The FTC filed a complaint alleging gun-jumping and imposed a record $5.6 million fine on Verdun Oil Co. (buyer) for exerting control over EP Energy LLC (target) before expiration of the HSR waiting period and deal closure. The transaction agreement between the parties allowed Verdun and its subsidiary, XCL, to take control over significant aspects of EP’s day-to-day business and the parties, which were competitors, exchanged competitively sensitive information to do so.
Transaction agreements often provide the buyer with some rights over the seller's business activities when those activities, e.g., outsized capital investments, etc., could impair the value of the target being acquired. Giving buyer control over ordinary-course decisions, however, allows the parties to act as if they are one entity prior to the expiration of the HSR waiting period, a violation of the HSR standstill obligation.
While an informative cautionary tale, we see no cause for any fundamental changes in the approach that our clients take to interim operating covenants and conduct. The conduct the FTC alleges was a straightforward gun-jumping violation that would be problematic under any administration. In our experience, a typical set of interim operating covenants does not cross the line the way the covenants and conduct did in this case.
Background
The underlying transaction was investigated by the FTC and ultimately allowed to clear via consent decree (divesting certain assets). The HSR waiting-period obligation ran from the date of the signed agreement (July 26, 2021) through the date the FTC accepted the consent decree (March 25, 2022). The violation alleged, however, was only for a portion of that period between signing and amendment of the purchase agreement to remove the buyer’s control over the ordinary-course actions of the seller on October 27, 2021, 94 days.
The gun-jumping conduct the FTC alleged was:
- The immediate transfer of control over key aspects of EP’s business to XCL and Verdun, including granting buyer approval rights over EP’s ongoing and planned crude oil development and production activities and many ordinary course expenditures in the purchase agreement.
- This resulted in EP’s immediate halting of new well-drilling activities so that XCL could control development and production plans going forward; this lasted until it became clear the FTC would investigate the transaction, at which time EP was again allowed to make its own decisions.
- Anticipating supply shortages because of this pause, the purchase agreement specifically provided that XCL and Verdun would bear all costs associated with EP’s supply shortages.
- Then the competitors, XCL and EP, worked to supply EP’s customers to meet EP’s supply commitments. EP employees effectively reported to XCL counterparts and provided XCL employees with details on customer contracts, supply volumes, and pricing terms.
- XCL also directly communicated with EP’s customers to discuss the supply shortages and arrange for alternative delivery (from its own supply or spot suppliers) to fulfill EP’s commitments.
- The purchase agreement required EP to submit all expenditures above $250,000 for XCL’s or Verdun’s review and approval, without any exception for ordinary-course expenditures. The FTC alleged that $250,000 was a relatively low value for an operator in the oil and gas industry.
- There was also evidence the buyer received and approved expenditure requests from EP falling below the $250,000 threshold, including hiring low level employees and contractors.
- XCL required changes to certain of EP’s ordinary course business operations like well-drilling designs and leasing/renewal activities.
- EP also provided access to EP’s competitively sensitive business information such as site design plans, customer contract and pricing information, and daily supply/production reports, taking no meaningful steps to resist and without a legitimate business purpose.
- Finally, Verdun coordinated with EP on contract negotiations with certain customers, specifically observing that certain contracts had below market pricing and directing EP to raise prices during the next contracting period.
The FTC investigation produced substantial evidence to support its allegations of gun-jumping, including emails:
- From EP requesting permission for shutting down planned fracking operations and XCL confirmation of the request to suspend such operations in response.
- From an XCL VP to EP’s COO confirming the parties had discussed combining operations pre-closing, including a statement that, “As discussed, we [XCL] would like to complete the … wells as a combined team, where XCL leads on frac design and vendor selection, and EP teams with XCL to execute the operations.”
- From an EP employee to an XCL employee noting that “as XCL has been directing EP Energy’s completions and has agreed to fulfill EP Energy’s contractual commitments between sign and close[,] any shortfall [in EP’s ability to fulfill its supply commitments] would be due to XCL’s decisions.”
- Between XCL and EP’s customers regarding supply forecasting based on EP’s supply.
Key Takeaways
- The need to be mindful of the types of controls requested in interim operating covenants and meaningfully tailoring those to controls necessary to maintain the value of the business until close.
- The need to ensure that irrespective of contractual obligations, the practical implications of pre-closing conduct do not amount to de facto control.
- Materiality thresholds for buyer approval of capital expenditures are not one size fits all, and the FTC will scrutinize whether the threshold is sufficiently high to allow the target to maintain ordinary business operations pre-closing.
- The importance of limiting information exchanges pre-closing and providing/accepting competitively sensitive information only via clean team where parties are competitors.
- Where relevant, continued antitrust compliance review (and documentation) of pre-existing business relationships between parties to a merger agreement to combat the appearance of improper pre-closing operational control.
