The Delaware Court of Chancery has denied a petition by United Rentals, Inc. (URI) for specific performance of a merger agreement between it and two acquisition vehicles (RAM Holdings, Inc. and RAM Acquisition Corp. (collectively, RAM)) controlled by private equity firm Cerberus Capital Management, L.P. The decision involves the interpretation of a merger agreement, but has also drawn attention to the use of reverse break fees in M&A transactions involving private equity firms. This provision is designed to limit a buyout fund’s exposure in the event of a failed deal and has evolved to give the fund a quasi-option to walk away from the deal upon payment of the agreed fee. To some extent, the market had been assuming that a private equity fund would not rely on a reverse break fee clause to refuse to close where the conditions to its deal had otherwise been satisfied, but this case will cause targets to reconsider the potential impact of this provision.

Background

Reverse break fees have become relatively common in recent transactions involving private equity buyers and have frequently been negotiated as exclusive remedies, as RAM argued was the case here. However, URI claimed that it had retained the right to specific performance (meaning RAM would have to complete the deal for the agreed price), and the final agreement contained remedy provisions that supported both arguments. Specifically, section 9.10 provided that URI could seek an injunction compelling RAM to draw down financing and close the transaction if such financing was otherwise available. Yet section 8.2(e), to which section 9.10 was expressly subject, provided that URI’s “sole and exclusive” remedy in event of RAM’s breach of the agreement was to terminate the agreement and receive a US$100 million reverse break fee. Section 8.2 further stated that URI waived the right to pursue equitable remedies, therefore arguably rendering section 9.10 meaningless.

The court found the agreement to be ambiguous and decided that it would consider extrinsic evidence of the parties’ negotiations to determine their intent regarding the scope of URI’s remedies. The evidence offered by the parties at trial was inconclusive, so the court applied the “forthright negotiator principle,” which provides that one party’s subjective belief, coupled with sufficient evidence that the other party knew or should have known of such belief, will bind the other party. The court held that by the end of negotiations, URI’s apparent belief that it had a specific performance right was not effectively communicated to RAM such that RAM either knew or should have known of URI’s understanding. On the other hand, throughout negotiations RAM conveyed to URI its understanding that the break fee was URI’s sole and exclusive remedy in the event that RAM refused to close. If it disagreed with RAM’s understanding, URI had an affirmative duty to clarify its position in the face of what the court described as an ambiguous contract with glaringly conflicting provisions. By failing to clarify its position, URI became bound by RAM’s understanding of the agreement.

Conclusion

In a market where deal certainty has become increasingly important to sellers and targets, the case has drawn significant attention to reverse break fees and we expect this attention will 

  • lead targets to be even more cautious in negotiating such a provision (for example, seeking higher break fees or full recourse and, if possible, additional remedies allowing the target to force the buyer to draw down its financing if it is otherwise available); and
  • make deals with strategic buyers potentially more attractive because these deals typically do not involve similar limitations on remedies.