What other deal protection and costs coverage mechanisms are most frequently used by acquirers?
Mergers & Acquisitions
Confidentiality, of course, is a common mechanism, but a noticeable change in the last couple of years has been the acceptance by certain sellers to underwrite due diligence and advisory costs of the potential buyers in deals where the assets are less attractive. There are several different models and variations, but the general concept is that the seller accepts to pay - or reimburse - the buyer if the deal does not close.
Although it is not possible to provide an exhaustive list, in addition to exclusivity and “no shop” provisions, the inclusion of break fees is relatively common. Where setting a break fee, care must be taken so that the party seeking to recover the fee can demonstrate that it is a payment to represent loss incurred by that party as a consequence of having invested in the negotiation of a transaction that has ultimately been aborted rather than a provision intended solely to penalise the other party and prevent them for terminating the agreement because it would be economically unfeasible to do so.
More innovative approaches are also considered. Recently, we have seen consideration being given to the granting of options to prospective purchasers which would be triggered in the event that a third party were to seek to acquire the company. The issuance of those additional shares would make the transaction more expensive and, it is hoped, unappealing to such a third party. Another potential tool is the so-called “crown jewel” provision, pursuant to which a company would agree that in the event that a transaction does not proceed it would dispose of one of its key assets to the counterparty in the transaction.
When agreeing to any deal protection mechanisms, particularly those that stand to make a company materially unattractive (such as the granting of options) or potentially compromise its future (such as by the sale of one of its “crown jewels”) there is a risk that the directors could be found to be in breach of their fiduciaries because such measures are not in the best interests of the company. However, there is no bright line test and the acceptability of such provisions will turn on their facts.
British Virgin Islands
As with exclusivity discussed at question 13 above, subject to complying with their fiduciary and other duties under the act, cost coverage mechanisms such as break fees can be entered into between the acquirer and the target’s board of directors. Similarly no shops, go shops and lock ups are all permitted however the directors of the target company will need to consider their fiduciary duties and duties under the act and the application of such protection and cost coverage mechanisms will be highly deal specific.
As with exclusivity discussed at question 13, subject to complying with their fiduciary and other duties (including exercising their powers and discretions (for example, to issue shares) for a proper purpose, and not to frustrate, or protect, a particular deal), parties are generally free to contract as they wish. The Board of target is able to agree to a wide range of deal protection (no-shops, go-shops, matching rights, lock-ups, voting agreements, top-up options, dispositions re anti-trust issues, escrows, indemnities, earn-outs or contingent purchase price payments, etc.) and cost coverage mechanisms (break fees, reverse-break fees, failure fees, etc.). The use of any particular protection or cost coverage mechanism should be considered on a deal-by-deal basis.
ZL: For the purpose of deal protection and costs coverage, Termination Fee and Non-Disclosure Agreement are most frequently used by acquirers besides the mechanisms detailed in Question 13.
i) Termination Fee (also referred to as Breakup Fee)
At early stage of acquisition, both parties of the acquisition will stipulate in the framework agreement or similar instrument that when the target company fails to obtain shareholder approval, agrees to a competing offer or the necessary government approval is denied or other stipulated event occurs, the target company will pay termination fees to the acquirers.
ii) Non-Disclosure Agreement (NDA)
Acquirers and target companies will execute Non-Disclosure Agreement before the implementation of substantive work and the target company will undertake to guarantee the confidentiality of all sensitive information disclosed by the acquirers.
Besides the above mechanisms, acquirers will take other mechanisms such as M&A insurance to cover the risks and costs pertaining to the transaction, but those mechanisms have not been used frequently.
As mentioned above, letters of intent or exclusivity agreements in Finland often do not include any cost coverage or break fees for the acquirer in the event that the seller decides not to proceed with the transaction. The parties often rely on a transparent process when engaging in a transaction in Finland.
In public transactions, the Board of Directors should only in very limited circumstances agree to a break fee. In practice, agreeing to a break fee may be justifiable in some situations provided that it is in the interest of the shareholders and the amount of the break fee is reasonable (in practice mainly compensation for costs).
Matching rights are conceivable, i.e. the Business Combination Agreement can stipulate that the obligation to support a bidder continues even in case of a superior competing offer for a certain period of time in which the bidder has the possibility to match the superior offer. While ‘no talk’ clauses would not be permitted, non-solicitation (‘no shop’) clauses are customary.
Acquirers tend to impose measures to ensure the protection of the deal. As is typically the case in M&A transactions worldwide, such mechanisms most frequently include letters of credit, letters of guarantee, the use of escrow accounts for gradual payment of the price, as well as - a potentially unique practice in Greek M&A transactions, the use of post-dated cheques as security for deal protection / deferred payment of the purchase price. Market practice is that each party bears its own transaction costs.
If the target company is not listed and not subject to the Takeover Code, the parties can reach a commercial arrangement. If the Takeover Code applies, it prohibits “offer-related arrangements” between a bidder, or any person acting in concert with it, and the target.
Other deal protection measures most frequently used in connection with acquisitions of listed companies include:
- Matching rights
- Break fees, inducement fees, termination fees and reimbursement of expenses.
A matching right, is normally included into a transaction agreement between the bidder and the target, and provides the bidder a right to amend its offer within a short period of time and announce a revised offer to match any alternative and superior offer, which the target is open to accept. This is one of the most commonly used deal protection mechanism used in the Norwegian market. The purpose of such clause is however, mainly to keep an initial bidder in the game, but it will not prevent a determined competitor from potentially winning a bidding competition.
As such, there is currently no general prohibition under Norwegian law against agreeing, break fees. Break-up fees have, however, generally been less common in Norwegian M&A-transactions compared with other jurisdictions, but for a period; such fees gained increasing popularity also on Norwegian public transactions. The enforceability of a break-up fee arrangement under which it is the target itself that undertakes to pay such fees is however to some extent unclear.
The Norwegian Code of Practise now unconditionally recommends that the board must not hinder or obstruct any takeover bids. The Code of Practise also recommends that the target company should not undertake to pay compensation to the bidder if the bid does not complete (break-up fee) unless it is self-evident that such compensation is in the common interest of the target company and its stockholders. According to these recommendations any agreement for financial compensation (break-up fee) to be paid to the bidder should be limited to compensation for the costs incurred by the bidder in making a bid.
Asset lock-ups (crown jewel), buyer share options, sign-and-consent deals and limited window shops may occur, but are rather unusual in the Norwegian market. Some of these arrangements may, depending on how structured, also be in conflict with the latest version of the Code of Practise.
The most common deal protection and cost coverage mechanism is a security deposit, whereby a buyer deposits with a seller an agreed amount in cash which is retained by the seller if the buyer unreasonably refuses to complete the transaction or is returned by the seller if the seller unreasonably withdraws from the negotiations (sometimes in double amount). After recent amendments to the Civil Code, this type of security is explicitly provided by Russian law.
See above on the use of break fees. Otherwise, within the context of private M&A in particular, parties are free to agree upon any set of commitments deemed necessary to secure the relevant deal. However, such activity should not be undertaken in the public M&A context where this would prevent the involvement of potential competing bidders.
Isle of Man
All deal protection measures used in the UK may be used in the Isle of Man, however the most frequently used measures are conditionality and exclusivity agreements.
If the Takeover Code applies, it prohibits “offer-related arrangements” between a bidder, or any person acting in concert with it, and the target.
In Japan, other than exclusive negotiation rights before the execution of the final agreement, deal protections are not frequently used by acquirers. However, in the case of public tender offers, acquirers commonly first enter into an agreement with some large shareholders under which these shareholders agree to sell their shares to the acquirer upon receiving the tender offer.
Penalty clauses are known to be added to final agreements as a cost coverage mechanism.
A non refundable deposit (or a deposit only refundable if the acquirer does not close as a result of a seller breach) protects the seller. Break fees are possible to protect the acquirer, though the directors are not able to fetter their discretion and the payment of break fees on a transaction involving the take-over of a listed company is an undeveloped area.
In addition to exclusivity agreements, prospective acquirers may seek to protect the deal through other measures. They may wish to secure the attainment of an irrevocable undertaking from the target’s most significant shareholders. Such undertaking is generally binding on the shareholder, but may be conditional in nature. Certain shareholders may be more willing to grant letters of comfort, indicating their intention to accept the bidder’s offer once launched.
Maltese rules do not provide for break fees, and therefore the parties to a transaction are free to make their own arrangements so long as these do not fall foul of the financial assistance provisions.
In transactions concerning private entities, it is quite common for the transfer of shares to be preceded by a promise of sale agreement. These agreements generally feature restrictions on the conduct of the target’s business until completion.
Termination or break-up fees that become due if the transaction with the acquirer is not completed can be contractually stipulated, but this does not occur frequently in Austria.
If the seller unjustifiably breaks off the negotiations the potential acquirer under certain conditions could be entitled to compensation claims based on culpa in contrahendo (violation of pre contractual obligations).
In private company deals, the target company’s shareholders are usually directly involved in the sale. Very strong deal protection is thus the norm as directors’ concerns are lessened because shareholders typically either directly sign the acquisition agreement or consent to the transaction shortly after signing. Target companies in these types of transactions typically do not have a right to terminate the deal to enter into a competing transaction and are frequently expressly prohibited from taking actions in furtherance of a competing transaction (without any fiduciary exception).
No-shop provisions in public company deals are typically more limited and are subject to exceptions. For instance, the target company board may be permitted to discuss and negotiate unsolicited bids or, particularly in acquisitions by financial buyers, to actively solicit competing bids for a limited period of time (a so-called “go-shop”). Public company deals also generally contain a covenant requiring the target company board recommend to its shareholders that they tender or vote to approve the transaction (as applicable). However, for the same reason that no-shops are more limited in public company deals, recommendation covenants in public company deals generally contain a “fiduciary out” provision that allows the board to change its recommendation to comply with the directors’ fiduciary duties (e.g., if a third party makes a superior proposal). Target boards also usually have the right to terminate an existing transaction in order to enter into a superior transaction, subject to compliance with the no-shop restrictions and typically to matching rights and the payment of a termination fee as described below. Deal protection provisions typically include matching rights, which allow buyers to match superior proposals and keep their deal intact, and, if there is one or more large shareholders, voting agreements to vote in favour of the transaction or tender. Finally, buyers in public company deals typically negotiate for the payment of a “termination fee” by the target company if the transaction is not successful because the target accepts a competing offer. These fees are required to be reasonable and generally range from 2-4% of the transaction’s equity value and frequently less for certain proposals received under a go-shop.
It is atypical in both public and private deals for a buyer to be reimbursed for expenses absent entering into a definitive agreement. However, in some cases, a fee is payable by the target company to the buyer if its shareholders vote against the transaction, even if there has been no competing bid (a “naked no vote”). Any such fee is generally lower than what the termination fee would otherwise be.
The use of escrow accounts to hold refundable deposits during exclusivity periods is increasingly common.
The use of reciprocal break fee provisions in definitive transaction documents, in order to prevent unilateral termination, is increasingly common.
If the target company is not listed, the parties can reach a commercial arrangement.
If the company is listed, Rule 14 of the Securities (Takeover) Rules 2010 shall apply.
Where the Takeover Code does not apply, then conditionality and exclusivity are the most frequently used.
A common way to secure the transaction is by including a liquidated damages clause within the agreement, whereby the parties agree and asses, in advance, the amount of cash compensation that will be owed by the defaulting party to the other(s), in case of failure or improper fulfilment of obligations.
Another deal protection and cost coverage mechanism is an advance payment (or security deposit) of a small amount of the agreed transaction value. If the acquirer refuses to conclude the transaction, the advance payment is retained by the target. On the other hand, if the target refuses to conclude the transaction, it must return the advance payment in double amount to the acquirer.
Break-fees or reverse termination fees are occasionally used and typically bespoke; perhaps 5-10% of transactions. They are more common with transactions involving foreign parties and more likely with schemes of arrangement (as opposed to takeovers).
In addition to the measures referred to in question 13 above, it was historically also common for a target board to agree to pay a bidder a break fee or work free.
Such arrangements are no longer permitted and target boards are prohibited from entering into any arrangements which provide a bidder with deal protection. This is subject to the exception that target boards are still permitted to offer break fees (to a value equivalent to 1% of the value of the target company) to a friendly bidder in circumstances where they are already subject to a hostile approach from another party or where the target board is running a formal sale process.
A bidder may sometimes consider acquiring a stake in the target in order to bolster its chances of a successful bid and also provide a degree of downside protection in case a competing bidder might ultimately acquire the target at a higher price than they were willing to offer. Such activities need to be carefully considered prior to any action being taken, both from a Code point of view, to ensure that there will be no impact on the offer price (see question 17) and also to ensure that any such dealings are made in compliance with the applicable insider dealing and market abuse rules and will not prejudice the bidder's ability to effect a squeeze-out of minority shareholders in due course.
The other common form of protection which bidders will generally seek, wherever possible, is irrevocable commitments from shareholders in the target company to accept the proposed offer, or if such commitments cannot be obtained, letters of intent/support, which can be publicly disclosed and evidence an intention to accept the proposed offer.
In the context of private share or asset sales, where there is to be a gap between signing of transaction documentation and closing, it is usual for the seller to agree to not sell or otherwise transfer the target shares or assets and to continue to operate the target business in the ordinary course.
There are no restrictions which prevent a private seller from agreeing to provide a break fee if the transaction does not proceed, however, in doing so, the relevant directors will need to be mindful of their overriding duties to act in the best interests of the company.
Standard coverage is agreed in private preliminary agreements (e.g. purchase offer, letter of intent or memorandum of understanding) before the transaction is completed and/or in the shares/assets purchase agreements at completion.
Deal protections are mainly representations and warranties from the seller, personal or in rem guarantees, escrow accounts, purchase price adjustments, earn-outs or non-compete or exclusivity agreements.
Additionally, merger and acquisition insurances are getting more importance.