Merger reverse break fees are here to stay

Author: Olly Jackson | Published: 12 Apr 2018
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Despite being relatively rare, the continued presence of reverse break fees in deals underlines the seller-friendly conditions in the market currently. It was expected this kind of deal protection would decrease following the ban of break fees in the UK in 2011 though this has not happened.

Glass breakingAs the M&A market becomes more competitive, reverse break fees – where the buyer has to pay the seller a fee for not going through with the deal or breaching its covenants - could become more common on the bidder side as an additional incentive to help sellers over the line to exclusivity.

Carl Bradshaw, M&A partner at Kirkland & Ellis, said that he has seen an increased incidence of reverse break fees because of the strong seller-favourable conditions, driving tougher terms around deal certainty.

"A general trend of increased merger control complexity to deals has also prompted them to be considered more often, sometimes in exchange for reducing 'hell-or-high-water’ purchaser covenants to divest existing businesses," he said.

Break fees were banned in the UK seven years ago because they were blamed for deterring additional offers as targets were more likely to focus on reaching a deal with first bidders. However many market participants have claimed since then that the ban could damage competition in takeovers and result in poorer deals for target shareholders. This could lead to fewer competing bids for companies and less value for bidders.

"Competition is becoming more challenging, putting more pressure on buyers to allocate more risk onto themselves"

Of course, the ban on break fees cannot be used as the sole reason for the extraordinary high valuations currently but it could nonetheless exacerbate the situation. Without the presence of break fees, their counterpart for buyers were expected to become less prevalent because the seller is reluctant to accept them in a deal without having the equivalent term in their favour. But due to the current competitiveness of the market, they could be seen in an increasing number of transactions.

A partner at a global private equity firm said reverse break fees remain a very small portion of overall deals – about one in 10 – but they are starting to gain traction.

"Competition for deals is becoming more challenging and is putting more pressure on buyers to accommodate the seller and allocate more risk onto themselves," he said.

Again, this only goes to underline the dominance of sellers in the market – in that they are able to call the shots and dictate more favourable terms into deals. This does not look likely to change soon. With private equity expected to better last year’s record year ($621 billion raised), terms are likely to become even more seller-friendly. To get sellers comfortable with execution risk, Chinese buyers have even been resorting to cash deposits or letters of credit upon signing the deal. The European and US sectors could see more seller-friendly terms soon.    


  •           Reverse break fees are becoming more common due to the intense competition in the M&A sector and this is expected to increase for this year;
  •           The use of reverse break fees was expected to decline after the UK ban on break fees in 2011, but they have remained static. With the influx of regulation this year, this is also expected to boost them;
  •           The UK Government’s plans to increase their merger intervention powers could also see an increase in their usage.

But reverse break fees also play an important role in overcoming regulatory hurdles. Herbert Smith Freehills partner Mark Bardell said that they are becoming more common now because there are more hurdles for businesses to navigate. For certain sectors subject to more stringent regulation like aerospace or pharmaceuticals for instance, reverse break fees are more common as targets look for greater assurance.

The UK government’s robust powers to intervene in mergers on national security grounds may potentially result in an increase in deal protection, including various types of risk-associated fees. It proposed lowering the threshold where ministers can scrutinise business investment to £1 million ($1.42 million approximately) in October. Previously, ministers could only intervene in mergers involving companies who had a UK turnover of over £70 million or where the share of UK supply increases to 25% or over. This broadens the scope of investigation hugely. The UK plans to implement a more extensive regime for screening transactions for national security issues in the long term that will further increase the scope for intervention.

According to Koregate Capital managing partner Edward Belsey, the expectation was that reverse break fees would fall away but that hasn’t been the case. Unlike corporates, deals involving private equity firms are extremely unlikely to include a reverse break fee. They are most common in larger deals with a tender process and often where there is more competition for buyers. Belsey anticipates that they will continue to appear in these deals for the foreseeable future.

"The trend will be driven by the market and I don’t see them falling away," he said. With more regulation on the horizon, the prospect of them falling away becomes even less likely.

Ashurst M&A partner Tom Mercer said that deals are currently subject to a lot of regulatory scrutiny, particularly cross-border deals. The influx of regulation after the financial crisis has boosted the likelihood of targets looking for more assurances. Their inclusion depends largely on the identity of the bidder, but the target will have to justify why a reverse break fee is needed.

"If the acquirer is a private entity there is unlikely to be any regulatory issues relating to their use – but by the same token it is generally accepted that private equity will not pay a reverse break fee," said Mercer.

But for corporates it is likely that there will be an increase in their use in spite of the ban on break fees, showing just how dominant sellers are in the market currently.

See also

GDPR will impact US M&A

Brexit effect impacts UK M&A

Cfius tightens grip over foreign M&A