Paying to Break Up: The Metamorphosis of Reverse Termination Fees

Abstract

Despite our giving lip service to the binding nature of contracts, every law student learns that there are numerous possible “outs” or “walk away rights” associated with any contract. This Article examines one particular walk away right – the reverse termination fee (RTF) – in one particular category of acquisition transactions – strategic transactions. In sophisticated acquisitions involving public companies, the risk that one party may walk away from the transaction is particularly high because there is generally an interim period between the signing of the agreement and the completion of the acquisition. Accordingly, acquisition agreements are peppered with various provisions designed to mitigate, allocate or otherwise address this deal risk. Allocation of deal risk is a vital component of deals where millions, if not billions, of dollars are at stake for buyers and sellers, as well as their shareholders and stakeholders. One of the primary ways of dealing with the risk that one party may abandon the transaction is through termination fee provisions. Typically, public company acquisition agreements provide for the seller to pay the buyer a standard termination fee in the event that the seller does not complete the transaction due to specific triggers, commonly involving situations where a third-party bidder emerges for the seller. In an increasing number of transactions, acquisition agreements provide for what is often referred to as a reverse termination fee, i.e., a payment from the buyer to the seller in the event the buyer cannot or does not complete the acquisition as specified in the agreement. While for several years there have been anecdotal reports of an increasing use of RTFs, this Article’s empirical study confirms that belief and examines why – despite repeated calls about the problematic nature of RTFs – such provisions are on the rise. Scholars and practitioners have analyzed standard termination fees in numerous articles, RTFs, on the other hand, have received minimal attention despite their growing popularity. An analysis of RTF provisions is particularly timely. In part due to the current financial crisis, such fees and their role as an exclusive remedy in acquisition agreements have been at the center of debate among parties in broken deals and the subject of heated litigation in the Delaware courts. This Article presents the first detailed study in legal literature of the use of RTFs to allocate deal risk in strategic transactions. This Article uses original data collected from an empirical study of strategic acquisition agreements involving public companies in the United States announced during two separate periods, January 1, 2003 through December 31, 2004, and January 1, 2008 through June 30, 2009. The analysis undertaken in this Article reveals three important findings about RTFs. First, parties to acquisition agreements are increasingly using RTF provisions. Second, there is a shift in the contractual triggers that give rise to RTFs. This shift has given buyers greater flexibility to walk away from transactions. And third, this shift may prove problematic for sellers and buyers.