The Unintended Consequences of Confidentiality Agreements in the Auction Context

April 23, 2002

The domestic mergers and acquisitions market exceeded $900 billion in 1997 and $1,772 billion in 1998. By all accounts, 1999 will certainly exceed the 1998 level of activity. With the unprecedented volume of strategic combinations at every level, in every industry and in all geographic corners, the attention paid to certain types of "form" documents has noticeably diminished. Confidentiality agreements are frequently hurried into place to propel forward the substance of a given transaction (typically, visits to the data room, target sites or management presentations). In our experience, these documents are seldom negotiated or considered in depth, and are generally viewed by strategic planning professionals as uniform in both scope and substance. Unfortunately, these "standard" documents have potentially troubling implications if they are not thoughtfully tailored to the situation at hand.

Most modern confidentiality agreements used in the auction context include some or all of the following five features. First, there is a contextual statement giving the reason for providing information to the bidder. Second, various protective devices are imposed, intending to prevent the misuse of and safeguard the target’s sensitive proprietary data. Third, there are specific exceptions to the application of the protective provisions. Fourth, there are provisions that preclude hiring away the target’s employees, particularly those employees operating in commercially sensitive areas (for example, the research and development arm of a pharmaceutical company). Fifth, there are provisions that preclude the bidder from making an uninvited run at the target or accumulating publicly available shares in the target, in each case either alone or with others ("standstill provisions").

Provided they are properly crafted, these agreements have several well-known beneficial effects in the auction context. These effects were clearly articulated many years ago in the General Portland Cement case. First, the agreements promote the free exchange of information between a target and its suitors, and they facilitate the creation of a level playing field prior to the negotiation of the definitive documentation. Second, they promote the maximization of shareholder value by promoting friendly, solicited combinations without unduly restricting the possibility of a bidding contest. Third, they provide reasonable time for a range of qualified bidders to evaluate the target. Finally, they allow the target to solicit interest from more than one potential bidder at a time, while still controlling the timing of the ultimate sale.

The possible negative implications of these agreements are not as well-known, and relate primarily to unintended consequences. Many negative implications arise in the wake of failed transactions. The busted deal, of course, is anything but rare. It has been estimated that since 1992 in the U.S. alone more than 2,000 publicly-announced mergers have been scrapped prior to completion. Confidentiality agreements can become potent weapons in future contexts if they are overly broad, deliberately vague or unduly restrictive. For example, in a hostile takeover context, litigators defending a target under siege will generally look at all prior contractual commitments between the uninvited suitor and the target for litigation fodder. In several recent contests for corporate control, the alleged breach of a confidentiality agreement written years earlier---and in a different context---was grounds for complaint by the target's lawyers.

These agreements have also been used out of context to block the recruitment of key personnel years after the confidentiality agreement was signed. Overly lax confidentiality language can encourage the dissemination of information among competitors in violation of the antitrust laws. An improperly crafted (or missing) standstill feature in the auction context can quickly turn an orderly sale into a quagmire of litigation or a publicly embarrassing hostile contest for corporate control. To avoid creative mischief later on, it is critical that such agreements be precisely crafted and tailored to a particular context.

We live in the golden age of the strategic acquisition. The most logical buyer of any business enterprise is the enterprise's own competition---a frightening prospect if the transaction fails or is completed with another bidder. Confidentiality agreements are careful balancing acts between the compulsion to share and the critical need to safeguard information regarding the company. Like all balancing acts, the tools used should be carefully selected for the particular job at hand, and with an eye to the possible uses and abuses of such tools in the future.

For more information, please contact ccarson@cohenlaw.com.