M&A in 2012: Reverse Break-Up Fees. Thursday, June 21, :00 p.m. 1:00 p.m. (CDT)

Transcription

1 M&A in 2012: Reverse Break-Up Fees Thursday, June 21, :00 p.m. 1:00 p.m. (CDT)

2 Speakers Glen J. Hettinger Partner Dallas, TX Scarlet McNellie Senior Associate Dallas, TX

3 Continuing Education Information If you are requesting CLE credit for this presentation, please complete the evaluation that Fulbright will send via tomorrow. If you are listening to a recording of this web seminar, most state bar organizations will only allow you to claim self-study CLE. Please refer to your state s CLE rules. If you have any questions regarding CLE approval of this course, please contact your bar administrator. If you should have any questions regarding credit, please Terra Worshek at tworshek@fulbright.com. 3

4 Administrative Information Today s program will be conducted in a listen-only mode. To ask an online question at any time throughout the program, simply click on the question mark icon. We will try to answer your question during the session if time permits. Everything we say today is opinion and hypothetical only. We are not dispensing legal advice, and listening does not establish an attorney-client relationship. This discussion is off the record. Anything we say cannot be quoted without our prior express written permission. 4

5 M&A Contracts as Risk Allocation Vehicles I ll gladly pay you Tuesday for a hamburger today! Risks: Business deterioration Business bonanza Financing markets or transaction Regulatory banking, insurance, anti-trust Factual premises Interim operations Fiduciary/stockholder second thoughts 5

6 Mechanisms to Allocate Risk Common Risk Allocators: Purchase price adjustment: fluctuation Earnout: risk of mispricing risk of working capital Representations and warranties: factual premises for the deal Covenants: interim operating risks Conditions to closing Indemnity: risk of breaches; subsequent discoveries 6

7 Today s Focus: Mechanisms to Allocate Risk Termination provisions Remedies Break-up fees Reverse break-up fees 7

8 The Deal Environment: Background for Understanding Types of Buyers: Financial Private equity buyers Pools of capital Use leverage Drive efficiencies into business Exit: Sale or IPO Liquidity event for investors 8

9 The Deal Environment: Background for Understanding Types of Buyers: Strategic Operate a business Synergies Complementary strategy Stock as currency May not need leverage even for cash deals May be competitor Convergence and borrowing 9

10 The Deal Environment: Background for Understanding Transparency: Studies commoditization? Perish the thought! Variety of tools multiplicity of structures, results, strategies Complexity: Multi-tiered analysis Complex variables Rapid evolution Demand for customized legal solutions 10

11 Basic Building Blocks of Remedies Specific Performance: Equitable: Injunctions are designed to remedy unique/nonmonetizable damages Delaware: Probably available because each business is unique Con Ed: New York law questions availability of injunctions for cash purchase 11

12 Basic Building Blocks of Remedies Classic Contract Damages: Difficult to measure: Lost premium Opportunity costs Difficulty of proof Third-party-beneficiary problems Uncertainty both for buyer and seller 12

13 Basic Building Blocks of Remedies Damage Modifiers to Classic Contract Damages: Caps Liquidated damages clauses Limitations for willful or intentional breaches? Break-up Fees: Traditional break-up fee Reverse break-up fee 13

14 Traditional Break-up Fees: Fiduciary Outs Payable by the seller to the buyer in the event that the seller terminates for better deal Seller terminates for more attractive competing offer Seller s board changes recommendation of transaction Seller s shareholders fail to approve the transaction Amount generally constrained by fiduciary duties of the seller s board Cannot coerce stockholder vote Cannot preclude competing bids 14

15 Traditional Break-up Fees: Rationale Consolation prize for buyer Defray the buyer s investment in time, out-of-pocket expenses, and opportunity Protect deal and limit stalking horse exposure Traditional break-up fees are limited in size due to Revlon duties to maximize shareholder value in a change of control transaction 15

16 Reverse Break-up Fees: Fundamentals Payable by the buyer to the seller in the event of the termination of the acquisition agreement Buyer breach Failure by buyer to obtain financing Regulatory failure Buyer s shareholders fail to approve the transaction Buyer option 16

17 Evolution of Reverse Break-up Fees Old deal protection 20% lock-up stock options Crown jewel options Revlon Duties Limits on Traditional Break-up Fees Not preclusive of new offer Not coercive of stockholder vote Market emerges 2.5% - 3.5% of deal value 17

18 Evolution of Reverse Break-up Fees Reverse Break-up Fees: Initially: mutual deal protection Use by private equity firms to protect the firm Adoption by strategic buyers to allocate risks New purposes changing the allocation of the deal risk through reverse break-up fees. As recently as , fairly uncommon to have reverse break-up fees in acquisition agreements. 18

19 Development of Reverse Break-up Fees Initially, reverse break-up fees matched standard break-up fees in percentage of the total value of the transaction. Reverse break-up fees have risen to better reflect the higher damages suffered by the seller when a deal is terminated (jilted seller). 19

20 Emerging Asymmetry of the Break-up Fees From , approximately 75% of M&A transactions, had reverse break-up fees equal in size to the standard termination fee In 2011, approximately 33% of M&A transactions had reverse break-up fees equal in size to the standard termination fee In 2011, approximately 60% of M&A transactions had reverse break-up fees higher than the seller s standard termination fee 20

21 Emerging Asymmetry of the Break-up Fees Revlon duties consideration Entrenchment concerns These fiduciary duties, imposed on seller, generally not applicable to buyer Shareholder approval risk to seller Perception of jilted seller Damages of seller considered higher 21

22 Summary M&A contracts focus on risk allocation Variety of tools are available to allocate risk Reverse break-up fees Not just for private equity buyers anymore Reverse Break-up Fees unshackled from 3% market 22

23 Basic Variations of Remedies: Overview Force closing: specific performance only Specific performance + damages Reverse break-up fee for buyer fiduciary termination rights Reverse break-up fee for regulatory/anti-trust failure Reverse break-up fee for financing failure Reverse break-up fee for buyer s breach Pure Options 23

24 Force Closing Specific Performance Only Most common remedy found in M&A deals Nearly always the remedy in deals that do not require debt financing, whether buyer is private equity or strategic Even when there is debt financing, strategic buyers may still offer specific performance as a remedy Private equity buyers will rarely offer specific performance 24

25 Specific Performance + Damages Where there is no reverse break-up fee, damages could be: Difficult to determine (seller s risk) High (buyer s risk) Variation: cap on monetary damages payable if awarded Variation: requirement that the seller first pursue specific performance Variation: damages only available if a court refuses to award specific performance Note: If court does not award specific performance, and there is a cap on damages, buyer has an option to acquire the company or to pay limited damages 25

26 Fiduciary Termination Rights The fiduciary termination right is the most common reverse break-up fee trigger Buyer pays the reverse break-up fee to terminate the deal when a bid has been presented to the buyer Buyer board changes its recommendation in connection with a competing offer for the buyer Buyer shareholder approval may be necessary to approve issuance of new shares to be used as consideration for the transaction (NYSE/Nasdaq rules) Buyer pays on stockholder rejection 26

27 Regulatory/Anti-Trust Triggers Payment of reverse break-up fee by buyer if regulatory authorities fail to approve the transaction Buyers could face hell or high water to close a transaction in the face of government opposition for anti-trust purposes p Required divestitures Capital requirements Allocates risk of regulatory disapproval to the buyer Use of the regulatory trigger increased in 2011 Variation: may include a valuable asset or IP license in the fee 27

28 Financing Triggers Buyer pays reverse break-up fee if financing is unavailable to the buyer to close the transaction Financing covenant Extent of buyer s obligation to obtain financing Reasonable best efforts standard Matching conditions in acquisition agreement with conditions in lending commitment letter More commonly used by private equity buyers in a typical leveraged buy-out 28

29 Buyer s Breach Trigger Buyer s representation and warranties breached Can act like a back-door fiduciary termination right or a back-door financing contingency I.e., allows buyers to terminate contract upon payment of the reverse break-up fee in the event that: Buyer does not have financing Buyer s shareholders have not approved the issuance of new shares 29

30 Buyer s Pure Option to Close Trigger Termination is triggered by the seller in the event that the buyer fails to close the transaction for any reason, including willful breaches Buyer pays py a reverse break-up fee Reverse break-up fee is the seller s exclusive remedy Functions as a cap on damages No right to equitable remedies Seller may have the right to terminate the agreement, but lack of access to specific performance with cap on monetary damages, effectively creates an option for the buyer 30

31 Structuring Remedies: Key Factors to Consider Does the deal depend on debt financing? Is there a key regulatory approval? Whose risk? Risk for willful breach Ability to tier the reverse break-up fee Strategic or private equity buyer? Damaged goods seller? Opportunity cost for seller? 31

32 Examples of Recent Reverse Break-up Fees Google/Motorola Mobility AT&T/T-Mobile Bi-Lo/Winn-Dixie Green Mountain Coffee Roasters/Diedrich Coffee 32

33 Trends Steady increase in use of reverse break-up fees. From 30% in 2009 to 41% in 2010 to 44% in 2011 Reverse break-up fees are more frequently set higher than the traditional break-up fee There has been a significant increase in the use of the pure option trigger Reverse break-up fees are on the rise also in strategic transactions 33

34 Drafting Considerations Sections in the acquisition agreement must be drafted carefully to prevent internal conflicts: Representations and covenants related to financing Closing conditions: financing, regulatory approvals Termination provisions: who has the right to terminate and in what circumstances Remedies section: specific performance (full or partial), break-up fees (standard or reverse) No third-party beneficiaries provision Closing conditions in the acquisition agreement should line up with financing commitment letters 34

35 Drafting Considerations: Specific Performance Provisions should allow seller to enforce specific performance under all circumstances Beware: entitled to seek Include separate remedies section thatt grants specific performance of all provisions No other provisions in the agreement should limit or conflict with the remedies section 35

36 Drafting Considerations: Buyer s Pure Option The reverse break-up fee must act as the cap on damages/exclusive remedy and leave the seller no other remedy to pursue Even applies to willful breaches of the agreement Explicitly state that equitable remedies and specific performance are not available Clarify that buyer is only required to pay the reverse break-up fee once, even if there are multiple triggers No recourse language 36

37 Drafting Considerations: Regulatory/Antitrust Triggers Reverse break-up fee payable for failure to obtain regulatory approval of the transaction The trigger in the agreement should be the failure to obtain regulatory approval by a certain date Buyer to consider the payment of the reverse breakup fee against a hell or high water provision Covenant regarding efforts that the buyer must undertake to obtain regulatory approval may be unappealing: Consider ramifications of such provisions with antitrust authorities 37

38 Drafting Considerations: Financing Trigger Reverse break-up fee payable for failure to obtain financing: What constitutes financing failure? Focus on financing covenant and level of buyer s obligation to obtain financing If financing is available but buyer chooses not to receive proceeds and close the transaction, will specific performance be available to the seller? Multi-tiered reverse break-up fee Lower fee if financing is unavailable Higher fee if financing is available but buyer breaches the agreement in some other way 38

39 Drafting Considerations for Lenders Xerox/ACS Agreement first use of provisions to limit remedies against buyers and lenders Xerox provisions provide: Reverse break-up fee as sole and exclusive remedy No recourse to lenders Exclusive venue usually New York Waiver of jury trial Amendment of key provisions requires lenders prior written consent Lenders as third party beneficiaries of any provision in the agreement drafted for their benefit 39

40 Drafting: Other Considerations Dealing with Complexity Provisions spread throughout agreement Complicated, non-intuitive cross referencing Remedies require a number of steps Build matrix Do not rely on studies or market Disclosure Is your deal an agreement or an option? 40

41 Questions Glen J. Hettinger Partner Dallas, TX Scarlet McNellie Senior Associate Dallas, TX

42 Continuing Education Information If you are requesting CLE credit for this presentation, please complete the evaluation that Fulbright will send via tomorrow. If you are viewing a recording of this web seminar, most state bar organizations will only allow you to claim selfstudy CLE. Please refer to your state s CLE rules. If you have any questions regarding CLE approval of this course, please contact your bar administrator. NY CLE Number If you should have any questions regarding credit, please Terra Worshek at tworshek@fulbright.com. 42

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