Recent Changes to Antitrust Merger Review Process
By Stephen Y. Wu and Carla A. R. Hine
The Federal Trade Commission (FTC) and U.S. Department of Justice (DOJ) recently announced important changes to the merger review process. First, the FTC announced proposed changes to its merger filing rules and the notification form parties to certain transactions must submit under the Hart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976, as amended. On the heels of that announcement, the FTC and DOJ released their final revisions to the Horizontal Merger Guidelines (Guidelines). These announcements will increase the burdens of compliance with the merger review process and, more generally, require increased sensitivity to avoid unnecessary antitrust pitfalls.
Proposed Changes to Hart-Scott-Rodino Premerger Notification Rules
As detailed in our August 18, 2010 On The Subject, "FTC Proposes Changes to Hart-Scott-Rodino Notification Rules and Form," the FTC announced proposed changes to its HSR rules and notification form. These proposed changes will eliminate disclosure requirements for information the FTC and DOJ no longer find helpful in their initial antitrust review, and introduce new provisions intended to capture additional information to make clear competitive relationships and implications not revealed by current HSR filings. Among the proposed changes are increased document disclosure requirements and the introduction of the concept of “associates” of the acquiring party. While the proposed changes may decrease the burden of reporting in some areas, they will significantly increase the burdens in other areas, likely resulting in an overall net increase in the effort required to prepare HSR filings.
Additional Document Disclosures: 4(d) Documents. Item 4(c) of the HSR notification currently requires submission of documents prepared by or for an officer or director "for the purpose of evaluating or analyzing the acquisition with respect to market shares, competition, competitors, markets, potential for sales growth or expansion into product or geographic markets." The proposed changes will add an Item 4(d) and significantly expand the scope of documents parties will be required to submit to include:
- Documents prepared by or for an officer or director of the notifying party that evaluate or analyze synergies and/or efficiencies related to the proposed transaction, and
- Documents prepared in the ordinary course of business – and not necessarily for purposes of analyzing the transaction – "by investment bankers, consultants or other third party advisors" for an officer or director of the notifying party that reference the entity or assets to be acquired, and evaluate or analyze market shares, competition, competitors, markets, potential for sales growth or expansion into product or geographic markets.
If implemented without change, this rule will significantly expand the scope and burden of the document collection and search necessary for submission of an HSR filing, requiring a two-year search for documents from officers' or directors' files for these broad-ranging classes of documents.
Introduction of "Associates." The FTC’s proposed changes introduce the concept of "associates" of the acquiring party to gather information not currently captured about entities not under common control pursuant to the HSR rules, but under common management, as well as entities controlled or managed by an "associate." By collecting this data, the agencies can assess the potential competitive impact of acquisitions by funds. This proposal will most directly impact private equity firms, and greatly increase their reporting burdens. The FTC recognizes that because associates are not controlled by the acquiring person, the acquiring person may not have perfect visibility into the operations of their associates, and will only require that information about associates be supplied based on best knowledge and belief.
Revised Horizontal Merger Guidelines
As we anticipated in the March/April 2010 issue of Inside M&A, the FTC and DOJ finalized their revisions to the Guidelines. The final Guidelines, which set out the agencies' current analytical framework for assessing the legality of proposed transactions, follow an earlier draft issued for public comment in April 2010. (See "FTC and DOJ Issue Revised Horizontal Merger Guidelines for Comment" for more on the April Guidelines, and "FTC and DOJ Issue Final Revised Horizontal Merger Guidelines" for more on the final Guidelines.)
The most significant revelations in the Horizontal Merger Guidelines include increased emphasis on evidence of competitive effects at the expense of traditional market definition, and greater evidentiary weight for documents prepared by parties in the ordinary course of their businesses over documents prepared in anticipation of the transaction. Like the proposed changes to the HSR rules, the revised Guidelines suggest an approach designed to consider the totality of the circumstances surrounding a proposed transaction.
Evidence of Competitive Effects and the De-emphasis of Market Definition. The goal of the agencies’ analysis is to determine the likely impact the proposed transaction will have on competition. Under the earlier Guidelines, the agencies would begin their analysis of the likely competitive effects by defining the relevant market, measuring the level of concentration that would occur within that defined market as a result of the transaction, and then extrapolating from that and other evidence the likely competitive effects within that market. The revised Guidelines express a preference for relying upon competitive effects outright, instead of trying to measure them within a defined market. This approach will provide the agencies with greater flexibility in challenging a transaction, and eliminates the need to rely on market definition, which has been a difficult evidentiary hurdle for the FTC and DOJ in past cases. However, it is uncertain how courts will accept this new approach because of the extensive body of case law that relies on market definition as a prerequisite for a successful antitrust challenge.
Greater Weight Placed on Documents Prepared in the Ordinary Course of Business. Under the revised Guidelines and following current practice, the agencies will look to the merging parties, customers and other industry participants for evidence of competitive effects. The new Guidelines explicitly state that the agencies will give more weight to the parties’ internal documents prepared in the ordinary course of business than transaction-related documents. Especially probative are documents that provide explicit or implicit evidence that the parties intend to raise price or reduce output, quality or innovation as a result of the transaction. In addition to the agencies’ traditional focus on prices, the revised Guidelines make clear that they will evaluate non-price dimensions of competition. The revised Guidelines also emphasize the role that certain economic methodologies and metrics may play in the overall competitive analysis.
The proposed changes to the HSR rules and the newly revised Guidelines demonstrate a more concerted effort by the FTC and DOJ to capture and review information about a proposed transaction more holistically. These changes, taken together, will increase the burdens of compliance and necessitate businesses to incorporate best practices into their everyday operations to avoid the pitfalls that may arise when planning a transaction. For example, in house counsel should regularly be involved in the document creation process – both during the ordinary course of business and transaction planning – to assure that company employees and outside consultants and advisors observe antitrust sensitivities and document market dynamics appropriately. Such attention can avoid distractions during the antitrust review process from carelessly worded documents.
Further, parties will want to build in more time into the transaction planning process to allow for internal antitrust analysis and strategic positioning to minimize risk of deal delay. For example, in light of the heavy emphasis the new Guidelines place on economic evidence, clients may consider engaging economic consultants earlier in the transaction planning process. Clients will also need additional to prepare HSR filings in light of the broader scope of documents required by the proposed rules. While this may seem more resource-intensive on a day-to-day basis, careful wording of documents and additional planning may allow for a smoother, more efficient, and ultimately more successful antitrust review of a proposed transaction.
The Top Five Traps in Health Care M&A Transactions
By Sandra DiVarco
In addition to the typical pitfalls and traps of corporate deals, health care M&A transactions also give rise to additional risks related to compliance with the specific laws and regulations that govern this complex industry. Health care businesses in the United States function within an intricate regulatory scheme, the requirements of which are brought to the fore when contemplating a transaction. The role of these issues is of increasing importance as the United States experiences a notable increase in health care provider M&A activity, which some have attributed to the passage of health care reform legislation and related alignment initiatives. Failure to fully comprehend the scope of these matters in health care M&A transactions is a recipe for potential deal disaster.
The following represent but five of the many traps counsel and business leaders may encounter in health care transactions.
1. Importance of In-Depth Due Diligence and Increased Regulatory Scrutiny
Perhaps no industry in the United States is as highly regulated as health care, thereby providing ample opportunity for risk. As a result, M&A transactions in the health care sector call for a level of diligence that exceeds that of corporate transactions in other business areas. Noncompliance with health care laws is a big dollar risk for health care businesses: the government can, by law, impose significant penalties and operational restrictions on noncompliant entities. In addition to the general function of permitting acquirors to identify material financial risks that may affect price, due diligence in health care M&A transactions provides an opportunity for acquirors to assess regulatory compliance risks. As such, use of a "standard" corporate due diligence request list is not sufficient in health care M&A transactions, as these forms typically do not contemplate the spectrum of documents and information relevant in health care due diligence.
Enforcement of health care laws is anticipated to increase moving forward, both as part of the Patient Protection and Affordable Care Act of 2010 – better known as the "health care reform legislation" – and as part of general government efforts to crack down on fraud and abuse in the health care arena. Both sellers and buyers in this context are advised to carefully prepare for and approach due diligence in any health care M&A transaction – sellers from the perspective of anticipatory preparation and buyers from the perspective of determining both a "go/no-go" with the deal and thoroughly evaluating risks to be abrogated or compensated as part of the transaction.
Enforcement activity in health care has been on the rise in recent years, with the government taking an active role in enforcing the complex laws applicable to health care providers and suppliers, including the Anti-Kickback Statute and Physician Self-Referral Law (referred to collectively herein as the "Fraud and Abuse Laws"). The Fraud and Abuse Laws make illegal certain business, referral and financial arrangements that are ordinary course in other business sectors. Complicating matters, the activities that constitute violations of the Fraud and Abuse Laws may be subtle and difficult to discern. As certain of the laws are strict liability statutes, even the smallest infraction without intent is on par with a flagrant violation, weighing the ability and basis for enforcement in the government’s favor. Violation of the Fraud and Abuse Laws can result in the imposition of severe penalties, including fines and civil monetary penalties (or costly negotiated settlements in lieu thereof) and restrictions or prohibitions on participation in federal health care programs.
Accordingly, due diligence of health care businesses and operations must necessarily include a thorough review of compliance with health care laws, including the Fraud and Abuse Laws, to assist in identification of noncompliance and give the parties an opportunity to address any issues. So-called "defensive diligence" by potential sellers in advance of undertaking a bid process or otherwise entering the M&A marketplace is becoming more common, and health care regulatory counsel increasingly recommend that potential sellers undertake such proactive reviews before permitting a potential acquirer or partner access to information.
In the M&A context, addressing noncompliance with health care laws has increasingly taken the form of self-disclosure to the government in anticipation of undertaking an M&A transaction after internal “defensive diligence” or hand-in-hand with a potential acquiror or partner either during the negotiation of or prior to closing of a transaction. Other disclosures may occur under the real or perceived threat of disclosure from a qui tam relator (whistleblower) who has knowledge of the noncompliance.
In addition, health care M&A due diligence must involve areas of risk unheard of in other industries, such as Health Insurance Portability and Accountability Act (HIPAA) (health information privacy) compliance and research program compliance, to fully evaluate these sources of additional potential risk.
2. Complexity of Governmental Regulation, Licensing and Accreditation Matters
Health care businesses are highly regulated and typically require numerous local, state and federal licenses, permits, accreditations and approvals in order to operate. Licenses, permits and accreditations are often nontransferable, or require significant paperwork and lead time in order to complete transfers within the deal timeline. Ensuring that health care providers and suppliers who participate as providers in federal and state health care programs are appropriately enrolled in these programs is vital to smooth transition of operations post-closing. As health care businesses require licensure and sometimes accreditation to treat patients – and bill for patient care, particularly through the federal health care programs that are the lifeblood of most hospitals and other health care facilities – the threat to interruption of operations, revenue and reimbursement if these matters are not carefully handled as part of an M&A transaction cannot be understated.
In addition, many states restrict the employment of licensed professionals – most commonly physicians, and sometimes others – by corporations, which corporations are thereby viewed as undertaking the practice of that profession in contravention to state law requiring licensure for such activities. These "corporate practice" issues arise frequently in health care M&A transactions where a post-closing corporate structure or the merger or other reorganization of the corporate structure contemplates a corporation’s employment of licensed providers.
3. Increasing Antitrust Scrutiny
Health care transactions with competitive implications are subject to increased scrutiny by the Federal Trade Commission (FTC) and Department of Justice (DOJ). Health care M&A transactions that meet certain thresholds require filings with and clearance from these agencies before the transactions can be consummated.
The FTC has recently linked its enforcement efforts to the desire, as expressed in health care reform legislation, to improve quality and control health care costs through careful management of the market. Merger enforcement has also been identified as a top priority of the Obama administration. Where a proposed transaction may adversely impact competition, the FTC and DOJ analyze the efficiencies identified by parties and consider whether the efficiencies outweigh the transaction’s potential anticompetitive effect (to avoid presumed harm to patients, i.e., through price increases). A comprehensive review and analysis of the potential efficiencies of a proposed health care M&A transaction is an absolute must in the early stages of transaction planning for those deals that have competitive implications.
Accordingly, an up-to-date understanding of relevant antitrust guidelines and their potential impact on a deal is essential to appropriately structuring health care M&A transactions.
4. Special Considerations for Nonprofit Health Care
A significant amount of hospital and health care operations in the United States is owned and operated by nonprofit corporations. Knowing the client’s business and anticipating traps in this context includes an understanding of the role of mission, vision and values inherent in such operations and an appreciation of the many differences between nonprofit and for-profit health care deals. For example, the true "bottom line" for nonprofits is often tempered by mission more than profit.
In order to maintain their tax-exempt status, nonprofit health care business entities must comply with the regulations and requirements of the Internal Revenue Service. These requirements impact many aspects of M&A transactions, including, by way of example, the need for nonprofits to obtain valuations to substantiate that, as a buyer, it pays fair market value in acquisitions from for-profit entities, or the need to use proceeds only for exempt activities. In addition, nonprofit health care assets are viewed as "charitable assets" of the relevant state in which they are located, and in many states the sale or other disposition of charitable assets to a for-profit enterprise is subject to the approval of the state Attorney General. More and more, states Attorney Generals are intervening in nonprofit health care M&A transactions, particularly those transactions where a nonprofit entity sells some or all of its businesses to a for-profit enterprise. Even where state law does not provide a specific right of intervention, an Attorney General may invoke his role as protector of charitable trusts generally as a basis for such scrutiny. Of additional concern, states which have historically recognized nonprofit health care facilities as exempt from property taxes have started to scrutinize and in some cases revoke that status upon a change of ownership or control of the property – even if the change results in continued nonprofit ownership.
5. Additional Concerns for Catholic Health Care
A significant segment of nonprofit health care operations in the United States is affiliated with the Catholic Church. According to the Catholic Health Association, there are more than 600 Catholic hospitals and 1,400 long term care and other health care facilities operating in the United States. Health care entities affiliated with the Catholic Church must obtain the approval of the Holy See – the “headquarters” of the Catholic Church in Rome – before entering into certain transactions. This approval, called an “Indult,” is issued after the party selling or otherwise transferring property prepares an intricate application to the Holy See, usually under the guidance of an expert in Canon (church) law. Approval of Indult requests can take weeks or even months to obtain, potentially impacting the timing of a deal if not thought out in advance.
In addition, Catholic health care sellers or buyers may require an acquiror to retain, or an acquired entity to follow, the Ethical and Religious Directives for Catholic Health Care (the “Directives”), specific guidance promulgated by the U.S. Council of Catholic Bishops applicable to business operations and patient care and treatment at Catholic health care facilities (i.e., provision of spiritual care and prohibition of sterilization and abortion). In the M&A context, the Directives may have a business impact on facilities that are sold or acquired by Catholic entities, and sometimes result in community concern regarding a restriction of certain services being available in the community.
Counsel to health care businesses and health care business leaders must be prepared for potential transaction traps to avoid significant liability and transaction risks. Involvement of counsel experienced in health care M&A early in deal planning and throughout the life cycle of the transaction is key to successfully navigating these issues.
Guideposts for a Carveout: Acquiring a Corporate Subsidiary or Business Unit Can Present as Many Challenges as Opportunities
By Dennis J. White
A recurring, yet nonetheless always challenging M&A scenario involves the situation where a buyer seeks to acquire a business unit that is being sold off by a large company.
The reasons for the sale can be varied. The business unit may no longer be a good fit with the larger enterprise’s overall business strategy. The business unit may require a significant infusion of cash or other resources that the parent is not prepared or equipped to contribute. Or the larger enterprise may be struggling and eager to raise cash for its core business.
Whatever the reasons (and it is advisable for a buyer to ferret out what are the true reasons), such transactions present unique opportunities as well as challenges. Unless attuned to the distinctive aspects of such corporate dispositions, a prospective buyer can easily be tripwired by unwelcome surprises.
For would-be buyers exploring such a transaction, it’s important to consider certain key guideposts.
Tailoring Due Diligence
Business units, whether they be unincorporated divisions or separate subsidiaries, are typically dependent in some fashion on their parent or affiliates and are therefore seldom able to operate as self-sufficient companies. Prospective buyers must constantly keep this reality in mind when tailoring due diligence for such transactions.
First, the business unit’s financial statements, to the extent historical financials are even available, may be incomplete and unaudited, and consequently may not provide a true picture of the unit’s financial position and performance. Accounting adjustments, such as allocation of overhead, may not properly reflect business realities. Related-party transactions, such as the leasing of real property, the provision of raw materials or services, and the purchase of the unit’s finished goods, can also dramatically impact operating results and therefore must be closely examined. Even external payables and receivables may be intermingled with other members of the consolidated group and not allocated. Such shortcomings and the lack of Sarbanes Oxley-mandated procedures and controls may pose problems for buyers that are public or plan to become public.
There may also be group liabilities for which the business unit is and may continue to be liable on a joint and several basis, such as those associated with pension plans, tax liabilities, environmental liabilities and borrowings under credit facilities. The buyer must identify all such potential liabilities and, unless it is willing to assume them, either eliminate them or secure satisfactory indemnification from the seller.
From an operational perspective, it is imperative that the buyer identify and understand all the group support functions that will disappear once the transaction closes and what it will take to replace them, especially if the business is operating on a standalone basis post-closing. In addition to typical accounting, legal and IT support, examples include insurance coverage, letters of credit, benefit plans, enterprise-wide licenses of mission critical software, and the usage of telecommunications systems.
In short, the buyer must carefully assess what is needed to operate the business successfully and how many of those necessary elements will actually be acquired, and how many the buyer must itself supply or purchase from external sources.
Structuring the Transaction
If the seller has structured the business unit disposition as an asset sale, the buyer must ensure that it is acquiring all the assets necessary to operate the business. The buyer should likewise confirm that no extraneous unneeded assets or liabilities have been gratuitously included by the seller. As in any asset purchase, the seller should take care as to what liabilities it is expressly assuming as well as any liabilities that might be imposed upon a successor owner by operation of law.
If the transaction has been structured as a sale of a subsidiary, particularly a recently formed entity into which the seller has dropped operating assets, the buyer must resist the temptation to assume that it is acquiring a self-sufficient entity. As in any stock acquisition, buyer must be particularly careful that in acquiring all the equity, it is not unwittingly assuming unwanted liabilities.
Depending on the relative bargaining strength of the parties and the number of bidders vying for the business unit, the corporate seller may resist a prospective buyer’s efforts to cherry pick assets and liabilities and insist that the buyer take the mix of assets and liabilities chosen by the seller.
From a tax perspective, an asset purchase allows the buyer to write up its tax basis in the acquired assets to their purchase price, thereby yielding the buyer tax benefits derived from higher levels of depreciation in the ensuing years. The sale of a subsidiary will yield the same result if the seller offers or can be persuaded to file a so-called Section 338(h)(10) election under the Internal Revenue Code. The result is that the transaction will be treated as stock sale for corporate purposes, but in general as an asset sale with a basis step-up for tax purposes. If the seller is unwilling to agree to a Section 338(h)(10) election, then the buyer should adjust its valuation of the business to reflect the tax benefits not being realized.
Negotiating Deal Terms
When it comes time to negotiate the terms of the transaction, a buyer of a business unit must be sensitive to the peculiar aspects of a business unit sale that should be reflected in the acquisition agreement.
First and foremost, there is the issue of price. As noted above, it may be difficult to get a firm handle on the business unit’s profitability given the lack of audited financials. Also, the buyer must take into account support services that it might have to furnish at its own expense in order to maintain operations. All this makes pricing of such transactions particularly difficult. The buyer will also need to gauge the corporate seller’s focus on speed and certainty of closing if it is to differentiate itself from the competition. Most corporate sellers will not be keen on earnouts, seller paper and indemnification escrows.
There are often lengthy discussions regarding what representations the seller is willing to make regarding the financial statements and whether the seller will be required to upgrade the quality of the financial statements.
Also important are representations as to the adequacy of the assets and potential joint and several liability with regard to tax, ERISA and environmental liabilities.
Certain third-party consents may be required, such as consent of the seller’s senior lenders and release of the business unit’s assets from the lien of the credit facility. If the business unit has important contracts with change-in-control termination triggers, consents must be obtained or the contracts renegotiated.
If the name of the business unit or its products is to change, the parties must address the logistics of how and over what time period signage and labeling on everything from buildings to instruction manuals will be updated. The buyer may need an interim license to use the old name for limited purposes during a transitional period.
The unique nature of corporate business unit dispositions will often heighten the importance of post-closing obligations between the parties. Vendor and customer agreements, non-compete clauses, and non-solicitation provisions are a few areas worthy of focus.
The unit, for instance, may have transacted significant business with other operations of the seller. Raw materials or component parts may be two examples. Or the seller may be a significant customer of the business units finished goods and services. While a member of the consolidated group, such arrangements may have been transacted on an open account basis and not reduced to a written contract. A buyer in such circumstances, however, will have a strong interest in formalizing such arrangements since they may significantly impact the continuing profitability of the business unit. Also, the pricing of such inter-company arrangements may not necessarily reflect current market conditions and so a buyer should carefully examine them and, when appropriate, seek to negotiate such terms.
Trade secrets are also an important component. Information pertaining to the business unit may be spread throughout the seller’s corporate group. Beyond the normal confidentiality covenants, the buyer may have a keen interest in requiring the seller to collect and destroy all such information.
The scope of non-competition covenants, meanwhile, can also require extensive negotiation. The seller may still have other operations in the same space, or not wish to curtail its ability to expand into or make acquisitions in the same space. The buyer, on the other hand, does not want to pay for the business unit only to discover that the seller is soon competing with its former subsidiary. Non-solicitation agreements are another consideration. Many employees of the business may have over the years developed close ties with others in the seller’s group. The buyer does not want to risk losing key employees of the newly acquired business unit to the seller. The buyer will want to impose tight non-solicitation obligations on the seller and perhaps non-competition obligations on its new key employees.
Access to corporate records can also come up, as the new owner of the business unit may need access to income tax, sales tax, and other records in the event that there are tax audits or other governmental requests for information that pertain to periods prior to the closing.
Transitional Services Agreement
Sometimes, a business unit is highly dependent upon the seller for certain services that are critical to its operations, and the buyer is not in a position to supply or externally secure those services at closing, particularly if the closing is on a fast time track. In such circumstances, the parties must negotiate a transitional services agreement or TSA under which the seller will provide the needed services for a limited time.
From the seller’s point of view, it is a necessary accommodation to get the deal done, but the seller would prefer to move on and focus on its core business. From the buyer’s point of view, the securing of such transitional services is essential to maintaining the going enterprise value of the business unit.
Negotiation of a TSA is driven by deal timing considerations, the capabilities and resources of the business unit and the buyer, and, as is always the case, the relative bargaining strength of the parties. A negotiated TSA will commonly address a number of issues.
The buyer, based on its due diligence findings and its own internal capabilities, is typically the party that drives what services will be included in the TSA. The following are among the services commonly included: use of real estate, warehousing, distribution and procurement, data processing, telecommunications, employee benefits, finance and accounting, and training. The seller must be sensitive to whether there are third party contractual restrictions (e.g., software license agreements) on its ability to provide services to a business unit that post-closing is an unrelated party.
Moreover, the buyer will want to ensure that the duration of the transitional services arrangement is sufficient and that it is not left high and dry. Similarly, the buyer will resist any right of the seller to terminate the arrangement prematurely. In fact, the buyer may seek certain rights of extension if the transition takes longer than expected. The seller is apt to resist such extension rights.
Pricing can also warrant negotiation. Services can be priced on a service-by-service basis or at a flat rate. The pricing levels may increase for any extended term so as to serve as an incentive to the buyer to complete the transition.
The buyer may ask that the business unit be treated the same as seller’s other business as to the quality of services and timeliness. Because seller is providing such services as an accommodation and not as a primary profit center, it may insist upon a generally lower level of care (e.g., breach for only gross negligence and willful misconduct) than is customary in a typical commercial arrangement.
This article appeared in and is reprinted from the November 2010 issue of Mergers & Acquisitions.