What other deal protection and costs coverage mechanisms are most frequently used by acquirers?
Mergers & Acquisitions (2nd edition)
Please refer to the relevant Offshore Chapter.
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), but is rare in practice.
Break fees are sometimes seen in UK cross border private M&A transactions but remain relatively uncommon. A break fee must be within the target company’s express or implied powers and not be ultra vires. The directors of the company agreeing to the break fee will need to consider their fiduciary duties and comply with such duties in determining whether to agree to the break fee arrangement or not. The common law on penalties should also be considered as if the break fee is considered to be penal it will likely be unenforceable.
For deals covered by the Code, there is a general prohibition on break fees and other deal protection measures. Under the Code, and as mentioned at question 12 above, the target company (or any person acting in concert with it) may not enter into any offer-related arrangement with the bidder (or any person acting in concert with it), except with the consent of the Panel. Inducement fees arrangements (including break fees) would fall into this category.
There are two limited dispensations from the general prohibition (with the Panel’s consent) namely, (i) where a bidder has made a firm announcement to make an offer which has not been recommended, the target company can agree an inducement fee with one or more competing bidders; and (ii) where a target board launches a formal sale process, the target company will normally be allowed to enter into an inducement fee arrangement with one bidder at the end of the auction process when the preferred bidder makes its announcement of a firm intention to make an offer for the target company. The Panel will also normally consent to a target company entering into an inducement fee arrangement with a “white knight” bidder where the target is already the subject of a hostile bid from another bidder. In these circumstances, the value of the inducement fee must be no more than 1% of the value of the target company and be payable only if an offer becomes or is declared wholly unconditional. The legal position on financial assistance will also need to be considered (see question 19 below).
Reverse break fees (where a bidder agrees to pay a fee to a target if its offer fails to proceed for specified reasons, for example a failure to obtain bidder shareholder consent or where required regulatory approval is not delivered) are permitted but it is not acceptable for a bidder to use the reverse break fee to include conditions that, in effect, impose restrictions on the target that amount to deal protection measures (such as a restriction to engage in discussions with other bidders, a restriction on providing confidential information to competing bidders and giving the bidder matching rights or rights of first refusal in respect of a competing offer).
Such mechanisms generally include payment of the whole or portion of the purchase price into an escrow account, usually opened by a bank, deferred or retained payment of the purchase price, as well as corporate or bank guarantees.
Compensatory fines, break-up fees, other costs coverage mechanisms as well as no-shop, and non-solicitation provisions in M&A transactions between local parties (or with foreign investors) is becoming increasingly common.
If a cost coverage mechanism is obtained, it is usually in the form of a liquidated damages provision to ensure an expedite enforceability process. Potential acquirers that actually obtain this type of costs coverage mechanisms will demand that the value of the covered costs is considerable to avoid sellers to “trade” on the exclusivity.
The acquirer can seek deal protections from the target and/or the controlling or main shareholders (e.g. exclusivity or break-up fees).
In the context of a public offer, a friendly acquirer aiming to lock up its planned acquisition of the target can secure it by purchasing blocks of shares before the offer rather than obtaining the agreement of significant shareholders to tender their shares, as French law provides that contribution commitments lapse should a competing offer be made. The acquirer may also use break-up fees and undertakings from the target not to actively seek counter bidders. However, general principles on directors’ duties (i.e. to act in the target's interests) make break-up fees payable by the target rare or limited in amount.
Break-fees are occasionally used in transactions involving conditionality and are generally negotiated on a case by case basis. They are more common with transactions involving foreign bidders where overseas regulatory consents may be required as a condition to the transactions.
Acquirers may elect to contractually agree on exclusivity clause and break fees. However, pursuant to Egyptian law, in the event it was proven that the other party has not suffered any losses, subject to the court’s discretion, the agreed upon damages (break fee) should not be due. Further, the judge has discretion to reduce the damages specified by the parties, if such damages are excessive or the original obligation has been partially performed.
As with exclusivity discussed at question 13 above, 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.
The parties can agree break-up fees (but they are not common) in a letter of intent, in a preliminary agreement, or in an exclusivity agreement. This clause entails a penalty if a party breaks off the negotiations without reasonable cause; the purpose being to compensate the purhcaser for the cost of time and resources spent negotiating, in line with the general principle under Art. 1337 of the Italian Civil Code, whereby parties have a duty to conduct negotiations in good faith. Please see question 12 regarding the scope and issues of penalty clauses under Italian law.
Break/inducement fees are possible with the approval of the Panel (at a maximum level of 1% of deal consideration). Confirmation in writing from the target board and its financial adviser must be provided to the Panel confirming that they consider the break/inducement fee to be in the best interests of the company.
The Rules contain no restriction on a target entering an agreement not to shop the company or its assets (i.e. an exclusive period of negotiation). A target could require a standstill period in return for confidential information (i.e. the period during which the bidder may not seek to acquire the target otherwise than on a recommended basis), which tends to be in the range of 12 to 24 months. A target will still be able to respond to an unsolicited approach; it is not possible to prevent this.
Confidentiality, of course, 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.
In addition to the options mentioned above the most common measure used by bidders is to acquire a stake in the target in order to bolster their chances of following up with a successful bid and in the meantime offer them some protections in case a competing bid ultimately acquires the target at a higher price. Such dealings must always be carefully evaluated and assessed so as to be in line with the relevant legislation and regulatory framework.
In the context of private M&A transactions where there may be a time gap between the signing of the relevant documentation and closing, it is quite common for the seller to agree not to sell or in any way transfer and/or alter the business and/or assets of the target and continue to operate the target in the ordinary course of business.
There are no express restrictions which would prevent a private seller from agreeing to any break fee of the transaction that does not materialize however special care should be taken by the directors of the company to act within their duties towards the company.
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.
Deal protection and cost coverage mechanisms typical to mergers and acquisitions (such as confidentiality or non-disclosure agreements, non-solicitation agreements and break-up fees or reverse break-up fees) are not prohibited in Myanmar and may be used to protect deals from third party bidders as in other jurisdictions.
Common deal protection mechanisms include letters of credit, letters of guarantee, or escrow accounts for gradual payment of the price, which serve as a guarantee for the protection of transactions and especially for the payment of the purchase price. Break-up fees are not common but are enforceable in principle; the contractual structure for the legal basis of break-up fees is critical for their enforceability. Limitations based on general principles of law (e.g., fault or the abusive exercise of rights) will apply. Furthermore, in order to mitigate the risk of not receiving the necessary approvals for the transaction, the parties often define the granting of the relevant approvals as a condition precedent for closing. Each party carries its own transaction costs through the performance and until the closing of an M&A deal.
a) Public M&A Transactions
Management of the target company may agree to deal protection measures only if such measures are in the best interest of the company. Also, the “neutrality obligation” must be kept in mind. Based on these strict premises, some deal protection measures can be installed.
No-shop-clauses prohibit the target’s management to actively seek an alternative buyer. It may also contain restrictions on talking to third parties (“no-talk-clauses”). However, in order to not violate above mentioned premises, in these cases, certain exceptions from the no-shop-clauses are usually allowed, e.g. window-shop or go-shop clauses, granting the right to look for an alternative bidder in a certain time period. Fiduciary out clauses in case a better offer can be reached by a third party are then provided accordingly. As an answer to fiduciary out clauses or exceptions from no-shop agreements, a right of the bidder to match a potential better offer by a third party may be agreed upon.
Break-up fee arrangements are not yet common, as the legal enforceability is uncertain and such arrangements are subject to a number of limitations (for example, the target company’s management board can only enter into them if they are in the best interests of the target).
b) Private M&A Transactions
Break-up fees are increasingly demanded in cross-border transactions and sometimes seen in private acquisitions. Even without a break-up fee arrangement, there might be, subject to rather strict prerequisites, a pre-contractual liability if one party breaks off negotiations unreasonably after it has induced confidence that an agreement would be reached.
Earn-outs are increasingly demanded and protect the buyer from overpaying the future upside.
Other measures, as mentioned for public M&A, can be and are used more freely, as the takeover code-based “neutrality obligation” does not come into play.
A bidder could build a stake in the target company prior to announcing the bid.
Break fees payable by a target in in public M&A are not common in Belgium. The board of a target company should take into account the company’s interest when deciding whether to agree to such break fees.
Belgian publicly traded companies typically have one or more reference shareholder(s). A bidder can approach such reference shareholder(s) with the purpose of enhancing and securing the success rate of the public offer. It may seek certain commitments from these shareholders to support the offer, not to solicit any bid by another party and not to dispose of its shares.
13.1 In the context of Vietnam M&A transactions, it is increasingly common for vendors and purchasers to agree upon arrangements consisting of:
- the lodgement by the purchaser of an up-front deposit, calculated as a percentage of the proposed total purchase consideration (with 10% being common);
- the deposit being placed into escrow, in an account opened in the dual names of the parties with a mutually-acceptable escrow services provider such as a neutral bank; and
- the release or forfeiture of the deposit being subject to balanced, reasonable, and carefully documented contractual provisions.
13.2 The use of contractual protections such as indemnity provisions entitling innocent parties to recover from the defaulting party any loss or damage suffered as a result of unlawful and unilateral termination is also increasingly common in Vietnam (whether on a liquidated damages basis or a full indemnity basis).
13.3 From a costs perspective, it would be unusual to see any arrangements other than each party bearing its own transaction costs on its own account, regardless of the completion or non-completion of the transaction, regardless of the circumstances.
A way for a bidder to receive some degree of deal protection is to include a break fee in the transaction agreement. The parties are, however, not entirely free to determine the magnitude of the break fee payable by the target. According to the practice of the TOB, a break fee has to be reasonable and limited to the expected costs of the bidder. In addition, the bidder may request the target not to solicit competing takeover proposals (no-shop provision), whereas a clause prohibiting the target from passively discussing alternative proposals with third parties (no-talk obligation) would not be permissible. Also, an undertaking from the target to inform the bidder about interloper approaches or requests for due diligence is permissible. The same goes for a contractual matching right under which the target must give the bidder the opportunity to match the price and other offer terms offered by the competing bidder before the target board withdraws or changes its recommendation of the initial offer.
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 for by Russian law.
The parties usually cover their own costs. Break fees are sometimes used, but they are not the norm in M&A deals.
Leak protection mechanism, which prevents leaks of information.
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 favor 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.
In private transactions it is very uncommon (although not unheard of) that the transaction parties agree on break fees or other kinds of compensation in case of a broken deal. With respect to publicly listed companies, offer-related arrangements, e.g. break fees, are normally not permissible in Sweden.
Dear protection and cost coverage mechanisms are not very usual in Philippine M&As though we are seeing an increased use of break-up fee provisions, where if the deal does not push through the one responsible for the failure of the deal becomes liable to the other for a specified amount.
In transactions in which the controlling shareholders of the target company are involved in the process to market and sell the company, the acquirer will typically enter into a definitive agreement directly with such controlling shareholder. The controlling shareholders, in such definitive agreements, may negotiate and include certain deal-protection mechanisms that restrict the ability of the controlling shareholder to terminate the agreement or to shop for or accept a better deal.
On the contrary, if the controlling shareholders of the target company are not involved in the process to market and sell the company, the acquirer will typically enter into a definitive agreement directly with the target company. However, in the context of a tender offer bid, it is not always easy for the acquirer to enter into a definitive agreement with the target company because of the duties owed by the directors of the target company. Even in the case where the target company agrees to enter into an agreement with the acquirer, which will bind the board of directors of the target company to support the transaction, the target company frequently insists on including a “fiduciary out” provision. In such case, it is common for the acquirer to try to negotiate for a reasonable break-up fee in the definitive agreement to provide the acquirer with a certain degree of deal protection.
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.
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.
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 from 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.
Where the Takeover Code does not apply, then conditionality and exclusivity are the most frequently used.
Break-up fees are used (though not very common) but arrangements such as poison pills are not available in the Turkish market.
For cost coverage, share purchase agreements almost always include a compensation clause where the seller undertakes to compensate the acquirer for any damages arising from a breach of contract, including any misstatements in representations or warranties under the agreement. Specific indemnity clauses are also commonly used when the seller undertakes to compensate the acquirer for any damages resulting from a specific condition following the transfer of ownership.
In addition to exclusivity and conditionality, acquirers also rely on break-fee provisions. It is however imperative that the break fee must not be construed as a penalty. In some cases, the seller accepts to pay or reimburse due diligence cost if the deal does not close. Confidentiality is also another common mechanism. The directors of the target company always have to consider their fiduciary obligations and the application of any cost coverage mechanism is highly deal specific.
Reasonably, acquirers intend to ensure that once the transaction has been agreed the transaction will be completed and the other party cannot simply walk away from the transaction. To that end, acquirers may require the other party to undertake to pay a penalty to the acquirer for the case the other party fails to complete a closing condition (provided that such failure was attributable to that party) and thus frustrates closing, or otherwise unreasonably refuses to complete the transaction. It is of note that, if the failure or refusal of the other party constitutes a breach under the transaction documents, under Hungarian law the acquirer will have the right to claim the damage it incurred as a result (less penalty, if applicable), from the other party.
The parties often agree that each party shall bear its own costs in relation to the transaction. However, the acquirer may at times stipulate that the costs of a successful transaction, including the costs of the due diligence, shall ultimately be borne by the target company.