Canada: Deal Protection Mechanisms: Break Fees And Reverse Break Fees

When Burger King Worldwide, Inc. acquired Tim Hortons Inc. in December 2014, the arrangement agreement contemplated a break fee of $345 million and a reverse break fee of $500 million. These amounts are more than the 2013 GDP of Micronesia and Tonga, respectively. If these amounts seem large, consider that in the United States break fees and reverse break fees are sometimes in the billions. The fees need to be scrutinized and negotiated as carefully as any other aspect of a deal agreement because they may have significant consequences. The TMX Group paid a $10 million break fee to the LSE when their merger failed. AT&T paid an astronomical approximately US$4 billion to T-Mobile when their deal failed. So what are break fees and reverse break fees? In short, they each are a type of deal protection mechanism. 

The term "break fee" typically refers to a sum paid by the seller to the buyer in a proposed deal in the event that seller elects to end the agreement before the deal is completed. Break fees are typically agreed to consensually by the seller as part of overall acquisition negotiations. Break fees are generally used to promote certainty of a deal by imposing a penalty for terminating the deal, and serve to generally compensate the buyer for out of pocket costs incurred in regards to the deal. Accordingly, break fees vary from deal to deal. There is no hard and fast rule when it comes to setting the amount of the break fee. Break fees are commonly fixed dollar amounts, and are usually based on a percentage of the equity value of the seller. For example, the break fee in the Burger King and Tim Hortons deal represented approximately 2.7% of the equity value of the deal. Break fees may also be based on the enterprise value (i.e., equity plus debt) of the seller.

"Reverse break fees", on the other hand, are fees paid by the buyer to the seller when the deal is not completed. Like break fees, reverse break fees are deal specific, and are generally fixed dollar amounts. Reverse break fees may be used to compensate a seller for loss of reputation in a failed deal, loss of opportunity, and even compensate for any loss of key employees during the deal. However, reverse break fees can also be used by a strategic buyer to limit its liability in the event certain conditions of the deal are not met (e.g., failure to obtain regulatory approval). Reverse break fees are typically higher than break fees to reflect the perceived higher damage suffered by the seller if the deal is not completed.

Neither break fees nor reverse break fees should be negotiated in isolation. When considering the amount of a break fee or reverse break fee, the parties should look at all relevant factors including the triggers for the fees, in the case of a break fee, whether there already exists a separate mechanism for reimbursing expenses, and, in the case of a reverse break fee, whether the reverse break fee is the exclusive remedy of the seller. The buyer and seller can negotiate and specify one or more triggers for each of the fees. Typical triggers for a break fee include where a seller terminates for a more attractive offer, where a seller's board changes its recommendation of a deal, or where a seller fails to obtain shareholder approval for the deal. Typical triggers for a reverse break fee include a buyer's breach of the agreement, a buyer's failure to obtain financing, or where a buyer fails to obtain shareholder approval for the deal.

Negotiating a deal can be expensive and time consuming for a seller and a buyer. While having a break fee or reverse break fee will certainly not guarantee that a deal will be completed, such fees are a way for sellers and buyers to allocate risks in a deal.

Norton Rose Fulbright Canada LLP

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