- The recently announced $1.2 billion SAI Global Limited scheme established a new market practice for target liability caps by providing the bidder with additional transaction certainty and cost recoupment protection in the event of the target knowingly or wilfully committing a material breach of the scheme implementation agreement.
- Target companies typically seek to ensure that their liability to bidders under a scheme implementation agreement is to some extent capped.
- Former market practice tended towards capping the target's liability to an amount equal to the customary 1% break fee payable by the target.
- Capping the target's liability to the customary 1% break fee is considered a unfavourable outcome for bidders because it provides targets with no material incentive to comply with any of the customary exclusivity / deal protection provisions of a scheme implementation agreement. This is because if the target were to recommend a competing proposal without first complying with those provisions, its maximum liability to the bidder would still only be equal to the break fee (which would have been payable anyway if those provisions were complied with).
Customary forms of target liability cap and why they are problematic for bidders
The high water mark for targets is to set an aggregate cap on all target liability connected with the scheme implementation agreement that is equal to the amount of the break fee that would be payable by the target.
The customary exclusivity / deal protection provisions of a scheme implementation agreement typically provide critical protection to the bidder by requiring that, before the target directors may change their recommendation and recommend a superior proposal, they must first comply with exclusivity / deal protection provisions which include offering the bidder a right to match the superior proposal. A break fee is payable by the target where its directors recommend a superior proposal.
If the aggregate cap on all target liability arising under or in connection with the scheme implementation agreement is limited only to the amount of the break fee, then the maximum liability of the target to the bidder is equal to the break fee regardless of whether or not the target complies with the exclusivity / deal protection provisions. This means that, if the target were to simply recommend a competing proposal without first complying with those provisions, its maximum liability to the bidder would still only be equal to the break fee. This outcome arguably provides targets with little incentive to comply with any of the exclusivity / deal protection provisions.
A bidder may naturally then question what the incentive is or target boards and their advisers to comply at all with the "no shop, no talk, no DD" and matching right protections from the outset?
Certainly reputational risk for target directors and the potential for panel proceedings to be brought against targets somewhat mitigates the risk of intentional target misconduct. However, such factors may not provide bidders with sufficient comfort. Bidders could also seek an injunction to address target misconduct however that would require providing an undertaking as to damages which bidders may not be prepared to give.
What alternative approaches are available to bidders?
In order to maintain an incentive for the target to comply with any of the exclusivity / deal protection provisions, a bidder needs to explore alternative approaches for capping target liability.
The high water mark for bidders is to have no cap on all target liability under or in connection with the scheme implementation agreement, or to cap that liability at an amount equal to the value of the target.
A variation of this approach is to have the target's aggregate liability cap equal to the break fee, but to have that cap apply only to events that give rise to the right to demand the payment of the break fee by the target. That will leave targets with unlimited liability to bidders for breaches of the scheme implementation agreement that are not break fee triggers, so targets need to tread carefully depending on the list of agreed triggers.
Reciprocal caps are not the answer
Increasingly, in order to give target Boards more comfort on deal completion, targets are seeking 'reverse' break fees (usually in circumstances where any action or inaction by bidders causes a condition to the scheme to fail or in the case of material breaches by bidders). It is a common 'compromise position' to cap both target and bidder aggregate liability arising under or in connection with the scheme implementation agreement to an amount equal to the break fee.
While reciprocity gives a spurious appearance of reasonableness, it is much more advantageous to targets than to bidders as bidders' only real obligation under a scheme is to provide funds immediately prior to the implementation date (once all conditions are satisfied and the scheme is already effective). Targets on the other hand, have to drive the court, shareholder and independent expert processes whilst honouring stringent exclusivity and prohibited actions provisions. Not only do targets have more of an opportunity to derail a scheme, they also tend to have more to gain by doing so – in effect, any small liability cap will be borne by an interloper and not the target.
Target liability cap in the recently announced SAI Global scheme
In our view, market practice has now progressed to provide further protections to bidders, as reflected in the SAI Global scheme implementation agreement.
The SAI Global scheme implementation agreement provides the bidder, Baring Asia Private Equity, with the usual protection of a 1% break fee in the traditional circumstances of:
- the target's failure to make or maintain a positive Board recommendation;
- the implementation of a superior proposal;
- a material breach by the target of the terms of the scheme implementation agreement (including the exclusivity provisions and the target representations and warranties); and
- a prescribed occurrence occurring.
However, in addition to the 1% break fee, a mechanism was included to incentivise bidder compliance with the exclusivity provisions of the scheme implementation agreement. This was important to the bidder in this transaction given that the bidder was particularly focussed on ensuring a properly functioning exclusivity regime given the importance of those rights to the bidder.
The incentive mechanism in the SAI Global Limited scheme, effectively increases the target's liability cap from 1% to approximately 2%, solely in the event of the target knowingly or wilfully committing a material breach of the scheme implementation agreement. The 2% figure is simply a commercially negotiated threshold for purposes of the SAI Global scheme agreement, however, we expect that this threshold might increase in future and (unlike a break fee) we see no reason why this threshold need be limited to a bidders' actual costs and expenses. Importantly, so as not to be anti-competitive, a break-fee of the customary 1% is payable in circumstances where an interloper makes and implements a superior proposal in the absence of the target knowingly and wilfully breaching the exclusivity provisions and "shopping" the target around to a higher bidder.
This bifurcation of liability caps between the traditional break fee triggers and the additional trigger for knowing or wilful material breaches, gives a bidder greater comfort and protection that it will be left in no worse financial position in the event of a broken deal caused by a knowing or wilful material breach by the target.
Ramifications for future schemes?
We expect to see bifurcated target liability caps in schemes becoming standard market practice going forward because they:
- provide bidders with an ability (that does not offend any principles of the Takeovers Panel) to recover more from targets in the event of a broken deal where targets have knowingly or wilfully materially breached the scheme implementation agreement. (That is particularly important in schemes where bidders are usually on risk for a longer period and potentially subject to greater costs than in takeover bids); and
- should give bidders greater comfort that targets will comply with exclusivity provisions.