Break up Fee M&A: Everything You Need to Know
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.3 min read
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.
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