Australian Takeover Defence Series Part 6: Formalising the deal (break fees and reverse break fees)

Australia's takeover laws and regulations limit aggressive defensive tactics commonly seen in other jurisdictions. ASX-listed companies also face additional restrictions during control transactions. However, Australian takeover targets are not without defences and strategic and advanced planning is essential to resist undervalued bids and maximize value.

In Part 5 of HopgoodGanim Lawyer’s Australian Takeover Defence Series, we considered some tactical insights for target boards in negotiating the exclusivity provisions of an Implementation Deed. In Part 6, we consider break fees and reverse break fees.

Break fee

A break fee or compensating fee is the consideration payable by a target to a bidder under an Implementation Deed if specified events occur which prevent a bid or scheme from proceeding or cause it to fail (i.e. the target directors fail to recommend acceptance or change their recommendation, a third party acquires a specified shareholding (between 10% and 50%), or a rival bid is successful).

Break fees are a consistent part of the Australian M&A landscape and appear in the vast majority of deals and while they are a lock-up device (an arrangement that encourages or facilitates a control transaction and potentially hinders another actual or potential control transaction), the Australian Takeovers Panel does not prima facie view them as unacceptable (subject to a number of caveats).

Generally speaking, a break fee should be capped at 1% of the equity value of the target¹ in order to not be unacceptable. In some cases, it may be appropriate for the 1% cap to be 1% of the enterprise value of the target (rather than the equity value) if the target is highly geared with a large amount of debt.

When negotiating a break fee, regard should be had to only agreeing to objective and reasonable triggers, for example:

1. a change in the recommendation of the directors (although the reason for the change may of course still be relevant – see below);
2. a competing transaction that successfully completes;
3. a material condition within the target’s control not being satisfied; or
4. a material breach within the target’s control.

Potentially unreasonable triggers for payment of the break fee could include matters such as:

1. a change of directors’ recommendation because of a breach of the Implementation Deed by the bidder or a condition outside the control of the target not being satisfied, or an expert opining that the transaction is not fair and reasonable; or
2. a so called “naked no vote” break fee, where the fee is payable to the bidder if the takeover / transaction is rejected by the target’s shareholders (although this is not without precedent).

Other exceptions to the payment of a break fee will generally be negotiated and included, such as where conditions otherwise become incapable of satisfaction, or the bidder is in material breach.

Reverse break fees

Reverse break fees are less common than break fees, but can serve as a real way for the target board to allocate risk in a transaction. Common triggers for reverse break fees include where the bidder is in material breach of the Implementation Deed or withdraws the offer.

If the bidder requires specific regulatory or shareholder approvals, a target may look to insist upon a reverse break fee should those approvals not be forthcoming to compensate its transaction costs in an unsuccessful transaction.

Reverse break fees are not subject to the same “1%” cap as break fees are, although ordinarily they seem to follow the amount that may be payable to the bidder by the target for the break fee. While this cap does not apply, the target should still adopt a reasonable approach as to the potential quantum of any reverse break fee, to ensure it does not offend what is called the doctrine of penalties (and thereby be unenforceable).

In Part 7 of our series, we will consider the conditions to the transaction and how best to navigate the negotiation of such conditions. 

Don't miss the next part of the Australian Takeover Defence series where we will consider the approaches that may be made by a bidder. Subscribe to our Corporate Advisory and Governance mailing list here.

¹. The aggregate of the value of all classes of equity securities issued by the target having regard to the value of the consideration under the bid, as at the date the bid is announced.