On November 15, 2013, Chancellor Strine of the Delaware Court of Chancery issued an opinion in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, holding that in a merger under Delaware law the attorney-client privilege passes from the acquired corporation to the surviving corporation.

The case arose from a complaint brought by Great Hill Equity Partners and certain of its affiliates (collectively, the Buyer), who alleged that defendants, former shareholders and representatives of Plimus, Inc. (collectively, the Seller), had fraudulently induced the Buyer to acquire Plimus in September 2011. Plimus was the surviving corporation in the merger.

After the Buyer initiated the lawsuit, and a full year after the merger, the Buyer notified the Seller that it had discovered certain communications regarding the transaction between the Seller and Plimus's then-legal counsel among the files on the Plimus computer system. During that year, the Seller did nothing to retrieve these computer records, nor had it taken steps before the merger to segregate or delete these files. Significantly, the merger agreement lacked any provision that would exclude pre-merger attorney-client communications from the assets transferred to the Buyer. Nevertheless, the Seller asserted the attorney-client privilege over these pre-merger communications on the ground that, as former stockholders of the selling corporation, it retained control of the privilege for communications regarding the negotiation of the merger agreement.

The Buyer made a motion to the Delaware Court of Chancery to resolve the privilege dispute and determine whether a surviving corporation owns and controls pre-merger privileges that belonged to the target company.

Chancellor Strine explained that the issue involved statutory construction of the Delaware General Corporation Law (DGCL) Section 259, which provides that following 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 Seller took the position that the statutory term "privilege" only includes certain property rights, but does not extend to privileges established by a rule of evidence. However, the court found nothing in the language of the statute, legislative history or leading treatises to support this narrow reading of the statute. Rather, the court read the statute as using the broadest possible terms to set a clear and unambiguous default rule that all privileges of the selling corporations pass to the surviving corporation in a merger. The court held that contrary to the Seller's assertion, one of the most obvious examples of such a privilege is the attorney-client privilege. Accordingly, the court ruled that as a matter of Delaware law the attorney-client privilege over all pre-merger communications passes to the surviving corporation in a merger, unless the parties enter into an agreement that limits the transfer of these communications.

In support of its ruling, the court distinguished a New York Court of Appeals decision relied on by the Seller, Tekni-Plex, Inc. v. Meyner & Landis, which dissected into two categories the privileges belonging to a Delaware corporation sold in a merger (89 N.Y.2d 123, 136-39 (1996)). As the Seller emphasized, the case was later applied by the Delaware Court of Chancery in Postorivo v. AG Paintball Holdings, Inc. (No. 2991-VCP, 3111-VCP, , at *4-6 (Del. Ch. Feb. 7, 2008)). In Tekni-Plex, the New York high court concluded that although pre-merger attorney-client communications regarding general business operations pass to the surviving corporation, communications relating to the merger negotiations do not. However, both Tekni-Plex and Postorivo applied New York law and, as Chancellor Strine noted, neither decision cited DGCL § 259. No decision before Great Hill had explicitly dealt with the passage in a merger of attorney-client privilege under Delaware law.

The Delaware Court of Chancery also addressed and rejected the Seller's argument that a ruling in favor of passing the attorney-client privilege to the Buyer would create "serious public policy issues" in Delaware by chilling discussions between counsel and client. The court ruled that because the issue had been squarely addressed by the legislature through clear statutory language, the court was left with no public policy gap to fill. To rule against the passage of the attorney-client privilege would be to perform micro-surgery on a clear statute by inventing a judicially-created exception to the phrase "all privileges."

The court also advised that parties concerned about potentially privileged communications can carve out from the assets transferred to the surviving corporation any pre-merger attorney-client communications, which the Seller had failed to do. Absent this express carve-out, the 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 DGCL § 259.

The decision in Great Hill serves as a useful reminder to sellers and their counsel to take privilege issues into account when negotiating a merger agreement. If the seller wishes to keep its communications privileged post-closing (particularly if there is a risk of litigation being brought by the buyer), it should use its contractual freedom to exclude from the transferred assets the attorney-client communications that it wants to retain as its own.

For more information on passing the attorney-client privilege, see Practice Note, Attorney-Client Privilege: Clients and Client-Agents (Federal): Change in an Organization's Ownership or Structure. For information on the attorney-client privilege generally, see Attorney-Client Privilege and Work Product Doctrine Toolkit.