What steps can an acquirer of a target company take to secure deal exclusivity?
Mergers & Acquisitions
Exclusivity in Brazil is contractual. Therefore, obtaining the exclusivity depends on the leverage of the buyer during the acquisition process. Competitive M&A transactions in Brazil occur as in any other developed market worldwide. There is a stage where multiple potential buyers present non-binding offers. Only a handful - or one - make it to the second round. This is the stage where exclusivity is usually sought. The trick when exclusivity is obtained is to make it enforceable. It has to cover the seller and its economic group, as well as service providers. On top of that, Brazilians frequently establish compensatory fines in exclusivity agreements at a high value to ensure enforceability and, on the other hand, to avoid pointless and lengthy discussions on the damage caused by the breach of exclusivity provisions. The reverse side of this strategy is allowing the seller to “trade” on the exclusivity, since it has a clear value. However, this is almost never the case, as the values tend to be considerable. Several sellers, however, because of cultural issues, tend not to agree on fines. In a nutshell, exclusivity is a very complicated issue in Brazil, specifically when the market is on the rise and in the context of competitive biddings.
As is the case in many other jurisdictions, once an agreement has been reached to commence formal negotiations it is common to see arrangements whereby the parties agree that they will only negotiate with one another for an agreed period of time with a view to agreeing a definitive deal.
When negotiating and documenting the terms of any agreed deal, particularly where there will be a large gap between signing and closing, we are often asked to advise on “no-shop” provisions. These seek to prevent a target company from soliciting or encouraging third-party proposals once a binding transaction agreement has been executed.
Deal exclusivity provisions tend to vary from a less restrictive provision that permits the target company to provide information to unsolicited bidders, to the much more restrictive "no-talk" provision prohibiting the target company from responding to any third-party advances. Because of their potential for discouraging what may be superior competing offers, no-shop provisions are subject to increasing scrutiny.
Whilst such provisions are common in Bermuda M&A transaction, those which are overly restrictive could be subjected to scrutiny on the basis that the target board breached its fiduciary duty to act in the best interest of the company (including the shareholders as a whole) both on the basis that the target was locked into a transaction that did not reflect its true value and that its shareholders were unable to realise same.
Occasionally provisions try to push so far as to commit a board to move forward with a transaction or recommend the same to the company’s shareholders when it is clearer no longer in the best interests of the company (for example, because a third party has made clear that it wishes to enter into negotiations and has demonstrated a clear indication that should such negotiations be successful, they would represent a far superior proposal.
As a result, when negotiating exclusivity provisions, clients are well advised to seek a carve out where, in order to comply with director fiduciary duties, they will no longer be bound to refuse to negotiate with third parties and recommend that shareholders accept inferior proposals.
British Virgin Islands
Subject to directors of the BVI constituent company (whether acquirer or target) complying with the terms of the Act and their fiduciary duties, the BVI entity may permit exclusivity, however the directors of the target company will be required to consider whether granting exclusivity will be in the best interests of the Company or whether they should be holding out for a better offer or creating more competitive tension.
Subject to the Board complying with their fiduciary and other duties, an acquirer can negotiate for exclusivity and a no-shop, no-talk and/or an outright prohibition on supplying due diligence information to or negotiating with other potential bidders.
ZL: To our experience, in order to secure deal exclusivity, both parties of the transaction will normally enter into a Termsheet, letter of intention, or framework agreement when they have reached an initial intention of M&A, which includes not only the main clauses that should be included in a formal transaction agreement after DD, but also the exclusivity clause in the Termsheet.
For example, in order to secure deal exclusivity, the target company makes a commitment that within certain time (usually is during DD period) of signing Termsheet, it should not directly or indirectly look for share/debt financing or accepting investment offer provided by a third party; should not provide information in relation to share/debt financing to a third party or take part in discussion and negotiation in relation to share/debt financing; and should not reach an agreement or arrangement with a third party on share/debt financing.
For private companies, the parties (target company and the main shareholders) are generally free to agree upon applicable exclusivity restrictions. Depending on the deal dynamics (e.g. whether the transaction process is structured as an auction) such agreements are sometimes used to provide sufficient comfort for the acquirer to spend the required resources on the due diligence and other preparatory actions. However, such agreements do not necessarily include any cost coverage or break fees to the acquirer, but only confirm that the target company will not engage in other negotiations during the exclusivity period.
In public transactions, the Board of Directors may relatively freely agree to negotiate and enter into contractual arrangements with the offeror provided that this is deemed to be in the best interest of the shareholders. However, the target company may not agree to any contractual arrangements that limit the target company’s and the Board of Directors’ possibilities to act, i.e. the exclusivity should not prohibit the Board of Directors from evaluating a potential competing offer and thereby from acting in accordance with its duty of care and loyalty in situations where the Board of Directors has received a competing contact or if the circumstances otherwise change substantially.
In private M&A exclusivity agreements are a common feature. However, in a public M&A deal the target company’s board is obliged to act in the best interests of the target company. This may prevent the target from tying up a deal with a bidder. Break-up fees and certain non-shop agreements are usually not considered to be an inhibitive factor for competitive bidders, and are therefore in principle allowed.
Break-up fees payable by the target are nevertheless rare in Germany. As a general rule, the target must be able to show that the offer is beneficial to the target and its shareholders, and that the bidder would not be prepared to launch its bid without a break-up fee arrangement. The amount of the fee should be reasonable, and should not put undue pressure on the shareholders and supervisory board of the target to approve the bid. It should therefore be limited to compensating the bidder for its costs and expenses, rather than serving as a penalty for the target.
It is common practice in Greece that a Memorandum of Understanding or similar preliminary agreement, which according to Greek Law is a legally binding private agreement, be concluded in the beginning of the negotiations phase and/or prior to the preparation of the closing and performance of a M&A deal. Such preliminary agreements may typically contain confidentiality clauses, exclusivity obligations, and undertakings along with agreed contractual sanctions such as penalty clauses to ensure that the relevant corporate bodies will respect the ongoing discussions and agreements. Further, it is not uncommon in Greek M&A transactions that deal exclusivity throughout to completion is secured though the conclusion of notarial deeds allowing for the purchaser’s right to unilaterally complete the transaction, on the basis of agreed conditions, without the seller’s involvement.
The use of exclusivity agreements is standard practice in Guernsey. Where the provisions of the Takeover Code apply, the board of the target company are not permitted to agree to not solicit or recommend other offers.
Isle of Man
The use of exclusivity agreements is standard practice in the Isle of Man and follows market practice in the UK.
Exclusivity agreements (no-shop) are the most common deal protection measure used by acquirers in connection with acquisitions of non-listed companies in Norway. The exclusivity agreement is normally be entered into between the shareholders of the target and the potential buyer. Such agreements are legally binding under Norwegian law, even if they do not provide for payment of any consideration.
Measures commonly used to obtain exclusivity in connection with acquisitions of listed companies include:
• Signed support agreement (transaction agreement) between the target and the potential bidder under which the target’s board agrees to support the potential bidder’s bid for the target’s issued shares .
• Lock-up (pre-acceptance) agreements with principal shareholders.
• Exclusivity or non-solicitation provisions between the target and the bidder.
Note that a bidder’s influence over the target in a public tender process is quite restricted under Norwegian law. The STA and the Norwegian Code of Practice (which all Oslo Stock Exchange listed companies must comply) imposes strict limitations on a target’s board to make controversial decisions preventing other bidders from entering the scene without the risk of being held liable for damages. No-shop / no-talk provisions will generally take the form of covenants from the target not to solicit or encourage other offers, not to provide information to competing bidders; and not to enter into discussion or negotiations with any other bidder. The Code of Practice now includes a provision recommending that no-shop arrangements should only be entered into by the target if they are clearly in the common interests of the target and its shareholders.
In 2015 the Civil Code of the Russian Federation has been supplemented with Article 434.1 ‘Contractual negotiations’. This Article requires bona fide conduct of negotiations and establishes so-called pre-contractual liability of a party to negotiations acting in bad faith.
Unreasonable and unexpected withdrawal from negotiations in a situation where the other party cannot reasonably predict such termination of negotiations is now viewed as bad faith negotiating and may result in a breaching party’s liability in the form of payment of other parties’ damages.
In addition, the Civil Code now explicitly provides that parties to negotiations are entitled to enter into an agreement in relation to conduct of contractual negotiations, setting out relevant procedures and other covenants of the parties, including, inter alia, exclusivity undertakings. Such an agreement may provide for a penalty in the event of breach of relevant undertakings.
Exclusivity is very common in private M&A, albeit for short periods of time.
In a public context, it is possible to enter into exclusivity arrangements. However, the M&A Regulations require directors of a target to give careful consideration before entering into any commitment with an offeror (or anyone else) which would restrict their freedom to advise shareholders in the future. Further, once an offer has been announced, the M&A Regulations require all information provided by a target to an offeror or potential offeror to be, on request, given equally and promptly to another offeror or genuine potential offeror. Exclusivity will therefore have a limited impact on a public M&A transaction.
Break fees are unlikely to be enforceable in a public M&A context unless they are of a low value, and in any case no more than 1% of the offer value. Anything above this threshold will generally be regarded as punitive and thus unenforceable. The CMA must always be consulted prior to the parties agreeing any break fee.
There are no restrictions on break fees in a private M&A context, though directors should consider their duties in agreeing to any such fees. Excessive break fees will generally be regarded as punitive and thus unenforceable. In practice, break fees in the private M&A market are normally limited to the other side's costs.
Generally speaking, exclusivity cannot be secured until an exclusivity clause is set out in a written agreement. At the initial stages, the parties start negotiations with a Non-Disclosure Agreement, but this does not usually contain an exclusivity clause. After some negotiation (before or after completion of due diligence), the parties will usually execute a Letter of Intent (LOI) or Memorandum of Understanding (MOU), under which the potential acquirer may be given an exclusive right to negotiate with the potential seller. Usually, the duration of the exclusivity is from 60 to 90 days, but depends on the size and complexity of the deal. Upon execution of a final agreement, the LOI or MOU expires, and with it the exclusive right of the potential buyer, but by this stage the seller is usually fully committed to completing the deal.
It is common for a memorandum of understanding or letter of intent to contain an exclusivity period given by either the major selling shareholder (in case of secondary share sale) or the target company (in case of primary share sale).
Deal exclusivity is typically achieved by means of the execution of a term sheet at the early stages of an M&A transaction. In addition to the key commercial terms and timelines, a term sheet would also customarily include a binding exclusivity arrangement having the effect of locking-up the seller from soliciting competing offers, entering into discussions or negotiations with potential purchasers or disclosing confidential information on the target for a period of time. This would grant the acquirer sufficient time to conduct its due diligence on the target.
This mechanism does not, however, prevent a competing bid from being launched in the case of a listed company.
In private M&A transactions the acquirer often obtains exclusivity in the letter of intent, which prevents the seller for a certain period of time from engaging in negotiations with other potentially interested persons. To further strengthen deal exclusivity a contractual penalty can be foreseen in case the seller breaches the exclusivity obligation. However, under Austrian mandatory law judges are entitled to reduce a contractual penalty if the contractual penalty is considered excessive.
It is unusual for the board of directors of a U.S. public company to grant a meaningful period of true exclusivity to a potential acquirer. This is particularly the case in jurisdictions where courts apply enhanced scrutiny. Granting exclusivity to a potential acquirer precludes the consideration of alternative bids during the exclusivity period, and therefore may make it difficult for directors to fulfil their duties to shareholders to maximise value. However, where there has been an extensive effort to sell the company, whether through an auction process or otherwise, public company directors may be more willing to grant exclusivity to a buyer for a limited period of time to finalise a transaction. Public companies also sometimes grant limited exclusivity in which they agree for a period of time not to solicit other transactions but which is subject to an exception for unsolicited acquisition proposals.
In acquisitions of private companies, particularly where the target company’s shareholders are involved in the sale process, exclusivity is much more common and is often insisted upon by the buyer. In both the public and private markets, a grant of exclusivity is typically embodied in an exclusivity agreement.
Once a definitive agreement is signed, deal protection provisions (including no-shop provisions), which are discussed below, involve limited grants of exclusivity.
Exclusivity is commonly provided for in the form of binding memoranda of understanding or equivalent. The vendor will usually insist upon the lodgement of a deposit in order to secure exclusivity.
The board of the target company may solicit or recommend other offers. However there are no rules prohibiting the board from agreeing to deal exclusivity, provided that the directors are satisfied that they are acting in the best interests of the company and are fulfilling their fiduciary duties.
The Takeover Code, if applicable, imposes a general prohibition on offer related arrangements between a bidder, or any person acting in concert with it, and the target.
In all other cases, there are no rules prohibiting the target from agreeing to deal exclusivity, provided that the directors are satisfied that they are acting in the best interests of the company and are fulfilling their fiduciary duties.
According to the Romanian Civil Code, parties must act in good faith during negotiations. Unreasonable and unexpected withdrawal of a party from negotiations is viewed as bad faith in negotiations, and may result in the liability of such party in the form of payment of any damages suffered by the other party.
In order to secure deal exclusivity, parties generally enter into exclusivity arrangements.
For a takeover:
- true exclusivity is not possible as no party can be prevented from making a competing offer;
- exclusivity arrangements around recommendations/due diligence access could be possible, subject to fiduciary outs for the target company; and
- asset lock-ups can be achieved through offer conditions.
A potential acquirer is able to acquire up to 19.9% of target company’s voting shares (in total), assuming it does not control the voting rights of any target shares held by third parties. The potential acquirer cannot exceed 20% without making a takeover offer.
Pre-bid agreements with shareholders, where they agree to accept an offer made on certain terms, are permitted and are standard procedure in New Zealand takeovers. The agreements must state that control over voting rights remains solely with the existing shareholder, to avoid issues under the Takeovers Code. Pre-bid agreements are typically entered into immediately prior to launching the bid (and therefore also after building any initial stake), as they must be publicly disclosed.
For a scheme of arrangement –
- Exclusivity is possible, subject to fiduciary outs in the case of a superior proposal;
- Asset lock-ups can be achieved through the Scheme Implementation Agreement.
Voting agreements (where shareholders agree to vote in favour of a scheme) are not permitted where this would put a person over the 20% ‘control over voting rights’ threshold under the Takeovers Code. Voting agreements may also result in the parties becoming a separate interest class for voting purposes – defeating the purpose of the agreement.
Historically, bidders would often seek (and would frequently be provided with) contractual protections, such as restrictions on the ability of the target board to solicit alternative offers, arrangements intended to ensure that the bidder would have a right to match any competing bid for the target made by any third party and placing restrictions on the ability of the target board to agree to provide any other bidder with a break fee.
Following changes made to the Code, these measures are now no longer available and target boards are prohibited from entering into any arrangements which provide a bidder with exclusivity or other deal protection measures.
As a consequence, bidders now potentially face a less certain outlook at the outset of a proposed bid and will therefore often consider the options set out below in relation to stake-building and irrevocable undertakings as a means of making their proposed bid seem as close to a "done deal" as possible, thereby discouraging potential interlopers.
Exclusivity may be (and is usually) agreed by means of private preliminary agreements (e.g. purchase offer, letter of intent or memorandum of understanding) between seller and acquirer and for a certain term. The referred private preliminary agreements may be entered into as binding or non-binding (exclusivity makes no sense when the parties decide to enter into non-binding agreements).
In case of breach of exclusivity, when binding, acquirer may claim damages compensation according to Spanish law. In order to make easier a claim and quantification of damages compensation, the parties may agree specific compensations as liquidated damages (i.e. a penalty). Under Spanish law these agreed penalties could be agreed as cumulative or alternative to damages compensation. In case of penalty cumulative to damages compensation, Spanish courts could mitigate the amount of the penalty considering the circumstances involved.
There would be other options (e.g. purchase option rights) but they are unusual in Spanish M&A transactions due to time and costs constraints.