seventeenth annual institute on privacy and data security...

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Seventeenth Annual Institute on Privacy and

Data Security Law

Volume Two

INTELLECTUAL PROPERTYCourse Handbook Series

Number G-1277

Co-ChairsFrancoise Gilbert

Lisa J. SottoThomas J. Smedinghoff


56

Managing Deal-Related Cyber Risk: Due Diligence in M&A Deals and Third Party Service Provider Arrangements Outline

Michael Murray Brad Peterson Paul Chandler

Mayer Brown LLP

Submitted by: Rebecca S. Eisner

Mayer Brown LLP

© 2016 The Mayer Brown Practices, All rights reserved.

This material is the property of Mayer Brown LLP. Reprinted with Permission.

If you find this article helpful, you can learn more about the subject by going to www.pli.edu to view the on demand program or segment for which it was written.

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ABOUT THE AUTHORS

MICHAEL MURRAY is a partner in the Corporate and Securities practice of Mayer Brown, LLP, and focuses his practice on mergers and acquisitions, corporate governance, and general corporate counseling. He represents buyers, sellers, and financial advisors in connection with public and private M&A transactions, Joint ventures, and similar transactions. He can be reached at mmurray@mayerbrown,com.

BRAD PETERSON is a partner in the Business & Technology Sourcing practice of Mayer Brown, LLP. His practice is focused on helping large customers in business process and information technology outsourcing transactions. He is a graduate of the University of Chicago Graduate School of Business and Harvard Law School. He can be reached at [email protected].

PAUL CHANDLER is counsel in the Corporate & Securities practice of Mayer Brown, LLP, and represents clients in connection with the out-sourcing of information technology functions and business processes. He also assists clients that are working to develop, license, market, dis-tribute, and acquire rights in a wide variety of technology related products, services, and intellectual properties, including computer software and hardware, databases, online services, and telecommunications systems. He can be reached at [email protected].

Send comments about this article to [email protected].

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Table of Contents

CYBERSECURITY AND DATA PRIVACY: 2016 OUTLOOK ............................. 7 Increasingly Global Governance of Cybersecurity and Data Privacy ................................................................................... 7 Expanding Regulatory and Enforcement Activity .................................. 9 Continued Growth in Cybersecurity and Data Privacy Litigation ........ 11 Substantial Law Enforcement Activity ................................................. 13 Expanding Global and Technological Scope of Policy Debates ......... 15

WHEN SELLER CONTRACTS FOR IT ON BEHALF OF ACQUISITION ......... 20 Loss of Bargaining Power ................................................................... 20 Cloud-Based Technology .................................................................... 21 Lack of Historical Data ........................................................................ 21 Hypercare ............................................................................................ 22 Soliciting Buyer Input .......................................................................... 22 Ask for an Escape Clause ................................................................... 22 Leverage Existing Agreements ........................................................... 23

KEY PRIVACY ISSUES IN M&A TRANSACTIONS .......................................... 24 Buyer Concerns .................................................................................. 24 Seller Concerns ................................................................................... 26 Conclusion .......................................................................................... 26

BEST PRACTICES FOR BUYERS AND SELLERS IN ADDRESSING SERVICES AGREEMENTS IN CONNECTION WITH MERGER AND ACQUISITION TRANSACTIONS ....................................................................... 27

Services Agreements in Merger and Acquisition Transactions .......... 27 Changing Business Structures Are Creating New Opportunities ....... 27 Existing Third-Party Services Agreements Used Only by the Target .................................................................................................. 28 Existing Third-Party Services Agreements Shared by the Target and the Seller..................................................................... 29 Steps that Potential Sellers Can Take to Prepare for Future M&A Transactions ............................................................................... 31 Steps that Potential Buyers Can Take to Prepare for Future M&A Transactions ............................................................................... 32 Conclusion .......................................................................................... 32

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CYBERSECURITY AND DATA PRIVACY: 2016 OUTLOOK

As the cybersecurity and data privacy landscapes continue to shift around the world, the value for businesses of understanding those threats and responding in a strategic, coordinated and enterprise-wide fashion will be greater than ever in 2016. Cybersecurity and data privacy were top priority issues in 2015 for companies in a broad range of industries. Businesses took an array of steps to identify and mitigate the legal, reputational and business risks associated with these issues. For example, many businesses strengthened internal plans and capabilities to defend company networks and to respond to cybersecurity incidents, ensured effective oversight by their boards of directors, fine-tuned vendor agreements to account for cybersecurity and data privacy interests and worked closely with policy makers at the state and federal levels. Businesses also increasingly engaged with regulatory and enforcement agencies and, where necessary, contested high-stakes class actions.

This year is poised to see cybersecurity and data privacy continue to grow in importance for companies doing business in the United States and for US businesses operating globally. Here, we highlight five priority issues that these companies should consider as they assess, refine and operate their cybersecurity and data privacy programs in 2016:

• Increasingly global governance of cybersecurity and data privacy;

• Expanding regulatory and enforcement activity;

• Continued growth in cybersecurity and data privacy litigation;

• Substantial law enforcement activity; and

• Expanding global and technological scope of policy debates.

Increasingly Global Governance of Cybersecurity and Data Privacy

Many of the most significant cybersecurity and data privacy developments for US companies may well be seen outside the United States in 2016. Multinational businesses must navigate an expanding array of international statutes, regulations and enforcement policies. Increasingly, so, too, must businesses without any international footprint. A company’s data may very well cross borders—whether to be stored at an international data center (e.g., for a private cloud) or to be

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processed remotely (e.g., by a payroll service)—even for otherwise-domestic businesses.

Last year saw significant upheaval in the legal regimes governing cybersecurity and data privacy across the globe, most notably with the invalidation of the US-EU safe harbor scheme.

In 2016, businesses should expect to see continued evolution in the international sphere. Three trends are likely to be particularly significant:

• Continued Evolution of Data Transfer Regimes. The Schrems decision by the Court of Justice of the European Union in October 2015 invalidated the Safe Harbor regime upon which many companies relied for their transfer of personal data from Europe to the United States. Representatives from the US Depart-ment of Commerce and the European Commission had already begun negotiating a “Safe Harbor 2.0” when the Schrems opinion was handed down, but the likelihood of the success of the nego-tiations remains unclear. Some national data protection authorities in Europe have threatened that, absent sufficient progress by January 31, 2016, they will begin bringing enforcement actions and potentially start to investigate the legitimacy of other transfer methods. Such steps could have dramatic implications for compa-nies transferring data from the European Union to the United States.

• Expansion of Regulatory Regimes. Companies will face a host of new and expanding cybersecurity and data privacy regulatory regimes across the globe in 2016. Companies will be required to navigate many of these regulations for the first time, even as more rules are developed in other jurisdictions. For example: – Europe. In December 2015, the European Commission

released a new General Data Protection Regulation, which is to be approved by the European Parliament in early 2016 and to take effect by early 2018. This regulation will sub-stantially revise data protection and privacy rules for covered businesses (called “data controllers” under the regulation) and impose a new breach notification requirement. The regu-lation will harmonize data protection laws across the European Union and will apply to foreign entities that offer goods or services to individuals in the European Union.

– Indonesia. In 2016, Indonesia will implement the first data protection law in the country’s history. Companies doing

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business in Indonesia will be subject to its various requirements regarding data collection, usage, management and transfer.

– Australia. Amendments to laws in Australia now require covered businesses to disclose any “serious data breach” to the Office of the Australian Information Commissioner and take reasonable steps to notify individuals whose data has been compromised by a breach.

• Continued International Engagement on Cybersecurity and Data Privacy. In 2015, there was significant international discus-sion and debate on cybersecurity and data privacy, including between the United States and China. For example, in September 2015, President Obama and President Xi Jinping publicly con-fronted the thorny issue of economic espionage by agreeing that neither country’s government would conduct or knowingly support the cyber-enabled theft of confidential business information, trade secrets or other intellectual property in order to provide competitive benefits to their own industries. Then, in December, China passed a new counter-terrorism law that requires Internet service providers to disclose encryption keys to government authorities and to enhance their monitoring and reporting of Internet content. This year is likely to bring continued international developments on a broad range of contentious cybersecurity and data privacy issues. These changes may have substantial consequences for businesses, poten-tially altering the scale and origin of the cyber threats they face, their access to foreign markets and the scope of their respon-sibilities in foreign jurisdictions.

Expanding Regulatory and Enforcement Activity

Like their international counterparts, regulatory and enforcement agencies in the United States continued to expand their activities addressing cybersecurity and data privacy issues in 2015. As different federal and state agencies pursued their own distinct agendas, businesses faced a growing patchwork of regulatory requirements—a trend that is set to continue in 2016. The likely common denominators of these are more expansive and detailed rules and more frequent enforcement of those rules. Consequently, companies in a wide variety of industries should expect greater scrutiny and more substantial compliance costs as yet more agencies enter the regulatory field, new rules are imple-mented and regulated entities are examined for compliance with these new rules. In particular, companies should expect:

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• Greater Regulatory and Enforcement Activities by the Federal Trade Commission (FTC) Across a Broad Range of Fields. In 2015, the US Court of Appeals for the Third Circuit affirmed the FTC’s ability to regulate cybersecurity practices through its “unfairness” authority under Section 5 of the FTC Act. Likewise, the FTC signaled its intent to aggressively enforce existing privacy laws and to focus on such evolving areas as big data, tracking consumers across devices and privacy notices for mobile appli-cations. Companies should expect the FTC to pursue these topics throughout 2016, including through guidance regarding best prac-tices, white papers, workshops and enforcement actions. For exam-ple, in June 2015, the FTC released a guide highlighting lessons learned from its 50-plus law enforcement actions concerning data security. Additionally, the FTC has made clear that it may bring enforcement actions on a wide range of theories relating to the use of big data, de-anonymization and the potential disparate effects on certain consumers arising from the use of collected data. As with other topics, other regulators at the state and federal levels are likely to collaborate with the FTC or otherwise follow its lead.

• Continued Expansion of Cybersecurity Regulation by Financial Services Regulators. Federal regulators of banks and other financial services companies have long been active in the over-sight of cybersecurity at regulated entities. Often, their actions have set the tone for other regulated industries, as other federal and state regulators have adopted similar principles for their respective industries. This trend of financial services regulators acting aggressively on cybersecurity is on track to continue at the federal and state levels. For example, the New York State Depart-ment of Financial Services is set to embark on a major rulemak-ing in 2016. This regulator of New York-chartered banks and insurance companies (including non-US banks doing business in New York) is expected to propose new requirements regarding; cybersecurity policies and procedures; management of third-party service providers; multi-factor authentication; appointment of a Chief Information Security Officer; application security; audits; and notice in the event of a cybersecurity incident.

• Amendments to State Data Breach Notification Require-ments. The patchwork of state data security and data breach noti-fication laws continues to grow more complex in the continuing absence of federal standards. Companies should expect this trend

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to continue in 2016. For example, the California legislature revised its data breach laws effective January 1, 2016, to expand and clarify the existing notice requirements and to specify forms for notices. Entities around the country will need to consider California’s new requirements, as well as any potential incompatibility with other states’ notice requirements. (And companies will need to remain cognizant of their obligations under relevant state data security regulations, such as by implementation of a written information security program to satisfy Massachusetts law, where applicable.)

• Increased Regulation and Examination of Cybersecurity in the Securities and Commodities Markets. Regulatory agencies with supervisory authority over broker-dealers, investment advisers and financial market utilities have made it clear that cybersecu-rity will be an increasing focus of supervisory exams. In 2014 and 2015, for example, the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) reviewed the cybersecurity practices of a sample of broker-dealers and investment advisers and determined that there was a need to incorporate cybersecurity preparedness assessments in regulatory examinations. Similarly, in 2015, the Commodity Futures Trading Commission (CFTC) held a roundtable with industry experts to identify cyber threats to its regulated financial market utilities, and the National Futures Association (NFA) adopted requirements and guidance related to “Information Systems Security Programs.” Entities in these industries should expect this focus to be reflected in regulatory guidance issued and examinations performed in 2016.

• Federal Communications Commission (FCC) Rulemaking To Develop Privacy Rules for Internet Service Providers. The FCC’s reclassification of Internet service as a telecommunications service last year opened the door to new privacy regulations for providers of broadband Internet service. FCC Chairman Tom Wheeler has stated that this rulemaking could begin in early 2016. These new rules could address data breach notification, customer consent to share data, data protection and other signifi-cant issues for Internet service providers.

Continued Growth in Cybersecurity and Data Privacy Litigation

There were important developments in cybersecurity and data privacy class action litigation in 2015. Significant decisions, such as the US Court of Appeals for the Seventh Circuit’s decision arising

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from the Neiman Marcus breach, were issued by courts of appeals. In addition, the US Supreme Court heard argument in Spokeo v. Robins, which considers whether the violation of a right that triggers statutory damages can substitute for injury-in-fact for purposes of Article III standing.

The pace of data breach litigation continued to increase in 2015. Plaintiffs filed nearly 250 class actions respecting some 35 different data breaches last year. This year, litigation continues to be likely in the aftermath of large-scale data breaches and, increasingly, more smaller-scale data breaches as well. Indeed, 2016 is poised to continue trends seen in 2015, including: significant disputes over whether consumer plaintiffs have alleged cognizable injury for Article III standing—and thus may proceed past the pleading stage; litigation over indemnification for expenses sustained by third parties as a result of a data breach (e.g., disputes regarding insurance coverage under cyber-security policies); and the pursuit of data breach-related derivative lawsuits in a limited number of cases.

In addition, 2016 is almost certain to see courts more frequently decide issues that are relatively novel in the data breach context. These include:

• Class Certification. Data breach plaintiffs routinely employ tactics from the outset of litigation in an attempt to overcome the predominance requirement for class certification. For instance, to avoid the issue of having to prove damages on an individual basis, they have attempted to assert claims for injunctive relief under state consumer fraud statutes—which allow for recovery of attorneys’ fees—to require that companies implement specific data security safeguards. What is more, in non-data breach class actions, a number of courts have been willing to certify class actions to resolve common issues, even where individual issues of injury and the amount of damages exist and would have to be addressed in a more individualized proceeding after the common issues are resolved. In spite of such maneuvering, class certification is likely to remain a major hurdle for data breach class action plaintiffs in 2016 (despite some notable exceptions in 2015). However, the risk that companies will have to defend data breach litigation on the merits against a certified class is growing, making it increasingly important—from a litigation perspective—for businesses to take reasonable cybersecurity measures prior to a data breach.

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• Discovery. In 2016, it is likely that we will see more decisions on the scope of discovery in the data breach context. In 2015, for example, a federal magistrate judge found that certain documents created by a task force established by in-house and outside counsel to educate the attorneys about a breach and to enable them to provide legal advice to the affected company were privileged. A key issue in this decision was whether the documents at issue were created for a legal or business purpose.

• Summary Judgment. This year may provide significant develop-ments with respect to summary judgment in data breach litigation. Three noteworthy issues to be considered at this stage are: (i) the proper standard of care (i.e., what security safeguards was the affected company required to implement); (ii) what types of injuries are legally compensable (e.g., whether time spent to respond to a data breach or fees paid for data breach protection are recoverable); and (iii) causation and actual injury (i.e., whether plaintiffs can prove that the data breach caused those injuries). While data breach cases continue to proliferate and to dominate

headlines, recent studies have reported a significantly greater number of data privacy lawsuits in the last few years. Data privacy lawsuits have pursued complaints under statutes ranging from the Telephone Consumer Protection Act (TCPA) to the Fair Credit Reporting Act (FCRA). This trend is also likely to continue in 2016, as plaintiffs try to fit new technologies and new uses under existing laws. The increasing connectivity of devices and their use throughout consumers’ day-to-day lives appears certain to produce a steady stream of aggressive legal claims.

Substantial Law Enforcement Activity

Highly publicized cyber intrusions in 2015 underscored the increasing productivity, sophistication and diversification of cyber threat actors’ schemes. Such schemes targeted intellectual property, proprietary pricing data and medical information, among other types of sensitive information. They also damaged companies’ systems, imposed significant financial and reputational costs and even threatened national security interests. Law enforcement agencies continue to evolve to address these threats to the private sector, and businesses should expect 2016 to see substantial law enforcement activity, further raising the importance of developing productive relationships with relevant authorities before a crisis arises.

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• Prosecuting Cybercriminals. The number of cybercrime inves-tigations and prosecutions is expected to increase in 2016 and continue the long-term trend of growing collaboration among domestic and foreign agencies to target threat actors around the world. For example, the US Department of Justice plans to disrupt and dismantle 1,000 cyber threat actors and to resolve 90 percent of national security and criminal cyber cases during the next fiscal year. These ambitious targets reflect the vast augmentation of resources that the government has brought to bear against the cyber threat. Since 2002, the FBI’s number of cyber intrusion investigations has grown by more than 80 percent. And, since 2010, the US Secret Service’s cybercrime investigations have resulted in more than 5,000 arrests associated with more than $12 billion in actual and potential fraud losses.

• International Engagement. To continue at this pace and reach or exceed their targets, federal law enforcement agencies will need to cooperate extensively with their domestic and international counterparts. For example, in 2015, a prosecution for an alleged hacking and insider trading scheme was the result of collaboration among a who’s who of law enforcement agencies: the US Depart-ment of Justice, SEC, US Department of Homeland Security, US Secret Service, FBI, FINRA, UK Financial Conduct Authority and the Danish Financial Supervisory Authority. Similarly, the arrest, extradition and prosecution of Vladimir Drinkman for a data breach conspiracy involving over 160 million compromised credit card numbers resulted from coordination among law enforce-ment agencies in multiple countries. International cooperation of this sort will continue to define many of the most high-profile cybercrime investigations.

• Partnership with the Private Sector. For years, law enforce-ment agencies have viewed partnerships with private entities as critical to promoting cybersecurity. According to a 2010 White House report, “[p]rivate-sector engagement is required to help address the limitations of law enforcement and national security.” As is discussed in greater detail below, the Cybersecurity Infor-mation Sharing Act is expected to augment both the government and the private sector’s access to information about cyber threats and to bring new private-sector players into the conversation. Overall, law enforcement agencies expect that this broader private

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sector participation will help them to investigate threat actors and disrupt their attacks and schemes.

Expanding Global and Technological Scope of Policy Debates

Policy debates shifted in 2015 as cybersecurity and data privacy issues attracted both national and global prominence. Policy develop-ments in 2016 likely will continue this trend. For example, it is expected that: (i) industry will take advantage of significant legal authorities approved in 2015, such as the Cybersecurity Information Sharing Act and new “cyber sanctions,” both of which will require effective collaboration between the private sector and government; (ii) long-standing debates about privacy and security will be moved to the global stage (and likely become more political as the US presidential election approaches); and (iii) the proliferation of toys, devices and machines that are connected to the Internet will present new cybersecurity and data privacy challenges.

• Cybersecurity Information Sharing Act of 2015. In December 2015, the multiyear debate over the appropriate mechanisms and legal protections for cybersecurity information sharing came to a close with passage of the Cybersecurity Information Sharing Act. This legislation provides new authorities for private sector busi-nesses to monitor and defend their networks and share cyber threat information with the federal government and other private sector entities. With the ground rules for information sharing between and among the private sector and government now set, 2016 presents opportunities for businesses to take advantage of the authorities and liability protections this law offers.

• Cyber Sanctions. The US government is poised to use economic sanctions in 2016 as a new tool to deter foreign hackers from stealing vital assets from businesses—whether source code or confidential negotiating positions. Last year, President Obama issued Executive Order 13694, which created a new sanctions program aimed at actors outside of the United States who threaten US national security or target the country’s critical infrastructure, computer networks, intellectual property, economic resources or other vital assets. An initial set of regulations was published in the Federal Register on December 31, 2015, and it could only be a matter of time before the first entities are added to the sanctions list.

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• Encryption. As countries increasingly ask technology companies for law enforcement access to communications, the question of encryption has become a global issue. Last year saw the rise of the public debate over encryption, and 2016 is likely to see it play out on a global stage. This significant policy debate may well become even more polarized during the year of a presidential election in the United States, posing potential hindrances to passing legislation or reaching international consensus.

• Internet of Things. There was a significant increase in policy debates in 2015 concerning cybersecurity and data privacy issues raised by the Internet of Things. From consumer products to industrial machinery, the cybersecurity and data privacy implica-tions of the Internet of Things were scrutinized by Congress and executive branch policymakers. Automotive cybersecurity and data privacy issues, for example, were the focus of multiple pieces of proposed legislation and of regulatory study. Likewise, the Food and Drug Administration recently issued guidance on post-market management of cybersecurity in medical devices. This year will likely see continued growth in policymakers’ attention to the Internet of Things as the number, kind and capability of connected devices continues to grow. Cybersecurity and data privacy present novel, complex and global

issues across the legal, policy and regulatory spectrum. These develop-ments pose challenges that demand a proactive, risk-based response. Businesses must address these risks in a holistic fashion that reflects the strategic interests of their organizations and is effectively coordi-nated across their enterprises. From board oversight to the drafting of an outsourcing contract, from policy development to breach response, and from regulatory rulemaking to litigation, businesses should understand the risks they face and deliver a considered and multifac-eted response. As the cybersecurity and data privacy landscapes continue to shift around the world, the value for businesses of understanding those threats and responding in a strategic, coordinated and enterprise-wide fashion will be greater than ever in 2016.

For more information about the topics raised in this 2016 Outlook, please contact any of the following Cybersecurity & Data Privacy practice team lawyers.

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Matthew Bisanz + 1 202 263 3434 [email protected]

Kendall C. Burman +1 202 263 3210 [email protected]

Marcus A. Christian +1 202 263 3731 [email protected]

Rajesh De +1 202 263 3366 [email protected]

Laura R. Hammargren +1 312 701 8146 [email protected]

Charles E. Harris +1 312 701 8934 [email protected]

Gabriela Kennedy +852 2843 2380 [email protected]

Robert J. Kriss + 1 312 701 7165 [email protected]

Stephen Lilley +1 202 263 3865 [email protected]

Mark A. Prinsley +44 20 3130 3900 [email protected] Joshua M. Silverstein +1 202 263 3208 [email protected]

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Jeffrey P. Taft + 1 202 263 3293 [email protected]

Howard W. Waltzman +1 202 263 3848 [email protected]

Evan M. Wooten +1 213 621 9450 [email protected]

Oliver Yaros +44 20 3130 3698 [email protected]

Guido Zeppenfeld +49 211 86224 169 [email protected]

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WHEN SELLER CONTRACTS FOR IT ON BEHALF OF ACQUISITION

Law360, New York (February 1, 2016, 10:23 AM ET) –

Last year was a record year for mergers and acquisitions activity as 2015 generated $4.7 trillion worth of deals driven by inexpensive debt and the pressure to become more efficient in a low-growth economy.1 To help achieve the expected benefits of an acquisition, the information technology infrastructure and back office services of the acquisition must be inte-grated into the buyer’s environment or stood up independently. However, the integration approach is time-consuming and prone to failure; it is estimated that 50-80 percent of acquisitions fail due to lack of proper inte-gration.2 Given this high rate of failure, an acquisition that has its own independent IT and back office environment is more likely to be successful.

Nevertheless, it is not uncommon for an acquisition to be integrated into the seller’s IT and back office environment, thereby making it difficult to parse these services from the seller. To overcome this obstacle, there is an emerging trend for the acquisition to contract for these services before the M&A deal is finalized, thereby establishing an independent environ-ment that eliminates integration problems that often plague acquisitions. This contracting approach commonly involves the seller negotiating on behalf of the acquisition with a service provider before the sale of the acquisition is complete to allow the implementation of services prior to or close to the anticipated sale date. Those agreements would then be assigned or novated to the buyer after closing. This unusual contracting relation-ship produces a myriad of issues that the seller, service provider, and buyer must navigate. Some of the more significant issues are discussed below.

Loss of Bargaining Power

Perhaps the most significant obstacle faced by a seller negotiating agreements on behalf of an acquisition will be the loss of bargaining power. Oftentimes, a seller will engage current service providers to create new service agreements for the provision of services to the acquisition. While a service provider may have been willing to make contract concessions when negotiating an agreement to make contract concessions when negotiating an agreement to provide services to the

1. Maureen Farrell, 2015 Becomes the Biggest M&A Year Ever, Wall St. J., Dec. 3, 2015

available at http://www.wsj.com/articles/2015-becomes-the-biggest-m-a-year-ever-144 9187101?mod=djemCFO_h&mod=djemCIO_h (last visited Jan. 23, 2016).

2. http://www.themiddlemarket.com/video/seamless-integration-of-new-acquisitions-258423-1.html?page=3.

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seller’s entire organization, service providers are much less willing to extend the same terms and conditions in an agreement for the acqui-sition due to a smaller scope of work. As a result, the seller’s negotia-tion team should prioritize the terms needed for the acquisition and recognize that the service provider will not be as flexible as it had been in prior negotiations with the seller.

Cloud-Based Technology

The emergence of cloud-based technologies allows the acquisition to implement and stand up services much faster than a siloed approach. As with any cloud agreement though, there are trade-offs between the ability to negotiate customized terms versus the speed to deploy the solution using the service provider’s standard terms. In particular, areas where cloud agreements typically diverge from customized IT deals that may be important for the acquisition include service level credits as a sole and exclusive remedy, scaled-back audit rights, the ability to store and process client data anywhere, and minimal disen-gagement services. The economics of a cloud solution dictate that the service provider is not able to offer more robust terms that the acqui-sition benefitted from under the seller’s master agreement. Conse-quently, the seller’s negotiation team needs to evaluate these reduced terms and decide whether or not the proposed solution will meet the requirements of the acquisition.

Lack of Historical Data

It is common for performance data associated with the acquisition to be comingled with the seller’s other lines of business, thereby making it difficult to develop volume projections and associated pricing for the acquisition due to this lack of historical data. For example, if the seller is negotiating an agreement for back office accounting functions, it may not be possible to discretely identify invoice volumes. As a result, service providers will often push for a baselining period to allow both sides the opportunity to ascertain realistic volumes for the acquisition, usually followed up by a one-time true-up. A typical baselining period will last six months and the seller should push to include contractual provisions that describe a formulaic method to set the new volume baseline for the acquisition. To the extent that the new volume base-line deviates significantly from the initial assumption in either direction, the service provider’s solution may not be appropriately sized and the parties will need to engage in further contract negotiations which may

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result in an increase to absolute price or an increase to the cost per unit. If the new volume baseline is significantly higher, the buyer may be faced with a large invoice at true-up.

Hypercare

IT and back office functions are often shared services in many organizations, so it is unlikely that many seller personnel from these areas will move with the acquisition. As a result, buyer personnel will be thrust into the role of managing the relationship with the service provider, and seller personnel who move with the acquisition may encounter new escalation procedures for problem resolution. To mitigate these issues, the seller should contract for a period of “hypercare” during which the service provider provides extra resources (usually for an additional fee) to help ensure that the services are successfully implemented. A typical hypercare period lasts three months and is important in any transition to a new provider, but it is even more critical in M&A transactions given the number of new faces.

Soliciting Buyer Input

The buyer will want to have some input into the negotiation process to ensure that its legal and operational concerns are addressed. However, the buyer does not have any contractual standing to negotiate terms until the new agreement is assigned or novated to it. During the nego-tiation process, the seller should solicit input from the buyer on key legal, commercial, and operational/technical terms. From a solution perspective, subject matter experts of the buyer should have the oppor-tunity to vet the statements of work, service levels and pricing since operational ownership will transfer to them after the purchase of the acquisition. Likewise, the buyer’s legal team should be consulted to provide input on items such as liability caps, termination rights, and intellectual property rights. Service providers are more than willing to accommodate changes after assignment or novation, but bargaining power may be reduced at that point in time so it is more advantageous to address key concerns during the initial negotiation.

Ask for an Escape Clause

The seller’s negotiation team should strive to include a clause that would allow the seller to cancel the new services agreement should the acquisition fail to close. If the service provider is amenable to including such a clause, it is common for the service provider to look

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to recover business development costs incurred during the negotiation process.

Some, but not all, service providers are open to including such a clause. Those that oppose including this type of clause typically argue that the seller will most likely want to find another buyer for the acqui-sition target and therefore would still need to contract for the services. These service providers also cite that the seller can terminate the agreement for convenience (with payment of termination charges), although this method is usually more expensive than reimbursement of business development costs under an escape clause.

Leverage Existing Agreements

If all else fails and a new services agreement for the acquisition cannot be reached in time, a well-negotiated master agreement between the seller and service provider typically includes the right for the acqui-sition to still receive services as an eligible recipient of the seller. While this approach does not fully achieve the independence gained with a new services agreement specifically for the acquisition, this fallback option allows the acquisition to continue to receive services while the parties can continue to work on a new agreement.

–By Derek Schaffner, Mayer Brown LLP Derek Schaffner is counsel in Mayer Brown’s Washington, D.C., office and a member of the firm’s business and technology sourcing practice.

The opinions expressed are those of the author and do not neces-sarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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KEY PRIVACY ISSUES IN M&A TRANSACTIONS

9 October 2014 Mayer Brown Legal Update Many merger and acquisition (“M&A”) agreements lack specific repre-sentations and warranties regarding privacy issues. Often, this is because deal lawyers do not recognize potential privacy risks where the target company (the “Target”) lacks e-commerce websites or retail stores that collect consumer data. Nonetheless, significant privacy issues may exist even if the Target is a traditional “brick and mortar” business. Early attention to privacy issues in M&A transaction planning and due diligence can mitigate risks for both buyers and sellers.

Recent high-profile government enforcement actions highlight the need to analyze potential privacy risks. For example, Facebook’s acquisi-tion of WhatsApp in February 2014 resulted in the US Federal Trade Commission (“FTC”) sending a warning to both companies that the failure to honor WhatsApp’s personal data promises to its customers would constitute a deceptive act under the FTC Act. Likewise, Barnes & Noble’s recent acquisition of Borders’ customer list garnered intense FTC scrutiny due to past promises by Borders not to share its customers’ data without their consent.

This article examines key potential privacy issues that may arise in M&A transactions and describes measures that buyers and sellers should take to evaluate and mitigate the risks.

Buyer Concerns

Buyers should conduct thorough due diligence to determine, among other things, (i) the extent to which the Target collects, stores, uses or processes (collectively, “processes”) personal data, whether from customers, employees or others, (ii) the nature of the personal data processed, (iii) the countries where the processing occurs and (iv) the Target’s current and prior personal data policies and agreements. Special attention should be paid to personal data from EU member countries and other jurisdictions that have stringent privacy laws. Diligence findings should be reviewed with privacy counsel in the relevant juris-diction(s) to identify legal implications and compliance issues and to help the buyer draft appropriate representations and warranties to cover potential privacy risks.

The Target’s privacy policies are often an important source of infor-mation for buyers. These policies include any internal data policies,

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such as employee privacy policies, as well as any customer-facing privacy policies, such as those posted on the Target’s website. Buyers should be on the lookout for failures of the Target to comply with such policies, as well as for restrictions that could be inconsistent with how the buyer plans to use data acquired from the Target. If the Target has current and prior versions of these policies, the buyer should assess (i) whether applicable restrictions are different under each version, (ii) what particular data was collected under (and thus subject to) each version and (iii) how such data is stored (e.g., sepa-rately by policy version or segregated). Policy restrictions that impact the buyer’s intended use of data should be evaluated to identify steps needed to comply with such restrictions (e.g., obtain consent from the individuals affected).

If the proposed M&A transaction involves the transfer of personal data across national borders, the buyer should review the Target’s com-pliance with applicable cross-border transfer restrictions, such as those required by the European Union. For example, if the personal data of EU residents is involved and the seller indicates that the Target is EU-US Safe Harbor certified, the buyer should review the currency of the Target’s Safe Harbor certification, as well as the Target’s related internal assessments and compliance materials.

If the proposed M&A transaction is structured as a merger or stock purchase, the buyer may be assuming the Target’s past liabilities, including those for privacy compliance issues. Accordingly, buyers in such deals should conduct a more comprehensive analysis of the Target’s past and current compliance with privacy laws, including with respect to actual or suspected breaches of the Target’s privacy policies or IT security.

Even if they do not assume the Target’s liabilities, buyers should assess whether the Target complied with applicable privacy laws when it collected such data and any associated limitations on the buyer’s subsequent use of the personal data.

Regardless of deal structure, buyers should identify what personal data needs to be transferred to consummate the transaction—such as the Target’s employee payroll, medical or other data—and whether any consents or other formalities are needed to permit such transfers.

Finally, if the proposed M&A transaction involves the provision of services from the seller, the buyer should consider the extent and nature of any personal data involved (such as data for payroll or benefits plan administration services) and ensure that there are appropriate con-tractual privacy protections for the contemplated services arrangement.

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Seller Concerns

Sellers also have privacy concerns in M&A transactions, particu-larly when disclosing personal data during the due diligence process or prior to closing. Sellers should review the Target’s privacy policies and applicable privacy laws carefully to determine what personal data—including that of its employees—it can share during the due dili-gence process, as well as to evaluate the compliance, data use restrictions and other issues described above.

Sellers should take care to limit disclosure of sensitive information and personal data and to avoid disclosing data that could trigger security breach notification obligations (e.g., Social Security numbers, driver’s license numbers, credit card numbers or medical data). Sellers should also require that disclosures be subject to appropriate nondisclosure agreements and be conducted via a secure method that allows con-trolled access (such as an encrypted virtual data room).

If the proposed M&A transaction involves employee personal data, the seller should avoid sharing such data in instances where doing so would violate applicable privacy guidelines or policies or the employees involved have a reasonable expectation of privacy in the data (e.g., job performance reviews). In addition, for employees outside the United States, the seller should evaluate the laws of the applicable countries, which may, in some cases, require employee notice and consent prior to sharing or otherwise limit disclosure.

Conclusion

Current and evolving legal requirements require timely, substantial attention to privacy issues in M&A transactions, even in deals involv-ing traditional “old economy” businesses. Leaving these issues to the end of a deal can cause delays and increase risk. Careful attention to potential risks, including those described in this article, can help both buyers and sellers to mitigate risk in M&A transactions.

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BEST PRACTICES FOR BUYERS AND SELLERS IN ADDRESSING SERVICES AGREEMENTS IN CONNECTION

WITH MERGER AND ACQUISITION TRANSACTIONS

By Michael Murray, Brad Peterson and Paul Chandler

January 2012

Services Agreements in Merger and Acquisition Transactions

Services agreements are becoming more important in mergers and acquisitions (M&A) as companies increasingly rely on external pro-viders for critical functions. Early attention to services agreements in M&A planning, due diligence, and negotiations can increase deal value for, and mitigate risk to, both buyers and sellers. This article describes best practices for buyers and sellers in addressing services agreements in connection with M&A transactions.

Changing Business Structures Are Creating New Opportunities

Intense cost pressures have forced companies to reduce the costs of performing services3 that support their core businesses, such as information technology, human resources, finance and accounting, procurement, and facilities management. One effective way to reduce those costs is to outsource traditionally internal functions to service providers that can offer both economies of scale and service delivery centers with world-class tools and processes. Thus, a company being bought and sold in an M&A transaction (hereinafter referred to as a “target company”) is increasingly likely to depend on services being provided by multiple unaffiliated outsiders.

The M&A practice evolved in an era when “third-party services agreements” could generally be ignored until the transaction was nearly final, Even today, deal teams often focus on the M&A transaction first, leaving the services agreements and other post-closing operational details until the frantic rush to signing, or sometimes even as a

3. In keeping with current terminology for strategy consultants and technology archi-

tects, this article uses the word “services” broadly to include back-office processes, functions, and capabilities, including all of the underlying people, systems, technology, facilities, and other resources, along with the set-up, operation, and disengagement of those services.

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post-signing or post-closing item.4 In many cases, the people who know what services are needed and who can provide them are excluded from the deal team until very shortly before, and sometimes even after, the M&A agreement is signed. As a result, deal teams can sometimes miss opportunities to preserve the value of existing agree-ments and mitigate the risk of leakage of all or some of the transac-tion’s economic benefits to a third-party service provider.

In this regard, there are a number of opportunities to increase deal value and mitigate risk. These include: • Existing third-party services agreements used only by the target, • Existing third-party services agreements shared by the target and

the seller, • Steps that potential sellers can take to prepare for future M&A

transactions, and • Steps that potential buyers can take to prepare for future M&A

transactions.

Existing Third-Party Services Agreements Used Only by the Target

If the target of the M&A transaction is the only business in the seller’s corporate group using a services agreement, the easiest approach is generally to have the target continue using the existing agreement (and being bound by the existing agreement) after the acquisition. However, services agreements often prohibit assignment or change of control. Savvy third-party providers can, and often do, use those pro-hibitions as leverage to exact a price for the ease of continuing the services agreement—particularly if the existing pricing is not favorable to the provider, or if it is costly to replace the agreement.

Replacing an existing services agreement creates operational risk and might be surprisingly costly due to early termination fees or mini-mum volume commitments. Similarly, adding the target as a service recipient under the buyer’s existing arrangements may require lengthy negotiations with the buyer’s third-party providers.

4. In some cases, leaving service agreements to a later stage in the M&A process is a

conscious decision driven by the seller, the buyer, or both. Factors such as confi-dentiality, the buyer’s familiarity with the target, limitations on internal resources, and cost can drive such a decision.

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Replacing third-party providers on complex or large-scale services agreements often takes far longer than the M&A deal cycle and may require the involvement of people beyond the M&A team’s “circle of knowledge.” Rushed negotiations may result in substantial opportunity costs. In many cases, better pricing is available to customers that have the time to identify their true needs, conduct a robust sourcing process, and make long-term commitments. For a large-scale agreement for a critical service, this process can take three to 12 months from start to finish.

The current service provider’s leverage will grow as the closing date of the M&A transaction approaches and the buyer’s options narrow. As a result, there is a risk that the current provider’s demands will grow with its leverage.

Existing Third-Party Services Agreements Shared by the Target and the Seller

If the seller and the target both depend on one of the seller’s third-party services agreements, the target may be able to continue receiving services from the provider as a “service recipient” under the existing agreement, even after the buyer acquires the target. The seller would then invoice the target or the buyer for the target’s allocable share of the charges under the existing agreement.5 This method has the benefit of preserving the value of the existing agreement, if it works. In considering this option, the parties should address certain ques-tions, such as: • Does the seller have the right to designate the target or the buyer

(as applicable) as a service recipient? If so, what are the associated costs (e.g., for set-up or third-party consents)?

• Will the terms of the existing services agreement meet the buyer’s needs?

• Does the pricing permit the seller to allocate charges to the target or the buyer?

• Will the buyer have the right to require the seller to dispute charges or make claims for damages under the existing agreement?

5. For simplicity, we are assuming that the existing agreement is between the third-

party provider and the seller. Typically, the principles stated here would also apply if the agreement were between the third-party provider and the target.

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• Will the buyer have the right to audit the provider? (audit rights may be required to comply with legal obligations or the buyer’s policies)?

• Who prevails if the buyer and the seller disagree on directions to be given to the provider (e.g., with respect to in-flight projects)?

• Which party will own the intellectual property developed by the provider in the performance of the services agreement?

• Will the seller be liable if the buyer fails to comply with the existing agreement? (The risks of adverse consequences to the seller due to buyer noncompliance will be particularly troublesome if the existing agreement is critical to the seller’s retained organization.)

• Will the seller be liable to the buyer if the service provider fails to perform, or if the services are otherwise deficient? In other words, is the seller responsible for its third-party provider’s services, or is the seller merely managing and passing through those services to the target or the buyer on an “as-is” basis? Another approach is to negotiate a new contract with the provider

to continue the service. This approach provides a much easier separation between the buyer and the seller and allows the buyer to assess the existing third-party provider against its competitors to obtain the most favorable pricing and other terms. However, this may result in the buyer losing value because the new service contract covers only its own volume. A new contract may also cause the seller to lose value because it may pay higher unit prices under the existing agreement (or even face termination or termination charges) because of the reduced volume. Time constraints often make this approach impractical.

In some cases, there is an easy path to obtaining a new contract with the service provider because the seller has a right to split the existing agreement in a way that preserves its value (i.e., “cloning”). Or, the seller may be able to create two new agreements that divide the service scope, revenue commitments, termination charges, and other similar terms of the existing agreement (i.e., “cleaving”).

Cloning can have unintended consequences, however. For example, it might have the effect of doubling minimum revenue commitments or of requiring the provider to dedicate a specific person or asset to multiple customers. Thus, cloning is generally used only for simpler services agreements.

Cleaving means reducing service volume baselines and minimum charges under both the existing agreement and the new agreement.

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But it can also mean allocating personnel, intellectual property rights, rights to dedicated assets upon a termination, and other key resources and assets between the existing and new agreements. New projects may also be required to separate service delivery facilities, teams, and reporting capabilities for the buyer and the seller; to decouple the seller’s confidential information from the buyer’s confidential information; and to adapt to the buyer’s unique needs or integrate with the buyer’s systems. Cleaving typically involves more negotiation that cloning. The provider has likely scaled its service delivery organization for the combined volume under the existing agreement. As a result, the pro-vider sees more economic benefit in providing services under two similar agreements, without the costs of negotiating a new agreement, than in any increase in per-unit charges that may result from the cleaving. At the same time, the service provider may see an oppor-tunity to obtain provider-favorable terms and pricing in return for continuing to provide an essential service, particularly if the buyer has run out of time to find a different provider.

Steps that Potential Sellers Can Take to Prepare for Future M&A Transactions

Sellers can take steps to position themselves to maximize value and mitigate risk. These steps include: • Developing an organization to support divestiture activities, with

an “M&A playbook” and a staff for supporting divested businesses; • Maintaining a database of services agreements and the businesses

that they serve; • Ensuring that outside service providers are committed to:

○ Taking on work, shedding work, supporting divested busi-nesses, and providing M&A support upon request; and

○ Permitting the seller to clone or cleave existing agreements; • Ensuring that outside licensors, lessors, and similar third parties

have agreed to allow their software or assets to support divesti-tures, at least for a minimum time period;

• Including in the divestiture team, at an early stage, the people who will be responsible for arranging services to be provided by or for the seller;

• Analyzing the target’s internal servicing capabilities, the services the target needs from shared contracts or from the seller’s

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organization, any services the target provides to the seller’s organi-zation, the costs required to provide those services, the effect the divestiture will have on the seller’s retained organization (includ-ing pricing impacts under existing services contracts), and how best to provide the needed services; and

• Identifying projects under third-party services agreements that the buyer may not need and that should be put on hold pending a transaction.

Steps that Potential Buyers Can Take to Prepare for Future M&A Transactions

Buyers can also take steps to maximize value and mitigate risk. These include: • Incorporating rights to expand services and obtain acquisition

support into third-party services agreements; • Developing an organization to support acquisition activities, with

an “M&A playbook” and a staff with responsibility for support-ing acquired businesses;

• Identifying in advance any services that will need to be replicated or replaced, as well as the means to mitigate the impact of service failures;

• Documenting services and associated service levels that the buyer’s own internal services organizations can perform for acquired businesses, and determining the expected timing needed to bring those services online for a target;

• Assigning to the acquisition team, at an early stage, the people the buyer will use to procure the needed services from a third party;

• Commencing negotiations with third-party service providers as promptly as possible; and

• Leveraging best practices developed in outsourcing and large-scale agreements for critical services.

Conclusion

Dramatic changes in the ways that companies source core business functions require timely, substantial attention to services agreements in M&A transactions. Leaving these issues to the end of a deal can cause delays, squander value, increase risk, and lead to disputes. The

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best time to begin developing services agreements is well before the target is identified. Integrating the approaches described in this article into contracting policies and overall M&A strategies and approaches can help both buyers and sellers to maximize value and mitigate risks in M&A transactions. CM

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