Allison Fulton is a life sciences and FDA partner at Sheppard, Mullin, Richter and Hampton. Ariel Yehezkel is the corporate practice group leader with extensive experience advising food and beverage companies. Allison Wu Troianos is an associate in the firm's corporate practice and advises companies on mergers and acquisitions.
When considering an acquisition of a food and beverage company, potential buyers of a company or its assets should pay particular attention to U.S. Food and Drug Administration requirements and their implications on the target’s business.
Buyers should be cognizant of the regulatory issues at the beginning of the process so that their risk can be assessed in the context of the transaction, and in turn, be addressed by specific representations, covenants and indemnification provisions in the transaction documents. The following considerations should be top of mind throughout the course of due diligence and negotiations.
1. Food Safety Modernization Act
The Food Safety Modernization Act (FSMA) introduced the most sweeping changes in food law in 70 years. FSMA applies to food manufacturers, distributors and other partners in the supply chain, and creates compliance obligations focused on preventing food safety issues before they occur.
Under FSMA, the FDA requires all facilities engaged in manufacturing, processing, packing and holding of food for the U.S. market to register their facility. Facilities outside the U.S. that manufacture food for the U.S. market also must register with FDA. The registration process puts the facility on FDA’s radar, and the agency is permitted to inspect the facility at any time permitted by the Federal Food, Drug and Cosmetic Act. Facilities must renew their registrations every two years, and FDA has the authority to suspend registrations. Most states have similar facility registration requirements.
FSMA also requires food facilities to implement preventive safety controls, including evaluating hazards that could affect food safety; identifying preventive controls to minimize or prevent hazards; monitoring the controls to ensure they are working; identifying actions to correct problems that arise; and maintaining related procedures and records. Food facilities also must implement strategies to prevent the intentional contamination of food in the facility or during transit.
Given FSMA requirements, during the due diligence process, companies should identify the food facilities that manufacture, pack or hold food bound for the U.S. and seek inspection histories from U.S., state and international regulators. Buyers also should request procedures of the target company demonstrating compliance with FSMA, including procedures relating to preventive controls. Required documentation, such as a facility’s written food safety plan and records of corrective and preventive actions (CAPAs) also should be requested and reviewed during diligence. A company that is unable to produce these documents raises a red flag because the company may not be compliant with federal food law — or worse, not aware of the requirements.
If the target company cannot produce documents required under FSMA, or if there is evidence that significant safety issues have originated in a target’s food facility, buyers should explore whether the target has other facilities to which it can shift production or warehousing. In addition, a broad "compliance with laws" representation — typically made by a target company — could be tailored to specify that the company is, and has been, in compliance with FSMA for a certain number of years, typically between two to three years, and with its own policies and procedures.
2. Current good manufacturing practice
Closely related to the food safety requirements under FSMA are the current Good Manufacturing Practice (cGMP) regulations, which outline minimum requirements for manufacturing facilities to ensure food is produced under sanitary conditions. These regulations require, for example, that production activities are executed by properly trained personnel who follow documented policies and procedures, use calibrated equipment and work in facilities designed to prevent cross-contamination.
Buyers of dietary supplement companies, in particular, should be aware of cGMP requirements. FDA has separate, and more onerous, cGMP requirements for supplements. While the food regulations focus on sanitization and preventing cross-contamination, the supplement cGMP regulations look more like drug regulations. For example, supplement manufacturers must conduct identity testing on each batch of dietary ingredients received from raw material suppliers with certain exception for qualified suppliers, retain samples of raw materials, in-process and finished products, and maintain detailed batch records. Facilities that produce both foods and supplements often struggle to establish a single Quality System, given the heightened requirements for dietary supplements.
Prior inspection records from U.S. and other regulators provide insight into a facility’s compliance with cGMP regulations. Buyers’ requests should include any prior Warning Letters, Form 483s and Establishment Inspection Reports (EIRs). EIRs provide a narrative account of the inspection, and FDA investigators often include statements about facility management, such as their knowledge and participation during the inspection. Such statements can provide helpful insight into the facility’s leadership, as well as the competence of quality and manufacturing personnel who met with FDA.
Prior recalls also provide insight into a food facility’s safety and quality record. Recalls are made publicly available by FDA, and the buyer should ask the target for communications with FDA relating to any recalls in recent years. If a recall is not yet closed, records of corrective and preventive actions (CAPAs) implemented by the facility should be evaluated. CAPAs that are long overdue, continue to recur or are inadequately investigated may raise a red flag. The facility’s procedures governing recalls, product complaints, deviations, supplier qualification and other manufacturing and quality controls also should be evaluated.
Buyers also should be sensitive to products with single-source suppliers. For example, if only one chocolate or pizza sauce supplier is qualified by a facility, then the facility should have a plan to prevent disruption to the market if the supplier were unable to deliver.
Prior inspections and recalls can be included on schedules to the transaction documents, and identified cGMP risks can be addressed in tailored representations. Known product quality issues related to inspections, recalls or other events should be reflected in indemnification provisions.
3. Product labels, ingredients and disclosed allergens
A top reason for food recalls today is undisclosed food allergens or — in the context of dietary supplements — undeclared ingredients. As such, buyers should be aware of the target’s compliance with laws regarding ingredient disclosures and product labels.
Food labels must disclose their ingredients and any major food allergens, including milk, egg, peanut, tree nuts, soy, wheat, fish and crustacean shellfish. Failure to disclose allergens or ingredients can lead to consumer safety issues or unwanted class action litigation.
Disclosure requirements for food labels are updated periodically by FDA, and responsible food companies must stay current with those requirements. For example, FDA recently changed its rules to require disclosure of "added sugars" on all food labels and modified its rules on mandatory vitamin disclosures FDA requirements for food labels detail minutiae like the order of ingredients and font size in the nutrition facts panel. Claims such as "low calorie," "light" and "less sugar" also are defined specifically by FDA regulation.
Potential buyers should request the target’s current product labels and ingredients, and documentation evidencing the regulatory review of product labels. Any FDA enforcement actions or other notifications regarding noncompliance with labels or ingredient disclosures also should be evaluated. Non-compliance risks identified could be included in corresponding representations and indemnification protections in the transaction document.
4. Product marketing, websites and testimonials
While FDA is solely responsible for product labels and ingredients, FDA works jointly with the Federal Trade Commission on issues relating to product promotion and advertising, including statements on company websites, social media and television.
Buyers of traditional food companies should be cognizant of class actions and other third party actions relating to product claims. In particular, there has been a bevy of class actions involving food labeled as "natural" or "naturally" made. Even if the claims can be substantiated, litigation costs are incurred in defending such suits.
Buyers purchasing dietary supplement companies should pay careful attention to claims made on websites and other promotional materials. Some supplement companies can be aggressive with their claims and make statements that are not appropriate for supplements. For example, a statement such as "supports healthy bones" may be appropriate for a supplement, but "helps prevent osteoporosis" would not.
Testimonials and enforcements generally are viewed as statements by the company and as such, must meet the promotional standards for company statements. Notably, FTC has taken action against supplement companies for testimonials that do not reflect a "typical consumer experience" or that are not substantiated.
During the due diligence process, buyers should review publicly available promotional materials to get an accurate picture of the product marketing claims. Claims that are improper or unsubstantiated likely would garner regulatory attention, or attention from third party litigants. The buyer also should request any third party actions involving any of the products or their claims.
As with the other considerations raised, incidents of non-compliance with promotional standards should be disclosed and addressed in the transaction document through specific representations and covenants, and known issues should be addressed in indemnification protections.