Break Fee Clause

Introduction:

Break fee is becoming an important feature of corporate transactions. Break fee also known as the termination fee is a compensation that is paid by the party who breaks a deal or an agreement. It is the compensation of the cost that a party incurs in the event an agreement is terminated. Generally, the break fee clauses are to protect applicable in two situations

• If a Mergers and acquisition deal is terminated by either party
• When a contract ended by either party before expiration [1]

E.g. If a lease agreement is terminated by the lessee before its expiration, the lesser should be paid compensation for the lost months of rent.

The objective of the break fee compensates the bidder for the due diligence costs, out of pocket expenses, investigation, negotiations and management costs for the deal and/or any economic loss that may be incurred by the party because the proposed transaction was not completed[2]

Company X makes an offer to acquire Company Y and they enter into an agreement. However, acquisitions cannot take effect immediately. There may be some problems detected by the regulators which are difficult be overcome or Company Y may lookout for better deals. In such situations, the efforts of Company X may be rendered fruitless. In an era of emerging M & A, s this clause is most commonly used to protect the time and efforts of the invested by the acquirer company. The compensation is paid by the target company. The sellers may also insist on adding reverse break fee clauses in case the bidder changes his mind.

Why is it Important?

The use of break fee clause is not very common, specifically in private and small deals, but when the amount of deal increases there come disruptions, such as other Companies trying to offer the target company a better deal or government interventions, specifically in high concentration sector. In any such situation, the possibility of the deal sustaining is lessened. Thus, it is important to introduce the break fee clause to indemnify the party affected.

1. Covers costs of planning, negotiating, managing a deal
2. Protects the buyer if the seller receives a higher bid
3. To keep the parties invested in the deal.
4. It keeps some of the companies from bidding as they would have to also cover the breakup fee.
5. Helps mitigate the loss.

Limitations for Break Fee Clause

There are three limitations to a break fee/termination fee clause:

1. After deciding a percentage, a copy of the letter of intent containing the proposed breakup fee must be sent to SEBI. SEBI will check whether the set per cent is reasonable and shall make any necessary changes if necessary.
2. If the is between transaction is a foreign entity and Indian entity and if the foreign entity is the non-breaching party, then the prior approval of the reserved bank is required to pay the break-up fee to the foreign entity. [3]

Types of Break Fee Clause:

A break-up fee clause may be either included in the preliminary agreement or the letter of intent. The following are different forms of break fee clause:

No Shop Clause

Adding a “No shop clause” in the agreement prevents the seller from soliciting additional bids from the third parties while the target company and the original bidder are negotiating a deal. However, in the case of public companies, the no-shop clause has a risk of being overruled by the shareholders. If the deal offered by the third party is beneficial to and in the interest of the shareholders, they may vote against the no-shop clause, as have the right to vote for final decisions.

Fiduciary Clause

A “fiduciary clause”[4] is included by the seller/ target company in the preliminary agreement to prevent the seller from paying the breakup fee in certain cases which are explicitly stated. For e.g. “It is hereby stated that the seller is absolved of any the liability arising in lieu Break fee Clause in event of any of the following conditions:

If the board makes a decision in order to uphold shareholder’s interest.”

Reverse Break fee Clause

The Break fee clause compensates the buyer/ prospective bidder from a possible deal failure. But what if the buyer company is unable to complete the deal, which would incur the deal costs for the seller/target company. If such an issue arises the reverse break fee clause included by the seller in the agreement, which the buyer/prospective bidder indemnifies the target company against the risk of the deal failure at a certain per cent of the transaction amount.

The reasons behind including the reverse break fee clause may be[5]:-

• Buyer’s inability to finance the transaction
• Failure to complete the transaction before the due date.
• Buyer’s failure to get shareholder approval.
• Denial from the regulatory bodies.

Examples of Break Fee deals in India[6]

• Apollo and Cooper Deal

On June 2013, Apollo tyres Ltd., an India based Company announced its merger with Cooper Tire and Rubber Co., an American Company. The Apollo -Cooper deal together would have been a perfect global brand. From the geographical perspective, Apollo tyres is established in India, Europe and Africa and Cooper was big in North America and China. The transaction was an all-cash deal valued at $ 2.5 billion. However, things went south quickly, Chengshan situation – a Chinese subsidiary of Cooper Tire and Rubber Co. Was against this merger from the beginning. The Chinese firm tried to overbid the deal offered by Apollo tyres, which was declined. When the attempts to sabotage the deal went unfulfilled, they tried to instil fury amongst the workers of Cooper Tire and Rubber Co., which created a lot of chaos and Apollo amidst all was unable to secure finances[7]. The situation was such that the preliminary agreements had both break fee Clause and the reverse break fee clause. In case Apollo terminated the deal, they were liable to pay $112.5 million and if Cooper Tire walks out it had to pay $ 50 million. Finally, the Cooper Tire and Rubber Co. terminated the deal.[8]

• Microsoft and LinkedIn

In 2016, Microsoft and Linkedin were in negotiations where Microsoft was to acquire LinkedIn. Their preliminary agreement included of the “no shop clause” which means that in any event if LinkedIn entertained a deal from a third party whilst in negotiations with Microsoft, LinkedIn is supposed to pay a break-up fee $ 725 million to Microsoft.

Around the negotiations, LinkedIn did receive a bid from one of the biggest competitors of Microsoft. But LinkedIn did not act upon it, because if they did they were liable to pay $725 million to Microsoft.

• Staples and Office Depot[9]

In 2015 Staples and Office Depot, both retailers of office supplies announced their merger for $ 6.3 billion. This was opposed by the Federal Trade Commission on the grounds that it was against the anti-trust laws (antitrust laws prevent monopolization of market) this claim was reinforced by the U.S District Court of Columbia and the merger was blocked. Due to this, the Staples were required to pay a break-up fee of $250 million to the Office Depot.

• Jaiprakash Power Venture Limited and Taqa India Power Ventures Limited

The subsidiary of Jaiprakash Power Venture Limited, Jaypee group received an offer of acquisition from an Abu Dhabi based National Energy Company Taqa Ltd. The value of the deal was Rs. 9,689 Crores. But the deal was called off by Taqa Ltd. and the agreement has a reverse break fee clause owing to which they were required to pay Jaypee Group Rs. 54 Crores as compensation.[10]

Legal Issues Involved in Break Fee Clause

• Reasonable care should be taken by the company to see whether the target company has the legal and financial capacity to enter into a breakup fee arrangement.[11]
• The board of both the Companies must act in good faith and in the best interest of the company and the shareholders while considering the break fee arrangement.
• A clause barring financial assistance for unlawful activities can be added while drafting the break fee arrangement.
• A thorough background check in the Target Company’s background, especially in relation to honouring of the contracts is must.
• Significant care should be taken while drafting the break fee agreement, all the related clauses should be specifically outlined and exhaustive in nature, as the liable parties may attempt to clash on enforceability.
• The jurisdictional issues must be considered in cross border break fee clauses. In U.K break fee clause is usually prohibited, as they obstruct other potential bidders and thus, a fair competition. [12]

International Perspective

1. France: The break fee is not prohibited under French law, rather they have emerged as a trend in France. In France, Break-up Fees can be in two forms; either with the agreement of the core shareholders or with the target company itself. Any counter or competitive bids, however, shall be placed at least 2% higher than the original/ previous bid.[13]
2. The United Kingdom: In the U.K, break fees are generally prohibited under the UK Takeover Code, as in their opinion it is, they obstruct other potential bidders and thus, a fair competition. The seller may not enter into any arrangement with the buyer during an offer period or while considering an offer, without the panel’s agreement. In case a competing buyer announces their intention to make an offer, it is allowed if the break fee is not higher than 1 per cent of what the previous buyer proposed.[14]

Conclusion

The position of the break fee clause is India is very unclear. There are no regulations and no precedents on the break fee clause, due to which the courts have been to lay down guidelines with respect to Break Fee clauses in India. However, the Break fee clause is emerging slowly in India. One of the biggest examples of this clause was seen in the Apollo – Cooper deal. This clause has become a crucial part of a lot of greater deals. With the emerging trend of the Break Fee clause, arises the need to cap the per cent of the break fee clause and introduce guidelines in relation to the same.[15]

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References:

[1] Investopedia. 2020. Breakup Fee. [online] Available at: <https://www.investopedia.com/terms/b/breakup-fee.asp#:~:text=What%20Is%20a%20Breakup%20Fee,used%20to%20facilitate%20the%20deal.> [Accessed 15 September 2020].

[2]Sunder, V., 2020. Breaking Down Break Fee Clauses. [online] Irccl.in. Available at: <https://www.irccl.in/single-post/2020/04/17/Breaking-Down-Break-Fee-Clauses#:~:text=A%20break%20fee%20(termination%20fee,out%2Dof%2Dpocket%20expenses.> [Accessed 14 September 2020] “Chesire & Fitfoot’s Law of Contract states that break fee should be upheld if it is a reasonable forecast of the loss incurred by the frustrated bidder.”

[3]Rai, D., 2020. Analysis Of Break Up Fee Clause In Corporate Law. [online] iPleaders. Available at: <https://blog.ipleaders.in/analysis-of-break-up-fee-clause-in-corporate-law/> [Accessed 15 September 2020]..

[4] Rai, D., 2020. Analysis Of Break Up Fee Clause In Corporate Law. [online] iPleaders. Available at: <https://blog.ipleaders.in/analysis-of-break-up-fee-clause-in-corporate-law/> [Accessed 15 September 2020].

[5] Corporate Finance Institute. 2020. Breakup Fee – Examples, Guide, Penalty For Backing Out Of A Deal. [online] Available at: <https://corporatefinanceinstitute.com/resources/knowledge/deals/breakup-fee/> [Accessed 15 September 2020].

[6] Corporate Finance Institute. 2020. Breakup Fee – Examples, Guide, Penalty For Backing Out Of A Deal. [online] Available at: <https://corporatefinanceinstitute.com/resources/knowledge/deals/breakup-fee/> [Accessed 15 September 2020].

[7] Mishra, A., 2014. How The Apollo, Cooper Deal Was Botched | Forbes India. [online] Forbes India. Available at:<https://www.forbesindia.com/article/boardroom/how-the-apollo-cooper-deal-was-botched/37019/1> [Accessed 15 September 2020].

[8] Goyal, M., 2020. Apollo-Cooper Tire Deal In Trouble: Why Some Big Bang M&A Proposals Never Materialise. [online] The Economic Times. Available at: <https://economictimes.indiatimes.com/news/company/corporate-trends/apollo-cooper-tire-deal-in-trouble-why-some-big-bang-ma-proposals-never-materialise/articleshow/24055700.cms> [Accessed 15 September 2020].

[9] Corporate Finance Institute. 2020. Breakup Fee – Examples, Guide, Penalty For Backing Out Of A Deal. [online] Available at: <https://corporatefinanceinstitute.com/resources/knowledge/deals/breakup-fee/> [Accessed 15 September 2020].

[10] 2020. [online] Available at: <https://www.financialexpress.com/archive/taqa-calls-off-rs-9689-cr-jaiprakash-power deal/1273320/#:~:text=Jaiprakash%20Power%20Ventures%2C%20a%20part,to%20acquire%20two%20hydorpower%20projects.&text=However%20JPVL%20has%20said%20that,terms%20of%20the%20acqusition%20agreement.> [Accessed 15 September 2020].

[11]

[12] Browne, O., 2017. Break Fees And Broken M&A Deals. [online] The Harvard Law School Forum on Corporate Governance. Available at: <https://corpgov.law.harvard.edu/2017/11/15/break-fees-and-broken-ma-deals/> [Accessed 14 September 2020].

[13] 2013. Overview Of M & A Industry In France. [ebook] Chambers and Partners “Corporate M&A 2013”, p.Page No. 19. Available at: <https://www.orrick.com/api/content/downloadattachment?id=bd2acd22-8b00-4d8f-9a27-1218fe2ff900#:~:text=Break%2Dup%20fees%20are%20not,and%20more%20in%20recent%20years.&text=French%20law%20provides%20that%2C%20to,higher%20than%20the%20first%20price.> [Accessed 13 September 2020].1218fe2ff900#:~:text=Break%2Dup%20fees%20are%20not,and%20more%20in%20recent%20years.&text=French%20law%20provides%20that%2C%20to,higher%20than%20the%20first%20price.

[14] UpCounsel. n.d. Breakup Fee: Everything You Need To Know. [online] Available at: <https://www.upcounsel.com/breakup-fee> [Accessed 13 September 2020].

[15] Sunder, V., 2020. Breaking Down Break Fee Clauses. [online] Irccl.in. Available at: <https://www.irccl.in/single-post/2020/04/17/Breaking-Down-Break-Fee-Clauses#:~:text=A%20break%20fee%20(termination%20fee,out%2Dof%2Dpocket%20expenses.> [Accessed 14 September 2020].