contractual carve out:
“... [8 Del. C. Section 259] and [the] interpretation of it [in Great Hill] do not apply [in a case that] centers on an asset purchase, not a merger. Then-Chancellor Strine acknowledged as much in Great Hill when distinguishing [Postorivo v. AG Paintball Holdings, Inc., 2008 WL 343856 (Del. Ch. Feb. 7, 2008)], an asset purchase case in which the Court applied New York law to an asset purchase agreement that excluded certain assets, rather than a merger that included all assets, and the parties had agreed that under the specific contractual terms of their transaction, the seller retained the attorney-client privilege over communications relating to the negotiation of the transaction .... Postorivo did not even cite Section 259 of the [Delaware General Corporation Law].
He also characterized Great Hill’s question presented as ‘an issue of statutory interpretation in the first instance.’ Mergers governed by statute, which automatically transfer ‘all property, rights, privileges, powers and franchises,’ are distinct from asset purchase transactions governed by agreements, which enumerate the assets being sold.…
In addition to their different sources of governance, mergers and asset purchases present practical differences. Unlike a merger, in an asset purchase transaction, the selling entity is not extinguished by or subsumed within the purchasing entity. The seller still exists, holding any assets that were not purchased, together with related privileges.”
See DLO Enters., 2020 WL 2844497, at *4.
The court’s decision in DLO Enterprises makes clear that, in an asset sale, legal privilege remains with the seller. However, consistent with Delaware’s strong policy in favor of parties’ freedom of contract, the court reaffirmed, as recognized in Great Hill and Postorivo, that parties to an asset purchase agreement (or a merger agreement) are permitted to specifically articulate in the contract whether the privilege is passing to the buyer (or acquirer). This is true regardless of whether the parties are just restating the default law or dictating a different result. Indeed, to minimize the likelihood of a dispute regarding who “owns” the pre-closing privilege, it would be prudent to specifically articulate this in the transaction document.
Key takeaways
The Court of Chancery’s decision in DLO Enterprises clarifies an important area of Delaware law and extends the reasoning articulated years ago in Great Hill. With the benefit of DLO Enterprises, Great Hill, and related decisions, such as Postorivo, the following guidance can be gleaned:
- In connection with asset sales under Delaware law, the seller’s pre-closing privilege does not pass to the buyer, absent contractual language to the contrary.
- In connection with mergers under Delaware law, the target company’s pre-closing privilege passes to the acquiring company, absent contractual language to the contrary.
- The best practice under Delaware law, regardless of transaction structure, is to clearly express in the transaction documents, such as the merger agreement or asset purchase agreement, whether the privilege is passing to the buyer or the target in connection with the transaction.
Client Alert 2020-405b
