The costs of launching a public take-over are exorbitant. Many bidders are seeking ways to protect themselves if the deal collapses. This applies equally to buyout firms looking to complete public-to-private transactions (PTPs), especially given current market conditions.
A break fee is an arrangement made in the context of a recommended public take-over in which the target agrees to pay the bidder a substantial fee for wasted costs if a specified event occurs that prevents the transaction from completing. Of course, even though it is dressed up as an indemnity for costs, the break fee has at least one other very important purpose – to protect the deal from a competing offer.
Historically, the lack of market practice or guidance from the regulators on the use of break fees is considered one of the important reasons why PTP's have not yet taken off in Europe. However, break fees have recently entered the Continental takeover landscape by appearing in a number of take-overs in The Netherlands, the most established buyout market in the Benelux region. There has since been a flurry of debate about the validity and enforceability of these arrangements.
Cost protection or poison pill?
In December 2000 two office furnishing companies, Samas-Groep and Ahrend-Aspa, issued their merger proposal. That document included the following brief statement:
“Ahrend and Samas have agreed to strive for the Merger. For this purpose a “memorandum of understanding” was agreed by Ahrend and Samas stating that if Ahrend or Samas, as a result of a legal decision or arbitrage, is forced to accept the bid of a third party for the shares in the capital of the company, Samas or Ahrend has to pay to the other party a compensation of E13.5m for costs and possible damage”.
Hardly a model of drafting clarity, but the purpose and effect was clear. At the time there was a battle royal with rival Buhrmann announcing a competing take-over bid for all outstanding shares of both Samas and Ahrend, and rival Stonehaven Holding announcing its intention to make a bid for Ahrend. Any observer could see that this substantial payment was less about reimbursing wasted costs and more about including a poison pill to deter Buhrmann and Stonehaven. To put this in perspective, the Samas-Ahrend combination was valued at E841.6m, the break fee representing no less than 1.6 per cent of that figure.
Subsequently break fees also made an appearance in the so-called “dredging war”, the take-over battle for the Dutch construction and dredging outfit, HBG. A similar arrangement was to be found in the earlier Invensys take-over of ailing software company, Baan.
The Dutch take-over regulator, the Authority for the Financial Markets (A-FM), has not yet issued any policy statement concerning break fees. Also, there have not yet been any reported court decisions on the topic. This puts dealmakers in the unenviable position of trying to negotiate break fees that will stand scrutiny in an as yet untested area.
Enforceability against the target
The following concerns have come up in discussions among market practitioners in The Netherlands:
· Conflict with public order
A break fee may be void on the basis that it contravenes good morals or public order. This may be the case, for example, if a court were to take a policy decision that the arrangement effectively allows parties to manipulate markets. The most obvious example is where there is a “poison pill” effect or intent. Some felt that the (mutual) break fee agreed in the Samas-Ahrend deal was expressly designed to frustrate competing offers, and as such was in conflict with public order and void.
· Qualification as a penalty
If the break fee is structured in such a way that it qualifies as a penalty for the breach of an obligation to enter into a specific transaction, it may be reduced by a court on the basis that it is unreasonable. A penalty in this sense would include payment of a significant fixed sum either as the liquidated damages that the parties agree in advance will flow from a breach of contract or as an incentive to ensure that the parties comply with their contractual obligations.
A court has a very wide discretion in this regard, but cannot reduce the penalty to less than the actual damages suffered as a result of the unilateral termination of negotiations. As to what is reasonable depends on the facts of each case.
· Conflict with mandatory law
It has been suggested that a break fee is void because it contravenes the Listing and Issuing Rules of the Euronext Amsterdam Stock Exchange. It is doubtful whether this is correct. The only part of these rules that is possibly relevant is that dealing with Pandora constructions (including the so-called poison pill and crown jewel constructions), where the only restriction is that such arrangements must be made public immediately. The provisions preventing an accumulation of certain anti-take-over devices do not apply to break fee constructions.
· Ultra vires
A company must act within the scope of its objects as set out in its articles of association. In The Netherlands, this limitation has certain limited external effect. In particular, a legal act performed by a company may be set aside if, as a result, its object was transgressed and the other party was aware of the transgression or, without personal investigation, should have been aware of it.
Typically, the objects clause in the articles of association is broadly drafted and must be interpreted in the widest sense to include all incidental matters. Nevertheless, care should be taken in structuring a break fee to ensure that it is within the objects of the company, especially in cases where the break fee is a poison pill. A bidder that requests a substantial break fee that is intended (at least in part) to avoid the target or its shareholders co-operating with competing bidders should, without investigation, be aware that the payment of such a fee is outside the target's objectives. Only the company can set aside a break fee on the basis that it is ultra vires.
· Financial assistance
One of the better arguments that the break fee is not unlawful financial assistance is directed at the reason for the prohibition, namely to avoid a reduction of share capital at the expense of creditors of the company. Payment of a break fee is typically triggered if the transaction is aborted in which case there is no acquisition of shares. Therefore, even if the purpose was broadly to assist in the financing of the acquisition of shares, where there is no acquisition of shares, this is not the kind of mischief that falls within the scope of the prohibition.
Each director is responsible for the proper performance of his duties. A director should have “the insight and scrutiny which may be expected from a director who is suited for his task and performs it meticulously.” This duty is similar to the duty of directors in certain other jurisdictions such as England and Wales to act in good faith and in the best interests of the company.
A break fee can limit the directors’ ability to entertain alternative (possibly more favourable) offers. By negotiating a break fee that effectively fetters the directors’ discretion and restricts the consideration of other offers, the directors may have failed to act in the company's best interests. At a minimum, the target’s directors will have to satisfy themselves that by agreeing to the break fee they are acting in the best interests of the company and they may want to exclude the existence or recommendation of a competing offer from the set of events that triggers payment of the break fee.
If the proposed transaction is subject to shareholder approval, the discretion of the shareholders could be limited by the directors already having bound the target to pay a high break fee if the transaction does not proceed.
It is questionable what corporate benefit is to be obtained from the target agreeing to pay certain excessive break fees. It may be beneficial as a means of securing the initial offer to indemnify the bidder against wasted costs. If, for example, the take-over offer is critical to the continued existence of the target and the offer will not be made unless such a break fee is agreed, as was said to be the case in the Baan/Invensys deal, the directors of the target may be justified in deciding that a reasonable break fee is indeed in the company's best interests. This may differ where the extent of the break fee bears no relation to the costs of making the offer and is material in relation to the value of the offer
There are also other reasons cited as to why a particular break fee arrangement is indeed in the best interests of the target company, for example a letter of advice from the target company's financial advisers confirming that in their opinion the offer and the break fee are in the interests of the target company, capital investment, growth prospects, business development, access to greater resources, prospects for employees, synergies between the bidder's and the target company's businesses and the advantages (if relevant) of becoming an unlisted private subsidiary of the bidder.
The April 2003 decision of the Dutch Supreme Court in the highly publicised Rodamco North America/Westfield matter emphasises that when a target company is effectively “in play”, the directors of the target find themselves in a particularly difficult position. In the judgement of the court, directors of a target company that adopt anti-take-over measures, even if they believe those measures to be in the best interests of the company, can, in certain circumstances, be held accountable for mismanagement and the court can make an order setting aside the anti-takeover arrangements.
The existence of a break fee agreement may qualify as information that the A-FM regards as necessary for those to whom the offer is addressed to be able to assess the offer properly. As such it will need to be disclosed in the public offer memorandum. In addition, it may fall within the requirement that the offer memorandum contains a statement as to whether the offer has been discussed with the target and whether that has in turn led to any agreement being reached.
In circumstances where the structure of the transaction is such that a prospectus must be issued pursuant to the listing requirements of Euronext, the existence and content of the break fee agreement generally needs to be disclosed in the prospectus.
As already pointed out, any arrangement that qualifies as a Pandora construction must immediately be made public under the listing rules of Euronext.
Possible break fee structures
By way of practical guidance, consider the following 2 examples of break fee arrangements:
· The break fee will only be due and payable if the offer lapses or is withdrawn and before the lapse or withdrawal an independent competing offer for the target company has been announced and subsequently becomes or is declared unconditional in all respects or is otherwise completed or implemented. The break fee will only be payable to the extent lawful and shall only be due and payable 14 days after the relevant independent competing offer becomes or is declared unconditional in all respects or is otherwise completed or implemented.
· A break fee will be payable if the potential bidder discovers a major problem during the legal review of the target, before the announcement of an offer, and decides not to make an offer. The target’s directors might find it difficult to satisfy themselves that the agreement to pay an inducement fee is in the best interests of the target company. They would, for example, need to take into account the target’s cash flow and working capital position after the payment on the basis that the company remained independent. There would probably also be evidential problems in determining when the fee becomes payable. Also, given the tightening of the insider trading regulations, the pre-announcement due diligence is in any event a limited exercise, so query the usefulness of this arrangement to the bidder.
The break fee arrangement disclosed in the offer memorandum issued by Grupo Dragados . in respect of its offer for HBG contained a combination of these and other factors. HBG undertook not to support attempts by third parties to make offers for HGB except for a “superior offer”, i.e. an unsolicited bona fide proposal to acquire 100 per cent of HBG which the directors of HBG considered to be considerably more favourable to all stakeholders, in respect of which the financing was fully available and committed and which had a very high likelihood of being completed. This was formulated against the background of several court actions against HBG for mismanagement, hostile offers by Koninlijke Boskalis Westminster and Heijmans for parts or all of HBG and a highly contested merger between parts of HBG and Ballast Nedam.
So does this mean the way is open to the first big institutional-led PTP in The Netherlands?
Probably not. With share prices being what they are, there are probably enough candidates, and while cost protection is always important, the real obstacle lies not in the break fee, but whether a supervisory board of directors is prepared to lead the way and approve such a deal. Only when these captains of industry recognise the value of PTPs are we likely to see the flood buyout practitioners are waiting for. Most PTPs that have occurred to date involved the de-listing of small enterprises by their former owner and majority shareholder. They have not been the sort of PTP mega-buyout the market has been talking about. So far supervisory boards have typically resisted the PTP. Why? That is a matter for another article.
Based in Amsterdam, Gregory Crookes is a solicitor and senior associate in the corpoate group of Clifford Chance.