Bermuda companies are prominent performers on the global stage with pressure to compete, grow and meet their commercial objectives.

The high costs and reputational risks of failed business acquisitions or combinations structured by way of a merger or acquisition (M&A) have increased the need for bidders and their advisors to ensure that the deal is successful.

Consequently, deal protection provisions are some of the most heavily negotiated deals in M&A transactions. Those in favour of such provisions point to the value of them from an economic exploration perspective; they are seen as value-enhancing and encourage superior proposals. Those opposed seek to demonstrate the negative effects on shareholder value and so they negotiate against onerous terms.

While there are numerous deal protection mechanisms the common proposals in the deal protection package, at least at the outset of negotiations, include break fees and no-shop provisions.

Break fees first emerged in the US in the mid-1980s as contractual arrangements between a target company and a potential bidder pursuant to which the target company is obliged to confer a financial benefit (typically a lump sum or a percentage of the value of the target company calculated by reference to the bid value) on the bidder if certain trigger events occur that prevent consummation of the deal.

While break fees are permitted in Bermuda on the basis that they are intended to compensate for losses incurred in negotiating a failed transaction, the reality is that prospective bidders attempt to negotiate the largest break fee possible as a deterrent to deal cancellation.

Break fees in Bermuda are typically in the range of one to five per cent, although in practice a more usual range is between two and four per cent -- and where one goes above four per cent, the position that is intended to compensate for loss and not constitute a penalty alone becomes less tenable. However, a higher fee may be justifiable on the facts of a given transaction.

Directors should consider their fiduciary duties when negotiating a break fee, particularly their duty to act in the best interests of the company, for a proper purpose. The proper exercise by the target board of its fiduciary duties requires the board to be satisfied that the break fee agreed is appropriate and necessary in the particular circumstances of the transaction.

The parties may enter into a no-shop agreement whereby the target board agrees for a fixed, but limited duration of exclusivity that the target board (and its employees and representatives) will not encourage, seek, solicit, provide information about the target or negotiate with third party bidders during the lock-out period. The potential remedy for breach of the no-shop agreement is an injunction (preventing the target from negotiating with third parties) and damages – typically wasted costs.

The use of no-shops is common in Bermuda M&As. However, overly restrictive lock-out clauses could be subjected to scrutiny on the basis that the target board breached its fiduciary duty because it failed to enter into a transaction that recognised the true value of the company and allowed shareholders to realise the same.

A third type of deal protection, which may be advanced by in Bermuda and which has been advanced by parties to potential transactions where there is to be a consolidation of two groups, rather than an acquisition, is the 'crown jewel' provision. This is a device by which the target company agrees to grant the proposed acquirer an option to purchase, or otherwise obtain the benefit of, certain of the target's valuable assets in the event that the proposed M&A does not close, including as a result of a topping bid, the original acquirer retains the option to acquire those assets.

This type of protection gives the acquirer assurance that even outside of a successful M&A, it will nevertheless acquire key pieces of the target's business. This device also serves to deter competing bidders, as a superior bidder will at best acquire the target without the 'crown jewels'.

While there may be room for creative variations on crown jewels, we have not seen their use in Bermuda and we would expect boards of targets to be generally unwilling to agree to such a provision as it could make the target less attractive, reduce subsequent bids, and weaken the target if the merger does not proceed.

Accordingly, crown jewel provisions should be handled with care - with full discussion and documentation of the reasoning and justification for their use. It is also important to note that while there is no duty to shareholders specifically, having due regard to shareholders is heightened in the context of a takeover.

While there are numerous ingredients in the deal protection package there is no 'bright-line test' that a specific deal protection is appropriate. Whether or not a specific package of deal protection provisions is appropriate for a particular transaction, and whether a fight for any particular term is worth expending negotiating coinage, must be considered in the context of the transaction as a whole giving due weight to all applicable facts and circumstances including the desirability of the target and the respective bargaining power of the parties.

Deal protection terms should reflect a reasonable balance of the competing interests of the two parties to the transaction within the framework of the relevant market and deal-specific framework. The goals should be to achieve a reasonable outcome that weighs the economic interests of both parties and avoids litigation or delay of the transaction.

The crafting of a deal protection package that delivers the right level of protection while adhering to the various regulatory and legal constraints (and minimising the risk of court challenge) is -- and will continue to be -- important.

Article first published in The Royal Gazette, November 2015

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.