Breakup Fee
A cost stipulated in takeover agreements must be paid to the acquirer if the target company pulls out of the purchase post-signing the agreement.
What Is a Breakup Fee?
A breakup fee, also known as a termination fee, is a cost stipulated in takeover agreements that must be paid to the acquirer if the target company pulls out of the purchase post-signing the agreement.
The termination fee aims to reimburse the acquirer for the time and money spent negotiating the deal.
Sometimes the seller backs out of the transaction in search of a better offer, wasting time and money for the buyer. Therefore, a termination fee of typically 1% to 3% of the deal's value is inserted to deter the target company from suddenly pulling out of the deal.
The fee provisions are used to cover the acquirer's potential losses in case the acquisition fails. Similarly, reverse termination fee provisions are another requirement put forth by sellers, which provides for payment to the seller if the acquirer cannot execute the deal.
Suppose the corporation still wishes to withdraw from the deal and sell the company to another buyer. In that case, it can do so by paying the termination fee, which is usually paid by the new bidder and raises the bidding price for the new acquirer. Thus this provision also acts as a deterrent to new bidders.
Key Takeaways
- A breakup fee is a penalty the target firm must pay to the acquirer company if the target company withdraws from the transaction. The provision must be mentioned in the agreement to be implemented.
- When entering the deal, companies can include the fiduciary clause, No shop clause, reverse termination fee, etc., under the fee header.
- A reverse termination fee is a penalty that must be paid to the target firm if the acquirer pulls out of the agreement at the last stage to compensate for the efforts put into the deal.
- Some notable examples in the past when the fee or reverse termination fee clause was used or could have been used are AT&T to T-Mobile's failed merger, Microsoft's acquisition of LinkedIn, etc.
- In the United Kingdom, it is forbidden to include a breakup fee clause in the agreement; however, the reverse termination fee clause can be stipulated.
- Such Fees in Hong Kong are legally valid, but they should be de minimis or minimal compared to the deal value.
clauses Under the Breakup Fee
Following are the examples of the particulars that can be included in any standard breakup fee clause:
1. Fiduciary Clause: The target company adds a "fiduciary provision" primarily to safeguard its interests. Including such a provision avoids the breakup fee if the target firm violates any of the contract's expressly specified obligations.
2. No Shop Clause: This provision protects the buyer by prohibiting the seller from seeking bids from third parties while negotiating the deal. However, the shareholders have the authority to overrule this clause when making a final choice.
3. Reverse Termination Fee: It is the exact opposite of the breakup fee. This clause protects the seller by stipulating a penalty in the agreement if the buyer backs out of the contract in the post-agreement phase.
- Reverse termination fees are intended to assure the seller that the buyer will be committed to finishing the purchase or to reimburse the seller for participating in the transaction process if the deal fails to close.
breakup fee: Reason to include In Agreement
Being a buyer-favoring clause, the primary reasons for including this clause in the agreement are as follows:
- Other bidders in the market may make the target firm a better offer later during the deal execution. Thus, the termination fee will protect the buyer during the long process of acquisition.
- The fee provision helps compensate the buyer for the upfront expenditure if the deal falls through.
- The firm's board may have authorized the acquisition, but the shareholders may not want to sell the company. If the deal falls through at the last minute, this provision will kick in, protecting the company's interests.
- During the acquisition process, if a previously undiscovered problem in the target company is found, the buyer may withdraw from the agreement, with the target company covering the buyer's initial costs.
- After providing its consent, the company's board of directors may change its mind during the procedure. The fee provision avoids this and incentivizes them to work hard to ensure the merger is successfully completed.
examples of the Breakup Fee clauses
In the recent past, there have been a few instances where firms utilized or might have used a breakup fee clause or reverse termination fee provision when a party backs out or attempts to back out of an agreement. Some of the famous examples of this clause are as follows:
AT&T To T-Mobile Failed Merger
The amount paid by AT&T to T-Mobile in 2011 was one of the biggest instances of termination fees paid by any company in history.
AT&T was forced to pay a hefty $4 billion charge after the Federal Communications Commission and the Department of Justice blocked the transaction, citing the possibility of increased costs, inferior service, fewer customer choices, and significant job losses.
This fee included $3 billion in cash plus $1 billion in the spectrum.
Elon Musk And Twitter Deal
The deal between Twitter and Elon Musk included a breakup fee of $1 billion. According to a securities filing, if Elon Musk's $44 billion transaction with Twitter had failed, either party would have been required to pay the other a sum of $1 billion.
Microsoft's Acquisition Of LinkedIn
In 2016 after the negotiation, both parties agreed to a no-shop provision with a $725 million termination fee. LinkedIn also got an offer from Salesforce during that time, but it decided to accept the Microsoft offer.
Breakup fees in different countries
Rules related to termination fees are different around the world. Some countries prohibited it, some supported it, and some regularized it by capping the maximum fee that the target company could pay to the acquirer.
United Kingdom
In the UK, termination fees and other contract protection clauses are forbidden, although reverse termination fees are not.
Since September 2011, standard Breakup Fees (payable from a target to a buyer) and any other kinds of deal protection that impose responsibilities on a target in the UK have been prohibited by the UK Takeover Code.
Hong Kong
Breakup Fees are authorized in Hong Kong, but they must be de minimis, meaning they must be so small as insignificant. Typically, the charge is less than 1% of the contract value.
The target's board of directors and the target's financial adviser must declare in writing to the Hong Kong regulatory authority that oversees public M&A that the termination Fee is in the best interests of its shareholders.
South Africa
Breakup Fees are regulated in South Africa and are capped at 1% of the offer value.
According to Section 119(1)(c) of the Companies Act of 2008, a regulated business is prohibited from undertaking any activities that are "intended to delay, frustrate, or defeat an offer, or the making of fair and informed choices by the holders of that company's securities.
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