Saturday, August 9, 2014

Reverse Break Fees on Indian Transactions

Background; Concept

Internationally, in negotiated mergers & acquisitions (M&A) transactions, it is customary to incorporate various types of deal protection devices in order to guard against a scenario where the deal falls through before it is completed and parties have in the meanwhile invested significant time and incurred costs. Two such deal protection devices that operate almost conversely are break fees and reverse break fees. They are also known respectively as termination fees and reverse termination fees.

The background to these two specific deal protection devices as well as their description are set out below.[1] As for break fees:

Traditionally, break fees are arrangements between a potential bidder and target company, under which a fee is payable to the potential bidder if a specified event occurs which prevents the transaction from completing. Break fees are intended to operate as an incentive on the parties to ensure that the transaction goes ahead as the payment of the break fees would have lowered the value of the target company to the rival bidder.

As for reverse break fees:

The discussion thus far has been restricted to break fees which are agreed to be payable by the target. Are there situations where the bidder agrees to pay a break fee for terminating a transaction? In the US, the agreement by the bidder to pay such a fee is known as a reverse break fee. During the private equity boom, between 2005 to 2007, where sale processes were competitive and financing become more readily available, private equity sponsors excluded the financing condition and in its place, they guaranteed to provide a specified sum (normally approximately 3% a percentage of the deal value) if there is a breach of contract on the part of the acquisition vehicle (including failing to close due to the absence of financing). The reverse break fee was later evolved by parties to allow the bidder to have complete optionality in deciding to go ahead with the deal subject to payment of such fee.

Given the increasing importance of such deal protection devices, especially the reverse break fee, they have recently been subjected to academic analysis. In Transforming the Allocation of Deal Risk Through Reverse Termination Fees, Professor Afra Afsharipour conducts a detailed empirical study of reverse termination fees, and in The Validity of Deal Protection Devices under Anglo-American Law, Professor Wan Wai Yee examines the legal aspects and the enforceability of these relatively novel contractual arrangements.

Practice in India

Although such deal protection devices were not common on Indian deals, they are making their presence in more recent ones. On the outbound side, the Apollo-Cooper deal carried both a break fee as well as a reverse break fee, as discussed here. Although the deal fell through, it was mired in litigation and given the disputed circumstances in which the termination occurred, the question of payments remains unclear. The presence of deal protection devices in this deal is understandable given that the target was a U.S. company.

It appears that reverse break fees are also making their way into inbound deals.
I was recently informed (thanks to a young corporate lawyer in Mumbai) that the reverse break fee arrangement was present and invoked in the deal involving the failed acquisition of two Jaypee power plants by a consortium led by Abu Dhabi National Energy Co. PJSC, or Taqa. The deal size was Rs. 9,689 crore and the reverse break fee was around Rs. 54 crore ($9 million). Since the acquiring consortium withdrew from the deal, the reverse break fee would have become payable, subject of course to the detailed contractual arrangements between the parties. It is a different matter that soon thereafter the power plants become the subject matter of another acquisition deal.

Due to the possible risk of failure to close transactions, it is likely that such deal protection devices will become more common in India, both on inbound and outbound deals. Perhaps a market practice might have to develop regarding the types of arrangements, the quantum of amounts involved, and the like. More importantly, some attention may have to focus on the legal viability and enforceability of these arrangements under Indian law. Finally, if such arrangements become common in transactions involving public takeovers, it may be necessary to consider their impact under the SEBI Takeover Regulations.[2]

[1] The extracts are from Wan Wai Yee & Umakanth Varottil, Mergers and Acquisitions in Singapore: Law and Practice (Singapore: LexisNexis, 2013), Chap. 8.
[2] For example, the City Code in the UK as well as the Takeover Code in Singapore expressly stipulate the extent to which break fees or similar inducement arrangements are permissible.

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