Reverse break fees agreed in two recent transactions reflect a changing appreciation in the Australian market about their importance and usefulness. In this article, we take a look at the transactions and ask how targets should go about determining an appropriate size for the fee.
- Reverse break fees are fees paid by bidders to target companies when M&A transactions fail due to bidder-related issues.
- The quantum and triggers for reverse break fees have been a point of contention in Australia, but recent transactions show a long-awaited change in approach.
- The US$375 million reverse break fee in the Newcrest transaction is one of the largest (if not the largest) ever to be agreed in Australia.
What is a reverse break fee?
In an M&A transaction, a reverse break fee is a fee payable by the bidder to the target company in circumstances where the transaction fails due to a matter relating to the bidder. It effects an allocation of risk between the target and the bidder.
Typical triggers include material breach of the transaction agreement by the bidder, failure by the bidder to obtain regulatory approval (such as competition or foreign investment clearance) and failure by the bidder to obtain shareholder approval.
Reverse break fees serve two purposes. First, they compensate the target for the time and resources wasted in pursuing a transaction that ultimately does not proceed due to reasons within the bidder's control or influence. Second, they encourage the bidder to try hard to comply with its obligations to complete the transaction, thereby acting as a form of deal protection for the target.
A reverse break fee is usually agreed in exchange for the target agreeing not to sue the bidder for damages under the transaction agreement. In that sense, it can act as liquidated damages.
This is usually advantageous to the target as it may find it difficult to quantify its loss. However, it can also be detrimental because the reverse break fee usually acts as a cap on the bidder's liability, potentially limiting the target's recoverable loss to less than its actual loss.
The question of quantum
Reverse break fees have appeared in M&A transactions for many years, though their popularity has increased over the last 5-10 years. According to the HSF M&A Report for FY22, 58% of public company transactions provided for a possible reverse break fee.
One point of contention has been the quantum of the fee. Unlike a company break fee payable by the target to the bidder, reverse break fees are not capped at 1% of the target's equity value according to Takeovers Panel guidance. That is because they do not affect the likelihood of a rival bidder emerging for the target.
In the US, reverse break fees are typically twice the company break fee. That is meant to reflect the additional risk the target carries if the transaction does not complete. Given that break fees in the US are often in the range 3-4%, reverse break fees in the US may be as much as 6-8% of equity value.
Australian practice has generally not followed suit. Most reverse break fees have been the same as the company break fee, that is, 1%. The overriding principle seems to be a desire for reciprocity. Target boards have usually been willing to accept such a low fee when confronted by a bidder who is adamant that it will not agree to a higher fee and who can easily point to market practice.
That approach ignores the fact that break fees and reverse break fees serve different functions and should be analysed differently. While break fees may deter rival bidders and potentially be anticompetitive (as the rival bidder would ultimately bear the cost if successful), reverse break fees do not have this effect. If a reverse break fee is not a meaningful amount, it is akin to an option fee for the bidder if they choose to breach the transaction agreement and walk away from the deal (particularly given the fee is usually the exclusive remedy).
The question of triggers
Apart from a common trigger that the reverse break fee will be payable if the transaction is terminated due to material breach by the bidder, further triggers have been limited.
Bidders have usually resisted taking on the risk of regulatory failure. So, if the transaction is conditional on a regulatory approval, which is not obtained, the bidder will not be liable to pay the reverse break fee (unless it has breached its obligation to pursue seeking the approval in good faith).
In fact, bidders have rarely accepted that a reverse break fee would be payable for anything outside its control (such as failure to obtain bidder shareholder approval, where relevant).
Two recent transactions (Newcrest/Newmont and OZ Minerals/BHP) show a different approach.
The reverse break fee agreed by Newcrest and Newmont in their recently announced transaction shows a new approach to reverse break fees.
A reverse break fee of US$375 million is payable by Newmont if its board changes its recommendation that Newmont shareholders vote in favour of the transaction. That approval is required under NYSE requirements. This fee is equal to 2.2% of Newcrest's equity value on announcement of the transaction. It is 2.2x the company break fee.
The fee is equivalent to 1% of Newmont's equity value on announcement of the transaction. It is intended to be a meaningful sum, which would ensure that the Newmont board did not change its recommendation lightly. In that way, it adds to deal certainty for Newcrest shareholders.
As far as we are aware, in dollar terms, this is the largest reverse break fee ever in an Australian public M&A deal.
There is also a reverse break fee payable if, despite the board not changing its recommendation, Newmont shareholders vote against the transaction. In that event, Newmont must pay Newcrest’s out of pocket expenses for the transaction. This is known as a ‘naked no vote fee’. A similar trigger was included in the 2021 Afterpay/Square transaction.
In this transaction, BHP agreed to pay a reverse break fee to OZ Minerals if it failed to obtain certain regulatory approvals required for the transaction, namely Brazilian and Vietnamese competition approvals and any other government approvals the parties agreed were necessary. The reverse break fee was $95 million or 1% of the equity value of the transaction.
This approach departs from usual practice, but presumably was required by the OZ Minerals board due to specific risks of gaining the approvals.
Reverse break fee practice continues to evolve in Australia. We regard the approaches in the Newcrest/Newmont and OZ Minerals/BHP transactions as reflecting a more mature approach to the issue and which show that reverse break fees can be tailored to the specifics of the transaction.
Herbert Smith Freehills are acting for Newcrest in relation to the proposed acquisition by Newmont.