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

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

1. The Anatomy of a Breakup Fee

Like other deal protection devices, breakup fees are included in the merger agreement. Broken down into its structural components, a breakup fee clause consists of the payment amount and a list of enumerated events that trigger the payment. The payment amount is fixed at either a percentage of the transaction's value or a specific amount of money. In the U.S. merger market, "[t]ypically fees range from 1-5% of the deal size, with larger percentage fees in smaller deals."44 The triggering events usually fall into one of four broad categories: (1) the board's exercise of a fiduciary out; (2) the company's breach of any warranties or covenants; (3) shareholder rejection of the merger; or (4) the acceptance of a third-party bid. The board's exercise of a fiduciary out usually triggers the breakup fee, especially if the board then enters into another merger agreement with a competing bidder. The failure of the company to meet its material warranties and representations often dissolves the merger and also triggers the payment. For instance, a breakup fee may be triggered if one partner pledges to obtain the necessary antitrust or other regulatory approvals but does not. The common factor in most triggering events is that one party has intentionally reneged on its promises or negligently failed to take steps necessary to consummate the merger.

If a company must terminate the agreement because shareholders have rejected the merger even after the board recommended the transaction, a payment is triggered in approximately half of those deals employing the breakup fee.45 This lack of uniformity suggests that some practitioners believe that shareholders can be held accountable for voting down the deal while others feel it necessary to bind only the board's actions. The payment of a breakup fee always results when one partner jumps the deal to merge with a third party within a specified period of time, usually two years. This seems to be the one event that automatically triggers a breakup fee, illustrating that this device clearly possesses a protective component. In fact, a special two-tier breakup fee is now part of many contracts designed to capture a delayed merger with a second bidder after the original merger fails. For example, a board's failure to recommend the bid or shareholders voting down the proposal could trigger the first tier of a breakup fee resulting in the obligation to pay two percent of the deal value to the merger partner. If the same company then decides in the next year to consummate a merger with another bidder, a second tier of the original breakup fee could be triggered resulting in another payment of two percent of the original transaction value.46 Thus, the breakup fee could eventually amount to four percent of the original proposal's market value. Another variation on the second tier, known as a "topping fee," allows the abandoned partner to obtain the pecuniary amount the second bidder pays in excess of its original bid.47