Deals and Due Diligence in the #MeToo Era

The #MeToo movement has also, however, created a new and unfamiliar category of risk for potential investors in, or acquirers of, businesses that are heavily reliant on a small number of key individuals, the retention of top talent and public goodwill. Any public allegations of sexual misconduct, regardless of veracity, can so severely stigmatize an accused executive that the company must sever any remaining association with the scandal. Particularly for a small company that depends on the individual reputation or specialized expertise of key executives to build relationships and the company’s brand, a #MeToo scandal centered on one such executive can be tremendously damaging to its business.

In fact, even if allegations are not made against specific current executives, if there is an implication that internal complaints were ignored or discouraged, the company’s ability to recruit and retain top talent or customers may be irreparably damaged. Furthermore, because certain allegations may be widely discussed among current or prospective employees or customers, but not the wider public, the company may be paying a “#MeToo premium” for allegations of which the sellers are genuinely unaware.

Unlike with traditional due diligence considerations, the risk assessment for such deals is not confined to evaluating the potential legal liability of the target company. Sexual misconduct allegations against a key executive may cause significant reputational harm for the company, even if the allegations are unproven, the statute of limitations has run, the claims arising from the allegations were resolved in a settlement agreement, or the alleged conduct is not legally actionable under then-current law.

A cautious buyer, however, can take a number of steps to mitigate these risks, from a measured approach to due diligence on the front end, to documentation protections, to post-closing measures to ensure new problems related to past issues do not arise in the future.

Assessing the Risk

From a due diligence perspective, the current environment creates a greater need for prudence with respect to a company’s culture, both from a legal and public relations perspective. An investor or potential buyer should conduct a thorough review of a company’s employment policies, organizational structure, reporting lines (including alternate reporting lines in case of a conflict of interest), and employment agreements, as well as public and semipublic information.

Potential red flags include:

• Documents that suggest a company is aware of a pattern of misconduct. For example, various online news sites have reported that Harvey Weinstein’s employment agreement with the Weinstein Company required him to pay the company liquidated damages for violations of its code of conduct, ranging from $250,000 for the first instance to $1 million for the fourth and subsequent violations. This unusual provision suggests that the company was aware of past misconduct and anticipated future misconduct.
• A definition of “cause” in executive employment agreements or claw-back policies that excludes sexual misconduct. Employment agreements that entitle the executive to receive substantial severance payments despite being terminated for sexual misconduct signal that the company may tolerate known misconduct by the executive. At a minimum, the absence of sexual misconduct from a “cause” definition indicates a missing important enforcement element.
• An unusually large number of separation or settlement agreements. Although companies can have legitimate business reasons to settle even meritless claims, a careful investor should closely scrutinize the reasons why a company has a high incidence of threatened claims or enters into separation or settlement agreements that are disproportionally attributable to a particular reporting line or demographic.
• Employment recruitment or attrition data that is inconsistent with the market, particularly if the data suggests that the company has difficulty recruiting and retaining women.
• Exit interview information that reflects a pattern of similar complaints about the work culture or about specific executives who remain at the company.
• Communications relating to human resources or public relations personnel that suggest that allegations of sexual misconduct are suppressed or left unaddressed.

The presence or absence of any of the foregoing may not be dispositive for determining whether to proceed with a transaction. However, prudent buyers will note the existence of one or more of these issues and react appropriately, whether by seeking additional information, obtaining appropriate protections/remedies, or ultimately deciding not to move forward.

Seeking Appropriate Safeguards

Investors and potential buyers should also consider an appropriate scope of deal protections in the definitive documentation, including whether to require broad representations and warranties from key executives as a condition of closing the deal. If the deal warrants, key executives should each certify as to disclosure of any sexual harassment or sexual assault complaints lodged against them and any settlements of such claims. Executives can, and should, be further asked about their past conduct toward subordinate employees: Have they made sexual advances to or engaged in a sexual relationship with a subordinate employee; made lewd or sexually explicit comments to a subordinate employee; sent sexually explicit images to a subordinate employee; or been told by subordinates that their conduct (or the conduct of other executives) was offensive or inappropriate, whether at the company or at a prior company? Appropriate certifications by such executives, while an imperfect protection and remedy, will at least provide a purchaser with further assurances due to the personal liability attached thereto.

In some industries, such as the entertainment and publishing industries, it may also be prudent to seek information beyond the employment context. Some #MeToo reports relate to sexual advances or uninvited sexually explicit comments made to another person, where the alleged offender had the power to affect that person’s career advancement or the success of her (or his) business projects. Retaliatory acts are also an important subject of inquiry: A cautious buyer should ask for representations about whether a key executive has ever taken adverse employment action or made adverse business decisions against a person who had declined sexual advances or objected to the executive’s sexual conduct or comments.

In certain cases where personal representations and warranties are insufficient, specific indemnification provisions may be sought. These indemnifications can be based on contractual liability, escrow amounts or deductions from future compensation. In the absence of such provisions, purchasers may be limited to claims of fraud or misrepresentation, which are harder to enforce and may be valueless in the case of serial accusations.

Ensuring Ongoing Compliance

Following a successful closing of an acquisition, it is important to remain engaged with the policies and procedures of any business to ensure the right protections are in place going forward. For example, an appropriate review of the reporting policies for employees and amendments (as needed) to ensure adequate steps are taken by supervisors and managers upon learning of an issue. Formal policies and appropriate individual training should be implemented to the extent not already in place. If appropriate human resources professionals are not already in place, they should be hired and given authority to report directly to outside directors in the event problems are reported to them. Of course, if any such problems are elevated to the board level, directors should consult with counsel to ensure that appropriate steps are taken.

Conclusion

While the current environment adds an increased layer of risk to any acquisition, with proper counsel and structuring such risks can be mitigated. Although the heightened awareness surrounding sexual harassment incidents present a new and unique challenge for many acquirers and investors, they can be met with many of the due diligence skills and appropriate compliance procedures that were developed to address previous “emerging risks” that arose after other high-profile scandals, such as the accounting and lobbying scandals of the 2000’s or the insider trading scandals of the 90s. The extent of such safeguards should be determined based on an individual company’s level of exposure, but investors that are active in the merger-and-acquisition landscape should discuss baseline vetting procedures with in-house and external counsel, as well with human resource experts.