In Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013), a Delaware Chancery Court recently considered whether pre-merger attorney-client privileged communications between a seller’s outside counsel and the seller’s stockholders and representatives regarding a Delaware merger transaction were owned and controlled by the buyer or the seller’s stockholders and representatives following the closing of the merger transaction.  In one of his last decisions before his confirmation as Chief Justice of the Supreme Court of Delaware, Chancellor Leo E. Strine, Jr. held that the attorney-client privilege over all pre-merger communications, including those relating to the negotiation of the merger itself, passes to the surviving corporation in the merger, by plain operation of clear Delaware statutory law under Section 259 of the Delaware General Corporation Law (the “DGCL”), unless the parties to the merger agree otherwise.

The Great Hill Equity Partners case involved a buyer in a Delaware merger which sued the former stockholders and representatives of the seller for fraudulent inducement a year after the closing of the merger, after the buyer found some questionable communications between the seller and the seller’s counsel about the merger on computers that were acquired by buyer in the merger. Before the merger, the seller had no taken any steps to remove these communications from the seller’s records or computer systems, and otherwise never attempted to obtain the return of any such communications from the buyer.  Upon learning of these communications from the buyer, the seller’s stockholders and representatives took the position that such communications were protected under the attorney-client privilege, and that the seller and its stockholders and representatives controlled the privilege with respect to pre-merger communications regarding the negotiation of the merger. The merger agreement negotiated by the seller and the buyer did not carve out pre-merger attorney-client communications from assets being acquired by the buyer in the merger. The merger agreement also provided that the merger was to have the effects set forth in the DGCL. Under Section 259 of the DGCL, after a merger, “all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation . . . .”

The Delaware Chancery Court ultimately held that under Section 259 of the DGCL, in a Delaware merger, the attorney-client privilege passes to the surviving corporation as a matter of law, and may not be asserted by the Seller or its stockholders or representatives following the merger, unless otherwise agreed to by the parties to the merger.  Among other things, the Court ruled that the plain meaning of the words “all…privileges” in Section 259 of the DGCL clearly included all privileges, including the attorney-client privilege, and that the Court was not permitted to interpret the language in a manner inconsistent with the clear and unambiguous language of Section 259 of the DGCL.  The Delaware Chancery Court did, however, note that parties to a Delaware merger are free to negotiate provisions in the merger agreement or other merger documents regarding the transfer of the attorney-client privilege and other privileges, so as to exclude from the transferred assets controlled by the buyer any pre-closing attorney-client communications that the seller’s stockholders and representatives desire to preserve.

There may be serious unintended consequences under the Great Hill Equity Partners case for any seller in a Delaware merger transaction if seller’s counsel does not make efforts to preserve the attorney-client privilege for seller’s stockholders and representatives in the merger documents. When a seller communicates with seller’s counsel regarding the negotiation of a merger transaction, such communication is generally made with the expectation that the confidentiality of such communications with counsel will be preserved.  Based on that expectation of confidentiality, a seller is much more likely to be candid with seller’s counsel regarding issues in the merger.  Candor in the communications between a seller and seller’s counsel enables seller’s counsel to effectively represent seller in the merger, and may facilitate the disclosure and resolution of possible issues with buyer’s counsel prior to the closing of the merger.  The disclosure and resolution of possible issues relating to the merger prior to the closing of the merger helps to avoid litigation between the parties following the closing of the merger.  The possibility of such communications made between the seller and its counsel being used by the buyer against the seller or its counsel in a lawsuit following the closing of the merger may serve to chill any candor in communications between a seller and its counsel during the merger negotiations, and possibly lead to post-closing issues and litigation between the parties to the merger.

The ruling in Great Hill Equity Partners may open a Pandora’s Box in which every buyer in a consummated Delaware merger transaction which does not address the attorney-client privilege issues in the merger documents will actively search computer records and other records of the seller for attorney-client communications in support of indemnification claims against the seller’s stockholders and representatives for alleged breaches of representations and warranties, fraudulent inducement and other claims. This could create a potential landslide of lawsuits by unscrupulous buyers against not only the seller’s stockholders, but also the seller’s counsel, if any questionable attorney-client communications are located and such communications have not otherwise been preserved by the seller, its stockholders or representatives in the merger documents.

As a result, it is imperative for sellers and counsel for sellers to take affirmative action in any Delaware merger to include provisions in the merger agreement or other merger documents regarding the transfer of the attorney-client privilege and other privileges, so as to exclude from the transferred assets controlled by the buyer any pre-closing attorney-client communications that the seller’s stockholders and representatives desire to preserve, or otherwise make other efforts to preserve such attorney-client communications.  In addition to the possible exclusion of attorney-client privileged communications from the transferred assets of a seller, other strategies to preserve the attorney-client privilege in Delaware merger transactions include (i) incorporating joint privilege provisions (subjecting pre-closing privileged communications to a joint privilege to be held by the seller company (pre-merger) or the seller’s stockholders or representatives and give the seller company (pre-merger) or the seller’s stockholders or representatives equal rights to assert the joint privilege and its protections) in the terms of a merger agreement and (ii) entering into a common interest agreement between the stockholders and representatives of seller and the seller (pre-merger) under which the parties agree to joint rights to the seller’s privileged communications and agree to the prohibition of the use of the privileged communications against each other.  In addition to the employment of the above strategies in connection with the negotiation of documents relating to the merger, precautions should also be taken to remove all such attorney-client privileged communications from any paper records and electronic storage media of seller in which such communications may be stored, and to properly counsel all representatives of seller to avoid including parties not covered by the privilege in privileged communications during merger negotiations, so as to avoid any inadvertent waiver of the attorney-client privilege.

Although the Great Hill Equity Partners case dealt with a merger transaction governed by Delaware law, sellers in merger transactions governed by New Jersey law should take heed of the Chancery Court’s ruling.  The New Jersey statute governing mergers and consolidations of corporations, N.J.S.A. 14A:10-6, has provisions similar to Section 259 of the DGCL which generally provide that all of the privileges of the parties in a merger or consolidation vest in the surviving corporation in the merger, unless the corporation’s certificate of incorporation provides otherwise. Similarly, the New Jersey statute governing mergers of limited liability companies, N.J.S.A. 42:2C-77, provides that all of the privileges of the parties to the merger vest in the surviving limited liability company in the merger, unless prohibited by other law.  Additionally, at least two New Jersey cases have discussed the issue of control over the attorney-client privilege upon the change of control of a corporation, and have generally found that when control of a corporation passes to new management in connection with a merger or other succession, the authority to assert and waive the corporation’s attorney-client privilege passes as well to the new management, and that only the new management may assert or waive the attorney-client privilege with respect to communications made by former officers and directors (even if the communications at issue concerned matters within the scope of the duties of such former officers or directors). As a result, sellers in New Jersey merger and consolidation transactions involving corporations and limited liability companies should strongly consider implementing the strategies discussed above prior to the closing of the merger or consolidation in order to preserve the confidentiality of any attorney-client privileged communications between the seller and seller’s counsel.