We were talking about break-up fees in mergers and acquisitions letters of intent in class today, a subject to which we'll return in a future assignment dealing with exclusive merger agreements (best efforts, no shops, etc....) and still another dealing with Revlon duties.
I got back from class to discover a new post by David Fox on the Harvard corporate governance forum on the subject of break-up fees:
During the course of negotiations of every public company deal, inevitably the conversation will turn to the amount of the breakup fee payable by a target company to a buyer if the deal is terminated under certain circumstances. Because U.S. corporate law generally requires a target company to retain the ability to consider post-signing superior proposals, a breakup fee is an important element of the suite of deal protection devices (including “no-shop” restrictions, matching rights, etc.) that an initial buyer implements to seek to protect its position as the favored suitor. ...
Unquestionably, precedent often informs the discussion, and there is a significant amount of statistical data to back up a general proposition that fees “usually” fall in the 3% to 4% range.
Speaking of precedent, I've always been rather fond of St. Jude Medical, Inc. v. Medtronic, Inc., 536 N.W.2d 24 (Minn. App. 1995):
In the corporate world, termination fees are a common and generally accepted method to “reimburse the prospective purchaser for expenditures incurred in pursuing the transaction.” Gray v. Zondervan Corp., 712 F.Supp. 1275, 1276-77 n. 1 (W.D.Mich.1988).
Cancellation fee provisions typically require the [seller] to pay the bidder a specified dollar amount. * * * [T]he fee ordinarily ranges from one to five percent of the proposed acquisition price. A cancellation fee reduces the risk of entering a negotiated merger by guaranteeing the initial bidder reimbursement for the out of pocket costs associated with making the offer and, in some instances, for the bidder's lost time and opportunities. Accordingly, they are increasingly common in negotiated acquisitions.
Stephen M. Bainbridge, Exclusive Merger Agreements and Lock-Ups in Negotiated Corporate Acquisitions, 75 Minn.L.Rev. 239, 246 (1990).
As Fox notes, however:
While the statistical data have some baseline value, not least because of their consistency over long periods of time, dealmakers should be cognizant that the Delaware courts have resisted providing a bright line or range test for reasonableness of breakup fees.
He continues with a very useful analysis of the key deal points in negotiating break up fees.