INTRODUCTION: TERMINATION/BREAK FEES[1]
In mergers and acquisitions (M&A), it is customary to incorporate deal protection mechanisms to safeguard the parties in case the deal falls through. Termination fees, also known as breakup or break fees, is a deal protection mechanism that emerged in the 1980s[2]. It gives the acquirer / buyer, a right to receive monetary compensation from the target / seller in the event the target chooses to sell to another acquirer, for a superior offer. A break fee also motivates the seller to go forward rather than backward with the deal as the cost of breaking the deal is to be borne by the seller.
WHY HAVE A TERMINATION/BREAK FEE CLAUSE?
It is imperative that steps be taken to increase certainty of agreements in M&A transactions and parties enter into sealed arrangements, preventing one party from “walking away” without repercussions. A break fee clause will encourage competition between potential buyers which is good for seller companies. If potential buyers are promised a compensation for additional expenses and costs incurred in the course of the transaction, they would be keen to invest more on such transactions[3]. Other reasons for inclusion of a break fee clause are as follows:
- Competitive bidding: The bidder is well placed to demand a break fee if the target company terminates the agreement and chooses to undergo acquisition with another bidder.
- If the shareholders of the target company vote against the acquisition after the agreement has been formed.
- If the target company does not honour material terms of the contract.
- If the target company misrepresents itself to the prospective buyer.
Break fees may improve the chance of consummation of a deal, but every deal is subjective and should be considered on a case-to-case basis. Some estimates have stated that having a termination fee would increase the likelihood of closing the deal by around 15%[4]-20%[5].
REVERSE BREAK FEES
As the name suggests, it is a reverse of break fees, meaning the buyer promises to pay to the seller an agreed sum, when the deal falls through. Though it is not common, there are instances of usage of reverse break fees in India – for instance, Apollo Tyres and Cooper Tire & Rubber Co. were involved in a dispute pursuant to a failed acquisition deal, where there was a provision for a break fee as well a reverse break fee (more details on this case provided below). The purpose of a reverse break fee is to motivate the buyers in an acquisition, and to disincentivize the buyers from terminating or delaying the acquisition.
HOW MUCH BREAK FEE IS IDEAL?
The value of the termination fees ranges from 1% of the deal value to sometimes even 10.1% of the deal value[6]. It also varies from jurisdiction to jurisdiction and some jurisdictions have even chosen to cap or prohibit deal protection mechanisms all together[7].
The standards for break fees in other jurisdictions are outlined below:
- United States of America (US)
The US has no specific cap on break fees. It has had extremely high break fees such as 10%[8], which has leveled out to around 3%-4%[9].
- United Kingdom (UK) and Europe
In the UK, all deal protection mechanisms have been prohibited for public companies, prior to which it had a capped 1% limit for termination fees[10]. In European countries, though deal protections are allowed, a seller is to compensate the acquirer / buyer for only its out-of-pocket expenses.
- Singapore
Singapore places a 1% limit on termination fees, as per rule 13 of its takeover code.
The US market has the least restrictions, hence allowing for a natural standard of 3%-4% that has been determined by the industry. Further, there have been studies that show that an ideal termination fee of approximately 3%[11].
PRACTICE IN INDIA
In India, there is no regulation that directly interacts with breakup fees, although some have argued that there may be interaction with the Takeover Code eventually[12]. It is likely that such deal protection devices will become more common in India, both on inbound and outbound deals. In the recent proposed merger of Swiggy and UberEats, the deal fell through, as reportedly there was non-agreement regarding the break fee[13] (UberEats was subsequently acquired by Zomato in 2020).
In the case of the proposed out bound acquisition by Apollo Tyres (Apollo) of Cooper Tire & Rubber Co. (Cooper)[14], it was agreed that if Apollo walked away, it was to pay a reverse break fee of USD 112.5 million while if Cooper walked away, it would be liable to pay USD 50 million; this lower break fee in comparison to a reverse break fee is a noted trend. Cooper Tire terminated its agreement with Apollo Tyres, citing lack of financing from Apollo, but the court held that Cooper itself had failed to comply with its contractual obligations (mainly due to the labour strife in the US and opposition by Cooper’s joint venture partner in China), and therefore, Cooper was held liable to pay the break fee.
[1] André, P., Khalil, S. and Magnan, M., 2007. Termination fees in mergers and acquisitions: protecting investors or managers?. Journal of Business Finance & Accounting, 34(3‐4), pp.541-566.
[2] Restrepo, F. and Subramanian, G., 2017. The New Look of Deal Protection. Stan. L. Rev., 69, p.1013. Microsoft Word – 2016 0809 New look of deal protection.docx (stanford.edu)
[3] Chapple, L., Christensen, B., & Clarkson, P. M. (2007). Termination fees in a “bright line” jurisdiction. Accounting & Finance, 47(4), 643–665. Microsoft Word – break fee document.doc (ssrn.com)
[4] Officer, M. (2003). Termination fees in mergers and acquisitions. Journal of Financial Economics, 69(3), 431–467.
[5] Officer, M. (2003). Termination fees in mergers and acquisitions. Journal of Financial Economics, 69(3), 431–467.
[6] See, e.g., Baxter v. Syntroleum Corp. et al., Order on Defendant Syntroleum Board’s Motion to Dismiss, C.A. No. CJ-2013-5807 (Oct. 6, 2015)
[7] Restrepo, F. and Subramanian, G., 2017. The effect of prohibiting deal protection in mergers and acquisitions: evidence from the United Kingdom. The Journal of Law and Economics, 60(1), pp.75-113.
[8] Supra 6
[9] Supra 2
[10] Supra 7
[11] Supra 7
[12] Reverse Break Fees on Indian Transactions – IndiaCorpLaw by Umakanth Varottil
[13] Swiggy UberEats deal: Swiggy, UberEats can’t tally numbers for a deal | Swiggy (indiatimes.com)
[14] Cooper Tire loses $112 million Apollo deal breakup fee bid | Mint (livemint.com)