Reverse Breakup Fees as a Remedy for Failed Financing in M&A Transactions

September 29, 2016

A reverse breakup fee is a payment that buyer makes to seller in the event that buyer fails to close the transaction in any of a mutually agreed set of circumstances. The advantages of incorporating such a fee in the purchase agreement are that it

  • minimizes and quantifies buyer’s exposure under the purchase agreement;
  • largely eliminates the need for costly litigation; and
  • limits seller’s recourse to other remedies, such as specific performance, that may inhibit buyer’s ability to extricate itself from a difficult situation and move on.

Reverse breakup fees can be drafted so that they apply either in a limited set of circumstances or more broadly to any breach of the purchase agreement by the buyer that results in the agreement’s termination. In the former case, the limited set of circumstances would often include buyer’s failure to obtain regulatory approval, failure to obtain the consent of its own shareholders and/or failure to obtain sufficient financing. It is also possible to structure a two-tier reverse breakup fee so that one fee relates to the termination of the agreement as a result of narrow set of circumstances (such as a financing failure) and another (usually higher) fee to a termination of the agreement for any other breach of the purchase agreement by buyer.

This article will focus on drafting considerations and strategies related to the negotiation of a reverse breakup fee as a remedy for buyer’s failure to obtain sufficient financing. A reverse breakup fee of this type is an increasingly popular alternative to the most common alternative method of managing the risk of failed financing – a condition precedent in the purchase agreement that the buyer’s obligation to close is subject to its receiving debt financing sufficient to complete the transaction. Many sellers are unwilling to agree to this approach.

Issues to consider

a) The Trigger Event Underlying the Payment of the Reverse Breakup Fee

A financing reverse breakup fee is payable upon the termination of the purchase agreement by reason of buyer’s failure to obtain financing by a certain outside date. Both parties will need to consider who can terminate the agreement for failed financing and under what circumstances. Buyer will typically not want seller to have the right to terminate the agreement if (i) all the conditions in favour of buyer are not met (other than any financing related ones), or (ii) seller caused the financing failure, for example, by breaching the purchase agreement or failing to cooperate with buyer’s efforts to obtain financing. Seller, on the other hand, may not want buyer to terminate the agreement if buyer (i) willfully caused the financing failure or did not use commercially reasonable efforts to obtain the financing, (ii) did not first try to enforce the lender’s obligations under the financing commitment documents, or (iii) did not try to obtain alternate financing.

From a drafting perspective, when considering each of these issues, the parties will typically negotiate covenants regarding buyer’s efforts to comply with its own obligations under the financing commitment letters and to enforce the lender’s obligations under the financing commitment letters and covenants regarding seller’s efforts to cooperate with buyer.

b) Interaction Between the Fee and Other Remedies

When negotiating a reverse breakup fee that is a remedy for buyer’s failure to obtain financing, buyers and sellers must consider the availability of other remedies for seller both before and after the payment of the fee. Buyer, on the one hand, will want the reverse breakup fee to act as seller’s sole and exclusive remedy for buyer’s failure to obtain the financing, barring all other remedies including specific performance and damages. Seller, on the other hand, will want the reverse breakup fee to have a very limited impact on its ability to pursue other remedies, including specific performance and damages. More specifically, sellers will want to maintain their right to seek damages for breaches of the purchase agreement by buyer that existed prior to the failure to obtain financing, and for breaches of a buyer’s covenant to use efforts to obtain the financing. Sellers may also want to retain their right to seek specific performance before terminating the agreement and taking payment of the reverse breakup fee. While in practice it would be difficult for the seller to obtain specific performance, the right to do so can give the seller some useful bargaining leverage.

c) Amount of the Fee

In general, the amount of a reverse breakup fee that is payable only in the event of financing failure is lower than a reverse breakup fee that is payable in the event of any breach by buyer. In terms of financing reverse breakup fees, sellers will want the fee, inter alia, to incentivize a buyer to make necessary efforts to obtain financing and to adequately compensate seller for damages caused by a failed deal. Sellers may, consequently, ask for a higher fee where payment also caps damages for intentional breaches of the agreement.

d) Guarantees

Where buyer is a shell company, sellers may ask that reverse breakup fee be guaranteed by the parent company of buyer or, in the case of a private equity buyer, its sponsor. It is important to remember that some types of entities are prohibited from giving such guarantees, in which case an indemnity may be the solution.

The buyer’s guarantor and lenders may also benefit from the protection offered by a financing reverse breakup fee. In particular, they may ask that the reverse breakup fee payable by buyer to seller be seller’s sole and exclusive remedy against them as well. A clause that provides lenders with the benefit of the protection offered by a financing reverse breakup fee is part of what is known as a “Xerox provision”. In the United States, this provision has become increasingly common as a result of tort-based lawsuits filed by sellers against lenders in connection with acquisitions that died as a result of a failed financing.

Conclusion

When negotiating a reverse breakup fee that is intended as a remedy for buyer’s failure to obtain financing, buyers and sellers will need to consider (i) who can terminate the agreement for a failed financing and under what circumstances, (ii) the interaction between the reverse breakup fee and other remedies that may be available to seller, (iii) the amount of the fee, and (iv) where buyer is a shell company, the need for a guarantee by buyer’s parent or sponsor.

Buyers and sellers should bear in mind that a financing reverse breakup fee and its implications in terms of remedies and termination rights will vary from transaction to transaction, depending on such factors as the respective needs and bargaining power of the parties and  any requests from lenders and sponsors for protection.

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