MERGER BREAKUP FEES: A CRITICAL CHALLENGE TO ANGLO-AMERICAN CORPORATE LAW

Law and Policy in International Business, Spring 2003 by Tarbert, Heath Price

I. INTRODUCTION

The field of mergers and acquisitions (M&A) has witnessed more innovative legal approaches in recent years than any other area of corporate law. The United States and the United Kingdom lead the development of North American and European M&A law, though their approaches are by no means uniform. Nevertheless, the prevalence of cross-border mergers between U.S. and U.K.-based companies has brought greater Anglo-American regulatory harmonization. Because the M&A market plays an immense role in continually reshuffling and reshaping our global economy, many legal scholars have explored varying aspects of takeover law and regulation. The pinnacle of M&A legal research occurred in the 1980s and 1990s, following an unprecedented period of hostile takeovers. Hostile takeovers, acquisitions that occur despite target company resistance, have been extremely controversial on both sides of the Atlantic.

Despite the occasional hostile transaction, the emerging trend is toward "friendly" deals-transactions where both companies agree to the business combination. In contrast to the vast amount of legal scholarship analyzing and evaluating hostile transactions, this Article explores an important and problematic component of friendly transactions. The "breakup fee," a popular legal tool in the friendly merger process, currently poses great challenges for Anglo-American corporate law. Part I thus highlights the rise of "deal protection" devices in M&A transactions, focusing primarily on the function, structure, and use of breakup fees. Part II examines U.S. courts' treatment of breakup fees through a traditional legal analysis of statutes and case law. Judges have employed at least five distinct yet conflicting standards, raising serious doubt as to whether a coherent approach to breakup fees even exists in the United States. Part III similarly analyzes the validity of breakup fees under U.K. law. In the United Kingdom, a quasi-regulatory body has promulgated a crisp "soft law" rule to pre-empt litigation, yet this simple rule's validity is questionable when one examines breakup fees against the backdrop of the Companies Act 1985 and U.K. fiduciary duty law. Lastly, Part IV explores two underlying policy tensions common to breakup fees under both U.S. and U.K. law: (1) the inherent conflict between contract law and corporate law; and (2) the tension between facilitating efficient transactions and protecting fiduciary obligations to affected shareholders.

II. THE RISE OF "DEAL PROTECTION" DEVICES IN FRIENDLY MERGERS & ACQUISITIONS

The "friendly" deal is now the mainstay of the international M&A market.1 The overwhelming majority of deals making up the $3.46 trillion of M&A volume in 2000 were non-hostile.2 Recent international combinations include immense U.S.-U.K. friendly mergers such as Vodafone and AirTouch, British Petroleum and Amoco, and British American Tobacco and Rothmans, to name only a few.3 Therefore, it is no surprise that lawyers from both countries have sought to use tools of the legal profession to ensure that such friendly mergers are consummated. Before exploring these legal tools, specifically focusing on the breakup fee, this Article reflects upon the proper role of the target company's board of directors in the M&A context.

A. Reflections on the Role of the Target Company's Board

Two opposing models describe how a target's board should conduct itself during a business combination event: the passive and active board models. The passive approach asserts that a company's board should not play a proactive role in entering into M&A agreements without the prior consent of shareholders. Professors Easterbrook and Fischel have argued that the possibility of non-consensual mergers forces management to become more efficient, which will ultimately lead to higher share prices since their underlying assumption is that capital markets will reward efficiencies.4 If instead the board possesses full authority to enter into merger negotiations with whomever it pleases, the board could use such power to ensure its continued dominance of company affairs to the eventual detriment of shareholders. Economists frequently refer to this perceived dilemma as the "agency-cost" problem.5 One weakness of this argument is that it assumes that shareholders and boards maintain a traditional agency relationship in the strictest sense. Many jurisdictions, however, deem company management to have duties to an entire community of stakeholders that includes groups beyond equity holders.

The majority view supports the active board model. Under the active model, the board possesses the power to freely negotiate business combinations with whomever it deems appropriate and to erect reasonable barriers to thwart hostile bidders.6 While courts will scrutinize the use of defensive tactics, the ability to negotiate non-hostile mutual mergers has become largely non-controversial.7 Thus, the active board model has given rise to the friendly deal. In contrast to Professors Easterbrook and Fischel, other economists maintain that the agency-cost problem is virtually non-existent because directors cannot prevent the highest bidder from acquiring the company and therefore usually seek the highest value for shareholders.8 A normative evaluation of the active board model, which gives rise to friendly deals, is beyond the scope of this article. Yet the debated efficacy of the active approach casts doubt upon the very legitimacy of employing deal protection techniques in M&A transactions.9