Key Takeaways

  • A breakup fee is a termination fee paid by a seller if it backs out of a merger or acquisition (M&A) agreement.
  • These fees protect buyers by compensating them for time, resources, and opportunity costs.
  • Standard breakup fees typically range from 1% to 4% of the deal value, with enterprise value often used as a benchmark.
  • Courts assess breakup fees based on reasonableness, impact on shareholder value, and proportionality to deal size.
  • Reverse termination fees (RTFs), paid by buyers, are used when buyer-side risks like financing failure are present.
  • Strategic use of breakup fees and RTFs helps manage risk and encourage serious, committed negotiations.

A break up fee m&a is an element of deal protection devices that is used when drafting an agreement in a merger or acquisition. This element has come about because U.S. corporate law realizes a company may want the ability to consider post-signing proposals that might be superior.

These breakup fees are typically used in takeover agreements as a way to have leverage on the seller so they don't back out of the deal with the purchaser. The breakup fee is a termination fee that can be used to compensate a purchaser for the time and resources they put into completing the deal.

While having breakup fees is a standard component of merger and acquisition agreements, the court states that fees and terms cannot be so restrictive that they are preclusive of a truly superior proposal. Breakup fees will typically run between 1 and 3 percent of the deal's value.

Breakup Fees — Picking Your Number

Typically, precedence will play a large role in determining these fees, with standard averages running in the range of 3 and 4 percent. When studying trends in breakup fees, it's been determined that as the deal gets larger, the fees tend to go down.

While many drafters will use the data on other deals as a baseline for determining their fees, it is important that you verify the laws of the area. Some courts may use specific guidelines for determining what reasonable breakup fees include. An example of this is Delaware law that upheld court rulings that put breakup fees within the statistical range of 3 and 4 percent. Other court cases have helped shape the standards of drafting breakup fees in mergers and acquisitions, such as Delaware courts that criticized a 6.3 percent fee imposed by Cyprus Amax, stating that it was a stretch in reasonableness.

In a Caremark case, a number of factors were pointed out that a court may use to consider when determining the fairness of a breakup fee. They will take into account:

  • The size of the termination fee
  • The percentage of the fee
  • The benefit the deal will have for shareholders
  • Any premiums a director may want to protect
  • The total size of the transaction
  • The size of the partners merging
  • Why the counterparty may feel the protection is necessary to the deal
  • The equity and enterprise value of the deal

Courts will often avoid having one metric followed for all situations. Delaware courts have begun to change the way court systems view breakup fees. Instead of simply applying percentages of the deal to the equity value, they also consider the enterprise value.

Another example of setting a breakup fee in mergers and acquisitions was the case of Cogent. In this case, the target company had a large net cash balance. The court rejected claims the plaintiffs made because what was set as a 3 percent fee became higher than a 6 percent fee. In this case, the enterprise value would have been the appropriate denominator.

This same approach was used in a case involving Dollar Thrifty. The court held that the one-time special cash amount paid before closing was appropriate because it was rightly included in the denominator when the evaluation of the fee was made in that case.

A different instance involved VC Stine. In this case, it was determined that enterprise value was more important than the equity value when determining what would be considered a reasonable breakup fee. This is because in this instance, the net debt balance was not accounted for. Stine reiterated the decisions that enterprise value was more significant even if the target had very little debt. Stine did agree that although enterprise value may be the best metric, it is not ideal for every situation.

Even though it can be tempting to rely simply on the statistical data that can be found to set an appropriate breakup fee, it is vital to understand that this fee must be viewed as a whole with other deal protection devices the agreement puts into place. It is also important to look at the history of the sale process as well as other payable fees.

Purpose and Strategic Role of Breakup Fees

Breakup fees are primarily designed to protect the interests of the buyer in an M&A transaction. They serve three key purposes:

  1. Reimbursement for Costs: Buyers often invest significant time and resources in due diligence, legal review, and negotiation. The breakup fee helps offset these sunk costs if the deal falls through.
  2. Deal Certainty: By introducing a financial penalty for backing out, breakup fees increase commitment and reduce the likelihood of frivolous withdrawals or shopping the deal to other suitors.
  3. Compensation for Lost Opportunities: Buyers may forgo other potential transactions while pursuing a deal. A breakup fee helps mitigate the opportunity cost.

These fees are part of a broader set of “deal protection devices,” which may include no-shop clauses, matching rights, and reverse termination fees.

Reverse Termination Fees: The Buyer’s Breakup Fee

In contrast to seller-paid breakup fees, reverse termination fees (RTFs) are paid by buyers under certain conditions. These typically occur when:

  • The buyer fails to secure regulatory approvals.
  • The buyer cannot obtain financing.
  • A special condition precedent outlined in the agreement is not met.

RTFs have become more common in private equity and SPAC (Special Purpose Acquisition Company) transactions where financing uncertainty is higher. Just like breakup fees, RTFs are scrutinized for fairness and proportionality relative to the transaction size and deal risks.

Legal and Economic Considerations

When determining whether a breakup fee is enforceable or appropriate, courts will assess:

  • Reasonableness: Fees that are excessively high may be deemed coercive and unenforceable.
  • Effect on Shareholders: Courts consider whether the fee impedes a superior bid, thereby undermining shareholder value.
  • Economic Context: Courts may consider market volatility, the presence of competing bidders, or the complexity of the deal.

Importantly, Delaware courts emphasize enterprise value rather than equity value when evaluating whether a fee is fair. This reflects a more accurate assessment of the business's total value, particularly in deals with significant debt or cash balances.

Breakup Fee vs. Liquidated Damages

While both breakup fees and liquidated damages represent pre-agreed penalties, they differ in scope and usage:

  • Breakup Fees apply specifically to failed M&A deals and are triggered by specific events, like accepting a superior offer.
  • Liquidated Damages are broader and used in a variety of contracts to estimate harm in case of breach.

Courts may evaluate whether a breakup fee truly reflects anticipated losses (as a liquidated damages clause would) or if it acts as a punitive measure.

Examples of High-Profile Breakup Fees

Real-world examples help illustrate the use and scrutiny of breakup fees:

  • AT&T / T-Mobile (2011): AT&T agreed to pay T-Mobile $4 billion in cash and assets when the merger failed due to regulatory pushback. This was one of the largest breakup fees in history.
  • AbbVie / Shire (2014): AbbVie paid a $1.6 billion breakup fee after abandoning its acquisition due to tax inversion concerns.
  • Dollar Thrifty: The court held that the breakup fee should include a special cash dividend paid before closing, reaffirming that enterprise value, not equity alone, was the correct basis for calculation.

These cases highlight how courts and parties must carefully balance the protection of deal interests with fairness and shareholder rights.

Frequently Asked Questions

  1. What is a breakup fee in M&A?
    A breakup fee is a payment a seller agrees to make to a buyer if the seller backs out of a merger or acquisition agreement, often to accept a superior offer.
  2. How much is a typical breakup fee?
    Breakup fees typically range from 1% to 4% of the deal value, but courts scrutinize higher percentages for reasonableness.
  3. Are breakup fees enforceable?
    Yes, if they are considered reasonable and not preclusive of better offers. Courts, especially in Delaware, examine fairness, size, and economic context.
  4. What is the difference between a breakup fee and a reverse termination fee?
    A breakup fee is paid by the seller, while a reverse termination fee is paid by the buyer—usually due to regulatory or financing failures.
  5. Can a breakup fee be negotiated?
    Absolutely. The amount, conditions, and triggers of a breakup fee are all negotiable and should align with the deal's risk and value.

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