Almost every acquisition agreement involving the acquisition of a public company will include a provision whereby the board of directors of the target company agrees to stop soliciting competing bids or stop having any discussions with any other party who might be interested in a making a competing bid. This is generally known as the “no-shop” clause. However, the directors of the target company have certain fiduciary duties that they must comply with. Directors must act honestly, in good faith, and with a view to the best interests of the company, which in the context of an acquisition includes getting the company’s shareholders the most favourable deal. Hence, the “fiduciary out” clause was born.
A “fiduciary out” clause is the exception to a “no-shop” clause. A “fiduciary out” clause allows the board of directors of a target company to take certain actions, which includes terminating the incumbent transaction, if the failure to do so would be inconsistent with its fiduciary duties to the company and its shareholders. A typical “fiduciary out” clause gives the board of directors of a target company the ability to consider, and if applicable accept, an unsolicited competing bid that the board has determined is more favourable than the incumbent transaction. This type of competing bid is known as a “superior proposal”.
The “fiduciary out” clause is typically limited to specific circumstances, and its terms and conditions are generally tied to the negotiations regarding the terms and conditions of the “no-shop” clause and support agreements.
Given the limited nature of the “fiduciary out” clause, what constitutes a “superior proposal” is often also a highly negotiated matter. Generally, a “superior proposal” will require the board of directors of a target company to conclude certain matters regarding the competing bid including that the competing bid (i) is reasonably capable of being completed without undue delay (taking into account financial, legal, regulatory and other relevant factors), and (ii) is not subject to any financing condition or any due diligence condition. The board of directors of the target company must conclude, in its good faith judgment and after consulting with external legal and financial advisors, that the competing bid is more favourable, from a financial point of view, to its shareholders when compared to the originally proposed transaction.
Before the board of directors of the target company can exercise its “fiduciary out”, the acquisition agreement will generally require that it give the incumbent buyer a right to match the competing bid or amend its offer to provide for terms more favourable than the competing bid. If the competing bid is not matched or exceeded, and the board of directors of a target company determines that the competing bid is, in fact, a “superior proposal”, it may exercise its rights under the “fiduciary out” clause and terminate the incumbent transaction. Such termination is usually linked to a break fee or termination fee payable to the incumbent buyer.
While a buyer wants certainty that the transaction it has proposed and negotiated with the target company will be completed even if a competing bid is proposed to the target company by another buyer, the board of directors of a target company wants to ensure that it can appropriately execute its fiduciary duties. A “fiduciary out” clause is one of the items in the arsenal available to the board of directors of a target company to permit an exercise of its fiduciary duties and to maximize shareholder value.