What other deal protection and costs coverage mechanisms are most frequently used by acquirers?
Mergers & Acquisitions (3rd edition)
A bidder could build a stake in the target company prior to announcing the bid.
Break fees payable by a target 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.
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.
Although not frequent, “break up fees” have been starting to be more commonly used in deals as a protection of potential acquirers if a transaction does not close for reasons not attributable to the acquirer.
13.1 A break-up fee may be contracted in an acquisition for a party (either the buyer or the seller) that decides not to pursue the deal. A break-up fee offered in the letter of intent usually shows the buyer’s commitment to completing the acquisition. Such fees are not common in mid-market transactions for privately held businesses.
13.2 The breakthrough rule is a deal protection measure which allows a target company to help the bidder in the takeover process. The rule applies only if included in the target company’s articles of association after the takeover bid is published. The breakthrough rule provides that during the bid term, restrictions on the transfer of the target’s shares and restrictions on voting rights of the target’s shares prescribed by either (i) the target’s articles of association, (ii) an agreement between the target and its shareholder(s) or (iii) an agreement between the target’s shareholders - have no effect, can be temporarily suspended for the duration of the bid term provided that the target inserts this suspension in its if included in the target’s articles of association.
The rule also helps shareholders who acquired over 75% of the voting shares in the target company to convoke a general assembly in order to change the target company’s articles of association and/or to appoint or revoke remove the members of target’s supervisory board. In such a case, restrictions on voting rights of target’s shares, set out either in the articles of association, or in the agreement between the shareholder(s) and/or the target - have no effect. Additionally, special rights of shareholder(s) to directly appoint or revoke supervisory board members set out in the articles of association have no effect.
The breakthrough rule requires the management board of the target company to immediately inform HANFA, as well as the supervisory authorities of European Economic Area countries in which the shares of the target company are listed on a regulated market, of the fact that the target company has adopted or deleted a respective provision of its articles of association, thus activating the breakthrough rule.
13.3 If the seller has negotiated or terminated the negotiations contrary to the principle of good faith, it may be held liable for the damage it has caused to the acquirer. The same applies if the seller entered into negotiations with the acquirer without the intention of concluding the agreement. However, such situations are rare in practice.
Escrow mechanisms, fiduciary mechanisms and establishment of penalties before events of default or appearance of material events.
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.
Regarding public M&A transactions, the executive bodies of the target company may agree to some deal protection measures only if such measures are in the best interest of the target company. Those measures, e.g. no-talk clauses or no-shop-clauses, prohibit the target company’s executive bodies to engage in negotiations with any other interested buyers.
In private M&A transactions, break-up fees (contractual penalties) may be agreed upon. In the absence of such contractual agreement, the acquirer may have claims under the rules on pre-contractual liability in case the seller terminates negotiations unreasonably after inducing confidence that an agreement would be reached; there is however so far very little case law available and contractual penalties, if negotiable, are preferable from the acquirer´s perspective. While not securing the deal as such, earn-outs are increasingly used in Czech M&A transactions as they protect the buyer from overpaying the future upside of the company.
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 12 above, subject to directors of a company 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 the target company 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 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 undertakings to tenders 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.
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 usually define the granting of the relevant approvals as a condition precedent for closing. Each party carries its own transaction costs.
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.
Where the Takeover Code does not apply, then conditionality and exclusivity are the most frequently used.
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.
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.
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 potential buyer could negotiate with the target company a break-up fee in which the parties can agree on high penalties if any of them retire from the transaction with no reasonable cause or causing a perjury to the other party. Peruvian regulations do not contain specific rules regarding exclusivity agreements or deal protection during an M&A negotiation. In consequence, these agreements are carried out and established in private documents and or a case-by-case basis.
Other than break-up fees, deal protection and cost coverage mechanisms are uncommon features of M&A agreements in the Philippines. There is a perception that deal negotiations entail a measure of risk and that failure to arrive at an agreement is not actionable unless there is bad faith.
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.
At a pre-signing stage, it is usual for the parties to accept certain bilateral or unilateral obligations, such as confidentiality, non-compete, non-solicit or exclusivity undertakings, as well as penalty clauses to cover transaction costs in case one of the parties walks away from the deal.
In PTOs the bidder assumes all the costs entailed with the offering. In case there are any contractual arrangements, such as irrevocable acceptance commitments, parties usually assume their own costs. It is not common to have deal protection mechanisms in this context.
The parties usually cover their own costs. Break fees are sometimes used, but they are not the norm in M&A deals.
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). This type of security is explicitly provided for by Russian law.
The payment of break fees is not uncommon in large transactions. The TRP will generally permit a break fee, provided that it does not exceed an amount equal to 1% of the value of the transaction.
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.
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.
A non-refundable deposit, or a deposit only refundable if the acquirer does not close as a result of the seller’s breach, protects the seller. Break fees can also be used to protect the acquirer although the directors of the company are not able to fetter their discretion and the payment of break fees on a transaction involving the takeover of a listed company is an undeveloped area.
Deal protection may be strengthened by a requirement for the buyer to pay a refundable deposit into an escrow account when a non-binding offer is given. The deposit will be either refunded to the buyer if the seller does not proceed with the transaction or paid to the seller if the buyer does not make a binding offer at the end of the due diligence stage.
As stated above, the acquirer may impose break-up fees on the target and/or its majority shareholders.
13.1 In the context of Vietnam M&A transactions, it is increasingly common for vendors and purchasers to agree upon arrangements consisting of:
(i) the lodgement by the purchaser of an up-front deposit, calculated as a percentage of the proposed total purchase consideration (with 10% being common);
(ii) 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
(iii) 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.
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 are 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.
Usually if an up-front deposit is paid to the target company, acquirors request reverse break fees, payable by the target company and/or the sellers if the deal does not close.
Mechanisms for deal protection and cost recovery may be agreed between the parties in their preliminary agreements. Break-up fees is the most commonly used mechanism in Egypt.
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.
Please refer to the relevant Offshore Chapter.
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 because if the break fee is considered to be penal it may be unenforceable.
For deals covered by the Code, there is a general prohibition on break fees and other deal protection measures as it is considered that they could have the effect of deterring potential competing bidders from making an offer, or of leading to a bidder making an offer on less favourable terms than they would otherwise have done. Under the Code, 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 (where multiple break fees have been given, these must be aggregated) 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 as it is not a restriction upon the target company. However, 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).
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.
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.
Leak protection mechanisms or agreements, which prevents leaks of information.
Deal protection and cost coverage mechanisms can be contractually stipulated and apply if the transaction with the acquirer is not completed, but this does not occur frequently in Slovenia.
According to Article 20 of the Obligations Code (OZ) a party that has negotiated without the intent to conclude a contract and a party that negotiated with the intent to conclude a contract but abandons the intent without justifiable grounds, thus inflicting damage on the other party shall be liable for any damage incurred by the other party.