Break fees have for many years been a conventional deal protection feature of public M&A transactions. These fees, often referred to as termination fees as they are tied to the termination provisions in the contract containing the deal terms, are typically payable by a target company where it elects to end an agreement for an M&A deal with a prospective buyer (almost always in order to accept a higher offer from another suitor). Such fees can promote deal certainty for a buyer by attaching adverse monetary consequences to a target terminating the deal.
Reverse break fees (as opposed to break fees which are payable by the target) are payable by the bidder to the target in the event the bidder exercises certain termination rights under the contract containing the deal terms. Though such fees are less common in Canada than traditional break fees, their prevalence is on the rise. For example, between 2010 and 2011 approximately one-third of M&A deals in Canada included a reverse break fee.
Historically, in the private equity context, reverse break fees appear to have been rooted in the desire of target companies to obtain compensation in the event an M&A deal fails due to an inability of the buyer to obtain financing for the deal or the required regulatory approvals. Over time, however, such fees have become tied to a variety of termination provisions in the contract containing the deal terms.
In reality, when M&A transactions fail, the target company usually suffers greater consequences than the bidder as a result of the negative effect the termination has on the target’s reputation, morale and opportunity costs, and the potential loss of the target’s key employees. A reverse break fee may allow a bidder to cap its liability below the target’s actual damages however, from the target’s perspective a fixed reverse break fee avoids a protracted fight over damages. The payment and quantum of the reverse break fee should be structured in a way that discourages bidders from walking away from a deal unless there is good reason to do so. The amount of a reverse break fee may depend on the termination provision that is triggered in making it payable under the contract that governs the deal. In certain instances, reverse break fees are calculated on a tiered basis, with the quantum of the fee depending on which termination right is triggered. Typically however, contracts in M&A deals provide for one sum that is payable in the event of a termination for any reason.
Recent market trends suggest that parties are paying closer attention to ensure that the quantum of the reverse break fee is tailored to the particular circumstances of the deal. As one might expect, this has led to a disparity between break fees and reverse break fees. Unlike break fees, there are no established norms or typical ranges with respect to the amount of reverse break fees as they vary depending on the deal.
Many factors can influence the value assigned to a reverse break fee including:
- size of the deal;
- length of the interim period between signing the contract and closing;
- the existence of financing conditions;
- the identity of the bidder (whether it is strategic (in the same line of business and buying to hold) or financial (including private equity groups buying low and wishing to exit high));
- extent of regulatory approvals required to close and the perceived challenges in obtaining those approvals; and
- relative bargaining power of parties.
M&A activity in recent years suggests that the incidence of reverse break fees is on the rise in the Canadian market. As can be expected, no one size fits all as parties are paying closer to attention to setting the quantum of such fees to reflect the context of a deal and risk allocation.