By Maxime Mekki-Kaddache, Lucile Lam and Wanissa Nemsi, University of Montpellier, Centre du Droit de l'Entreprise, Program of Master 2 "Droit du Commerce International"
This Quick Overview examines how break-up fee provisions may limit risks associated with business negotiations in Europe.
Definition
A break-up fee is an indemnity that a party agrees to pay in the event that a proposed transaction is not completed.
Common considerations concerning break-up fee provisions
Why include a break-up fee provision in a contract?
A break-up fee provision provides for an incentive to close the deal for the party who has to pay the fees. Moreover, the provision limits uncertainty associated with damages in case of termination during negotiations.
Where are break-up fee provisions used?
Break-up fee provisions are used in letters of intent, preliminary agreements, as well as in option agreements. Break-up fees first appeared in the context of public takeovers and particularly in the agreements concluded by the shareholders of a target company when committing to tender their shares to a bidder company. They were generally included to conclude a takeover agreement, to increase the share capital, or in a public offering. They have now a wider scope of application and are also found in various agreements related to private companies as well as in industrial agreements or construction projects.
When should parties enter into break-up fee agreements?
The break-up fee provision is generally concluded at the earliest moment possible during the negotiations. In the context of a public offering, it may also be added during the course of the bidding process.
Who pays the break-up fees?
Usually, the beneficiary of the offer of the option or of any pre-contractual commitment has to pay the break-up fees. However, with the growing competition between investment funds participating in public offerings, the one who makes the offer occasionally has to pay the break-up fees. The fees are then called "reverse break-up fees." In case of a public offering, the target company sometimes agrees to pay break-up fees when the board of directors decides to accept a competing offer. Mutual break-up fees are also possible (as seen in the NYSE / Euronext transaction for example), but they seem rather rare.
What is the triggering event of break-up fees?
Parties can agree upon various events as being the triggering event for the payment of the break-up fees. They frequently include :
When must the fees be paid?
Parties may link the time payment to the occurrence of the triggering event : for example, at 08:00 a.m (at a selected time zone) of the business day immediately following the triggering event.
What is the amount of the fees?
Break-up fees are most of the time a determined amount. However, in rare occasions, they can be a determinable sum compensating the amount of fees due to banks or counsels or corresponding to a percentage of the difference between the original bid and a subsequent bid.
Specific issues concerning break-up fees under different European legal systems
Under the French legal system
1- The qualification of the clause
Under French law, break-up fee provisions can be considered differently depending upon their purpose. This qualification will lead to the application of different rules, including the risks linked to them.
If the aim of the break-up fee provision is to allow one party to back out of the deal (by paying the fees) it will be regarded as a withdrawal clause ("clause de dédit"), which is enforced as written. The French Court of Appeal of Versailles dealt with this issue in a decision of December 21, 2006. In that case, the focus was on a compensation clause included in a public takeover bid allowing the shareholders of the target company to unilaterally untie themselves from their commitment to tender their shares to an initial bidder company by paying a compensation. The court analyzed it as a withdrawal clause rather than a penalty clause, as it permitted to withdraw by paying a compensation. As a consequence, there was no possibility for the judge to revise a withdrawal clause. Such clauses have nothing linked with the remedy of a damage, they are only the price of withdrawal.
If the aim of the clause is to sanction a party for backing out, then the clause will be regarded as a "penalty clause." This will allow the judge, under article 1152 of the French Civil code, to revise the clause if "it is manifestly excessive or insufficient." The drafting of the clause must match one qualification or the other. The main consideration will be whether the clause appears to be drafted in order to force the parties to conclude the deal, which will be considered as a penalty clause (French court of cassation, March 20, 1990), or to offer the possibility to back out for any reason by paying a sum of money, which will be considered as a withdrawal clause (French court of cassation, November 17, 1993).
From a tax point of view, the fees received by the beneficiary of the break-up fee provision shall not be taxed as non-commercial profits (under article 92 of the French taxation code) if they really compensate the damage suffered from the termination. The French Council of State confirmed this solution in two decisions of May 7, 2014 and September 26, 2014. However, if the fees refer to a service performed, they may be taxable (French Council of State, February 19, 2014).
2- The break-up fee provisions involving listed companies
Break-up fees were born in pre-contractual agreements for the sale of stocks of listed companies. When these kind of companies are involved, some specific issues are raised, especially concerning the amount of the fees. In practice, this amount is low compared to the global amount of the bid. It is usually lower than 2% because the parties do not want to neutralize the positive effect of an eventual overbid which is, under French law, at least 2% higher than the previous bid. This 2% threshold is set by article 232-7 of the General Regulation of the French financial markets regulator ("Autorité des Marchés Financiers") stating that "To be declared compliant, a competing public cash bid must be at least 2% higher than the price stated in the public cash bid." For example, in the takeover bid of Cameleon Software, the information notice outlines "the commitment of the Company to pay the Initiator a termination fee of:
- i) 750.000 euros if the Company recommends a competing offer which does not comply with the considerations of the AMF (the French Financial Markets Regulator) or, if the Company takes measures that can modify its content and, according to article 232-11 of the General Regulation of the AMF, allow the withdrawal of the offer;
- ii) 500.000 euros in case of a competing offer complying with the considerations of the AMF and subject to a notice of results published by the AMF confirming the success of the offer. The absence of a higher bid by the Initiator does not have any impact on the payment of such compensation." (French AMF Visa, November 13, 2013, n°13-606)
Under the English legal system
The practice of break-up fees spread to the United Kingdom in the late 90s. In order to regulate such provisions, the Panel on Takeovers and Mergers issued the Statement 1999/10 which dispositions can be found in the "Takeover Code." Rule 21.2 of the Takeover Code provides that:
- Without the consent of the Panel, the offeree company may not enter into any offer-related arrangement with the offeror during an offer period or when an offer is reasonably in contemplation;
- An offer-related arrangement means any agreement, arrangement or commitment in connection with an offer, including any inducement fee arrangement or other arrangement having a similar or comparable financial or economic effect.
- Regarding a competing offeror which has announced a firm intention to make an offer, the Panel will normally consent to the offeree entering into an inducement fee arrangement with a competing offeror provided that the value of the inducement fee is no more than 1% of the value of the offeree company.
Conclusion
When exporting the break-up fee provisions to other areas of law, drafters must pay attention to the limitations existing in some sectors Thus article 232-7 of the General Regulation of the AMF will not be relevant in other areas such as industrial agreements or construction projects. It is interesting to export legal instruments but, the speciality of the context of each area must be taken into consideration.
ADDITIONAL RESOURCES
- La convention de "break-up fee," by Olivier Paulhan http://www.journaldunet.com/juridique/juridique020430.shtml
- Break-up Fees - Picking Your Number http://www.kirkland.com/siteFiles/Publications/MAUpdate_090612.pdf
- Alain Pietrancosta (Professeur à l'Université Paris I Panthéon-Sorbonne), Break-up fees et offres publiques : une pratique en voie de consécration?, RTDF 2008/2, p. 22
- Cour d'appel de Versailles, December 21, 2006, SA ACCOR Casinos c/ Der Krikorian, Revue Droit des Sociétés n°6, June 2007, n°119, note Thierry Bonneau "Clause d'indemnisation d'un engagement d'apport"
- Drafting International Contracts: An analysis of contract clauses, by Marcel Fontaine and Filip de Ly, Leiden, Boston, M.Nijhoff Pub., 2009