|Urs Kägi||Daniel Küpfer|
In public M&A deals, bidding and target companies often agree on payments in the event that the deal cannot close. Payments from the target to the bidder are known as (direct) break fees. Reverse break fees are payments from the bidder to the target. Both types of fee serve to protect the deal and to control parties' behaviour.
Reverse break fees can compensate the target if the deal is not carried out because of issues that are either the bidder's responsibility (such as the lack of approval of its shareholders), or are outside of both parties' control (such as the refusal of regulators to grant merger approval). Conversely, a reverse break fee, particularly if it is designed as a walk-away right, can be seen as the price for the bidder's option not to complete the transaction. Compared to (direct) break fees, reverse break fees are typically significantly higher, and because they do not affect competition between bidders, are generally less heavily regulated.
Originating in US private equity deals, break fees and reverse break fees have become the market standard in public M&A deals in many countries. US market standard reverse break fees are between three and six percent, depending on the trigger event. Especially for failure of antitrust approvals, reverse break fees can climb to 40% of the transaction value. In absolute terms, the largest reverse break fee ever agreed was, to our knowledge, $10 billion after Verizon Communications acquired Vodafone's 45% interest in Verizon Wireless.
Swiss public M&A
In Switzerland, break fees are more common than reverse break fees. In the past 16 years, the median break fee in public M&A deals was equal to 0.66% of the transaction value. No break fee exceeded CHF 5 million (approximately $5.1 million). The reason for these comparatively small figures is that the Swiss Takeover Board only accepts fees that correspond to the bidder's actual costs. This year, it reduced a $1.5 billion break fee, which Syngenta would have had to pay to ChemChina, to $848 million (1.92% of the transaction value). This is the largest break fee to date in Switzerland but still ranks at the bottom of the global market practice. Data on reverse break fees is scarce, although they are becoming a more common feature of deals. ChemChina, for example, would have to pay a $3 billion reverse break fee (seven percent) if the deal does not go through.
Challenges for board members
Involving Swiss bidding companies in international M&A transactions might expose their board members to challenges. As part of their strategic duties, Swiss board members must scout for business opportunities and present them to shareholders for a vote in the event of a merger or if the acquisition is equity financed.
Reverse break fees may be an essential element to create these opportunities for the general meeting to vote on. This is because the target company may not otherwise be willing to enter into the necessary transaction agreements, and only the board can negotiate a deal, even where shareholders' approval is required.
However, under Swiss law, where shareholders' approval is required, the board may not force shareholders into accepting a transaction by agreeing to a high reverse break fee. In this situation, the board may not agree to the fee unless it considers such a promise to be a necessity and a risk worth taking under the circumstances given the overall advantages of the envisaged transaction, with no better negotiations being possible. Furthermore, reverse break fees should not seriously interfere with a company's financial soundness, as this could be considered an ultra vires act. In other words, the board must feel confident that the agreed fee is in the company's best interests.
The board should carefully decide on this, i.e., following a diligent review process based upon adequate information and without conflicts of interests. Unlike for direct break fees, Swiss tender offer rules do not limit or apply to such reverse break fees. Therefore, they do not protect the board members. Obtaining external advice or a legal opinion from renowned experts can, however, help to increase their level of comfort.
Business judgement rule
Swiss corporate law gives the board considerable discretion in its business decision-making. Since 2012, the Supreme Court has acknowledged the so-called business judgement rule as the standard for determining whether a board decision is within its discretion. If the business decision was made free of conflicts of interest and following a diligent review process based on adequate information, the business judgement rule provides that the merits of the board's decision can only be restrictedly reviewed by courts.
Another increase of the amounts of reverse break fees is on the horizon. This will further challenge the decision-making in Swiss companies' boards. As a consequence, the structure of reverse break fees will become more sophisticated. This can be achieved by negotiating different triggers and multi-tier fees with varying fee amounts. Another idea is to increase the fee depending on the duration of the respective approval proceedings.
Urs Kägi and Daniel Küpfer