A series of public M&A transactions in Australia have recently been called off or renegotiated in light of a changing market and worsening economic conditions, highlighting the need for target companies to carefully consider and protect against deal termination risk.
- A number of schemes have been terminated or renegotiated recently, including Zip and Sezzle agreeing to terminate their proposed all-scrip merger with Zip paying Sezzle a US$11 million termination fee.
- Although a target’s options are limited if a bidder pulls a deal prior to it being formally signed, protections for the period after signing can be included in the implementation agreement.
- These include negotiating a significant reverse break fee, keeping specific performance available as a potential remedy, and ensuring an entity of substance stands behind the bid vehicle to satisfy any potential claims.
ZIP AND SEZZLE AGREE TO ABANDON MERGER
One of the highest profile Australian deals to fall through in the last few months was the proposed tie-up between buy now, pay later operators Zip and Sezzle. Zip and Sezzle announced an all-scrip merger in February pursuant to which Zip was to acquire Sezzle by way of a statutory merger under Delaware law (although both parties are listed on ASX, Sezzle is domiciled in Delaware). The transaction was subject to approval by Sezzle’s and Zip’s shareholders.
Following a deterioration in sentiment towards the buy now, pay later sector and a sustained decline in both companies’ share prices, Zip and Sezzle announced on 12 July 2022 that they had agreed to terminate the proposed merger. Zip’s ASX announcement put the decision down to ‘current macroeconomic and market conditions’. As part of the mutual termination, Zip agreed to pay Sezzle a US$11 million termination fee to cover Sezzle’s transaction costs. This compared to a reverse break fee of A$31.4 million (US$21.8 million) that could have been payable to Sezzle had the Zip Board changed its recommendation and advised Zip shareholders to vote against the deal (although it is not clear if the Zip Board would have been permitted to do this in the circumstances).
The termination of the Zip and Sezzle merger comes as other high profile transactions are encountering issues, including:
- in the US, Elon Musk seeking to terminate his proposed all cash acquisition of Twitter;
- Latitude and Humm agreeing to terminate the proposed combination of their consumer finance businesses;
- CVC Capital Partners ceasing merger discussions with Brambles;
- Aliro withdrawing its proposed all cash acquisition of Australian Unity Office Fund;
- IFM ceasing discussions in relation to a potential proposal to acquire Atlas Arteria; and
- Link and Dye & Durham renegotiating their scheme transaction.
There are some echoes of 2020 where the onset of COVID-19 led to a number of transactions being pulled or renegotiated, including EQT/Metlifecare, CML/ScotPac, Abano/BGH and Pioneer/Carlyle locally and LVMH’s bid for Tiffany overseas.
PROTECTING AGAINST TERMINATION RISK
There are a few steps that target companies can take to protect against a bidder walking away or seeking to re-trade in a falling market.
If a bidder decides to pull out of a potential deal before entering into an implementation agreement, the target’s options are usually limited. However, if the target and bidder sign a process agreement, a reverse break fee can be negotiated at that point (triggered by, for instance, the bidder failing to make a binding offer at or above a certain price).
Pre-deal reverse break fees are rare. A target’s chances of securing a pre-deal reverse break fee are higher where there are several competing bidders as it can be the price extracted for granting exclusivity. We have also encountered these where the bidder and the target have previously been in discussions that did not lead to a binding deal. That may cause the target to be unwilling to re-commence unless the bidder gives some more comfort that it is serious – once bitten, twice shy, as the saying goes.
A reverse break fee is more commonly agreed to at the time of signing the implementation agreement. In fact, these are now a feature in the majority of scheme transactions in Australia. The circumstances in which a reverse break fee will be payable usually include the bidder materially breaching the agreement, meaning it will be triggered if the bidder walks away from the deal without a legitimate reason.
For a reverse break free to provide a real disincentive to a bidder, it needs to be a substantial amount. Around 1% of transaction equity value is common in the Australian market, but this is not mandated by any policy or law, so there is no reason it could not be higher (unlike break fees, which are capped at 1% by Takeovers Panel guidance). At 1%, a reverse break fee can seem like an option fee that simply caps the downside for the bidder. For this reason, in the US, reverse break fees are often much higher than the company break fee, say between 2–6%. In the Twitter deal, for instance, the reverse break fee potentially payable by Elon Musk is 2.2%.
In the absence of a reverse break fee, a target’s monetary claims against a bidder who walks away without a clear right to do so will generally be limited to a contractual claim for damages. Importantly, the damages recoverable will equate to the financial loss suffered by the target company itself (usually just transaction costs), not the transaction premium lost by target shareholders. The approaches in the AWB/Agrium deal from 2010 and in the 2011 Eastern Star Gas/Santos deal, which required the bidder to compensate shareholders in the case of breach, do not seem to have been repeated.
An alternative to seeking payment of a reverse break fee or making a claim for damages is for the target to seek an order for specific performance. Specific performance, where the Court compels the buyer to complete the transaction, is a discretionary remedy, meaning the Court needs to be convinced it is appropriate in the circumstances. Traditionally, the main basis for ordering specific performance is that damages would be inadequate. This can be the case where the subject of the contract is unique (eg, land), where third party beneficiaries are unable to make a claim or where only nominal damages would be available.
Although Courts in the US have a history of ordering specific performance of merger agreements involving public companies (and that is what is playing out in the Musk/Twitter transaction), the remedy has not been thoroughly tested in the schemes context in Australia. Despite this, a target may wish to ensure the implementation agreement does not preclude them from seeking specific performance. Bidders will often try to include a sole remedy clause that limits the target’s remedies under the agreement to payment of the reverse break fee only.
On a more practical level, if a dispute does arise, it won’t matter what the target’s contractual rights are if the bid vehicle is not in a financial position to satisfy any Court order made against it. It will need to have the funds available to pay the reverse break fee, satisfy an order for damages or complete the acquisition. As most bid vehicles are set up as shell companies without any assets, thinking through a bidder’s ability to satisfy any order made against it is vital.
Ideally, all of the obligations of a special purpose bid vehicle would be guaranteed by an entity of substance. However, securing a complete guarantee is not always achievable, particularly if the bidder is a private equity firm rather than a corporate buyer. Assuming the bid price is good enough, a reasonable position for a target to accept in that situation may be for payment of the reverse break fee to be guaranteed while the private equity fund provides an equity commitment letter, enforceable by the target, in respect of the equity funding for the transaction. The terms of the equity commitment letter, including the circumstances in which it can be enforced and whether it covers any shortfall in debt financing, will need to be carefully negotiated. A target may also take some comfort from the identity of the bidder and the reputational risk that could arise from reneging on a deal without sufficient justification.
Ultimately, the best protection for a target company seeking to protect against termination risk in a falling market is to negotiate the most favourable implementation agreement it can, including all of the key protections highlighted above. This requires competitive tension, or a bidder will simply argue their proposed terms represent ‘market practice’ with reference to precedents. Even though Australia has an active M&A market, in the vast majority of transactions, there is usually only one bidder at the end of the day. That tends to make Australian implementation agreements favourable for bidders compared to overseas deal terms.