The 2007-2008 financial crisis saw reverse breakup fees emerge as part of a new structure of private equity in the United States. The use of reverse breakup fees quickly spread thereafter, and by 2010-2011, approximately one-third of M&A deals in Canada included reverse breakup fees. These fees serve to discourage bidders from walking away from deals and helped to determine the risk-sharing between parties involved in M&A transactions.
When reverse break fees are typically paid
In a previous post, we noted that reverse breakup fees are typically paid where there is an unavailability of "committed" financing. Part of the reason these fees have gained prominence is because target companies usually suffer greater consequences when M&A deals fail. These consequences often include: the negative effect of the termination on the target's reputation, morale and opportunity costs, and the possible loss of the target's employees.
Reverse break fees are deal-specific
A prior blog post further notes that reverse breakup fees are deal specific. In determining the amount of a reverse breakup fee one should consider the triggers of the fee, which typically include: a buyer's breach of the agreement, a buyer's inability to obtain financing, and a buyer's failure to secure shareholder approval for a deal. In some cases, reverse breakup fees are calculated on a tiered basis, with the total amount of the fee being dependent on the specific termination right which has been triggered. Often however, contracts in M&A deals provide for a fixed sum that is payable in the event of a termination.
Factors impacting value of reverse break fees
Other factors that influence the value assigned to reverse breakup fees include:
- the size of the deal; the length of the interim period in between when the contract was signed and when it closed;
- the existence of financing conditions;
- whether the bidder is strategic (in a similar line of business and buying to hold), or financial;
- the extent of regulatory approvals required to close and perceived challenges in obtaining those approvals; and
- the relative bargaining power of the parties.
Negotiating deals can be expensive and time consuming for all parties involved. It is important that both sellers and buyers in public and private M&A transactions have knowledge of reverse breakup fees and an understanding of how and when they are used as a deal protection mechanism.
The author would like to thank Brandon Burke, Summer Student, for his assistance in preparing this legal update.
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