In brief

  • Public deal making in the United States over the past year has seen the refinement of methods of the allocation of completion risk.  
  • These include higher reverse break fees where the acquirer withdraws for non-satisfaction of a financing condition, and targets and sellers being given an ability to specifically enforce financing commitments.  
  • These have been used not only in private equity acquisitions but also in leveraged acquisitions by trade buyers.  

In the United States, the past year was characterised by sharply reduced merger and acquisition activity, and deal making in the shadow of significant transactions, such as the Hexion-Huntsman and Dow Chemical-Rohm & Haas mergers, in which the acquirers sought to withdraw from announced deals.

These market conditions have led to the use of increasingly sophisticated methods of allocating completion risk in the United States.

Reverse break fees

Even before the credit crunch, private equity bidders had included financing conditions in acquisition agreements, allowing them to withdraw usually on payment of a reverse break fee in the order of 3% of the acquisition price if financing was unavailable. In 2008, similar structures spread to trade buyers whose ability to complete their acquisitions was dependent on external financing.

A number of cases in which acquirers relied on such conditions to withdraw from, or renegotiate agreed transactions, demonstrated the ease with which financing outs could be used by buyers, and the limited disincentive effect of a 3% reverse break fee—see, for example, the Brocade-Foundry merger, which went ahead following a financing failure with a reduced offer price.

2009 and 2010 have seen a number of refinements designed to address these concerns:

  • In the Pfizer-Wyeth merger agreement, the financing condition was limited so that Pfizer was only entitled to rely on it to withdraw where financing was unavailable because Pfizer had failed to receive a specified credit rating or suffered a material adverse change. Also, if it withdrew in reliance on the financing condition, Pfizer would have to pay a reverse break fee equal to about 6.7% of the enterprise value of the transaction.  
  • More recently, in the MSCI-Risk Metrics merger, as well as agreeing a break fee equal to about 6.5% of the enterprise value of the target, the merger agreement provided detailed terms regulating the conduct by MCSI of negotiations with financiers.  

By way of contrast, in Australia, although reverse break fees appeared in roughly a quarter of negotiated public acquisitions in 2009, most were in the order of 1% and were triggered by termination for breach of the relevant merger agreement rather than non-satisfaction of conditions.

Specific enforcement of financing commitments

As competition for deals increased during the early 2000s, private equity firms sought to give targets and sellers comfort as to the financial backing of their acquisition vehicles by making them third party beneficiaries (or otherwise giving them rights to specifically enforce) the acquisition vehicle’s equity and debt commitments—see, for example, Apax Partners-Bankrate, Apollo-ParallelPetroleum and Apollo-Cedar Fair. In this way, if a financier refused to agree on longform financing documentation or to provide funding, the seller or target would have the ability to enforce the financier’s obligations under the financier’s commitment letter.

Trade buyers in leveraged acquisitions have increasingly adopted similar arrangements in 2009 to deal with the increased uncertainty of funding—see, for example, the specific enforcement undertakings in the Pfizer-Wyeth Agreement and Plan of Merger.

Relevance in the Australian context

Although inclusion of financing conditions in bids and schemes is permitted in Australia, they are not currently common in public transactions. Nevertheless, the techniques developed in the US to deal with financing conditions provide potentially useful methods for allocating completion risks in relation to:

  • financing conditions in negotiated private acquisitions, where financing conditions are more common, and  
  • non-satisfaction of other types of conditions to which public takeover bids and schemes are subject.