DealLawyers.com Blog

We recently blogged about the importance of both detailed diligence on a target’s compliance and addressing post-acquisition regulatory issues promptly and properly. In the wake of such a post-acquisition regulatory development, the opinion in LPPAS Representative, LLC v. ATH Holding Company, LLC, (Del. Ch.; 5/23) may have an impact on how buyers deal with regulators.

The case involved a common purchase agreement indemnification provision giving the indemnifying person the right to control the defense of third-party litigation—or to participate, in the case of a governmental regulator. After closing, Anthem, the buyer, discovered what it believed to be fraudulent Medicare coding practices at the target, promptly reported to CMS and DOJ and cooperated with the agencies without contacting sellers. When Anthem provided notice that it would be seeking indemnification, sellers claimed their participation rights were violated. Anthem tried to argue that they substantially complied and that failure to permit participation didn’t materially disadvantage sellers as they didn’t actually have a right to control the defense anyway. Chancellor McCormick disagreed and ordered that Anthem had abrogated any indemnity obligation by breaching the sellers’ participation rights.

This Fried Frank memo gives two practice pointers for any buyers of companies that regularly engage with regulatory authorities:

Before engaging with a regulator about a potential or actual investigation into pre-closing alleged issues, a buyer should carefully review its obligations under the sale agreement with respect to participation rights of the seller. Failure to provide the seller with the participation rights set forth in the sale agreement could affect, or even be fatal to, the buyer’s indemnification rights with respect to losses arising from the investigation.

Consideration should be given to modifying standard participation right provisions. Among the relevant considerations would be the respective negotiating leverage of the parties and the perceived level of risk that post-closing regulatory investigations might arise. Among the possible modifications would be: First, at a minimum, providing greater clarity and specificity as to the timing and extent of any right of the seller to participate in the defense strategy. For example, the parties may wish to specify more precisely than is typical the triggering event for the seller’s participation right—whether it is any inquiry from a regulator that could lead to an investigation; or the formal commencement of an investigation; or an investigation having proceeded to a specified point; or a specific claim having been formally asserted by the regulator. Second, a buyer may wish expressly to exclude specified actions from the participation rights—such as initial self-reporting of possible violations and responses to subpoenas or other legally required actions. Such modifications may be particularly appropriate in light of the DOJ’s and other regulators’ ongoing efforts to incentivize prompt self-reporting. Third, a buyer may wish to provide for its own participation rights with respect to the seller’s own, separate defense in connection with regulatory or criminal investigations of the seller’s pre-closing conduct.

– Meredith Ervine