The decision of the NSW Court of Appeal on Tuesday to reject the appeal from the investment bank seeking an additional $30 million in advisory fees in respect of its defence work for Consolidated Minerals is a timely reminder of the importance of having clearly drafted mandate letters. Investment banks, their clients and their respective lawyers should carefully review the terms of mandate letters –particularly the fees clauses.
Discussions around the fees payable under mandate letters are not uncommon. However, unlike most disputes, this dispute was not resolved behind closed doors, giving the Court the opportunity to review terms commonly used in these mandate letters.
The Court of Appeal focused on interpreting three key aspects of the mandate letter:
- when will an offer be "successfully defended" so as to attract a "base defence response fee";
- what is the "transaction value" which should be used to calculate the "base defence response fee" (calculated as a percentage of transaction value); and
- what is the relevant increase in the offer price which should be used to calculate the further "incentive fee" which applies where a transaction completes at an offer price above an initial unsolicited offer (calculated as a ratchet-like percentage of that increase).
When is a base defence response fee payable?
A number of competitive bids were made for Consolidated Minerals following the initial unsolicited approach by Pallinghurst, the last of which was the ultimately successful bid made by Palmary.
The key question for the Court was whether the investment bank could claim multiple base defence response fees in respect of each competitive offer preceding the ultimately successfully Palmary bid, all of which it says were "successfully defended".
The mandate letter said that the investment bank was entitled to a base defence response fee in relation to an offer which either:
- results in a completed takeover, merger or other business combination being effected between the Company and the bidder; or
- is successfully defended by the Company in circumstances where the majority of directors of the Company recommend to shareholders that they reject the offer or otherwise determine to defend the offer.
The final Palmary bid was clearly an offer which resulted in a completed takeover. It was common ground that the investment bank was entitled to a base defence response fee in respect of this offer.
The Court then effectively took the view that, having regard to the terms of the mandate letter as a whole and the inferred intentions of the parties, the mandate letter should not be interpreted in a way which entitles the investment bank to multiple fees in respect of a single series of competitive offers.
In order to interpret the mandate letter in such a way, the Court took a very narrow view of the circumstances in which an offer is "successfully defended". It said that an offer cannot be regarded as having been "successfully defended by the Company" where the outcome of a bidding war of which the offer formed part was that the Company was taken over. It was found that the concept of "successfully defending" an offer did not extend to "the rejection of or non-acceptance by the shareholders of an Offer where a better one is accepted".
However, the Court was undoubtedly influenced in these circumstances by the fact that the investment bank was already entitled under the terms of the mandate to a fee in respect of the completed transaction.
The real lesson is that if a mandate letter is intended to entitle an investment bank to multiple fees in respect of a single series of competing offers then it needs to be carefully drafted so as to make it clear that this is the actual intention of the parties.
What is the relevant "transaction value"?
The base defence response fee was calculated as a percentage of the transaction value. The "transaction value" was defined as: "the total proceeds and other consideration paid ... or contributed ... in connection with the Offer ([including] any consideration transferred ... pursuant to a merger, acquisition or scheme of arrangement) ... including ... net debt"
The issue for the Court of Appeal was whether Palmary's cost of acquiring a pre-bid stake of 14.29% prior to making its offer constituted an amount paid "in connection with the Offer" and the answer was no:
"The acquisition of the pre-bid stake was made in anticipation of a takeover offer being made, but it was not, in my opinion, made in connection with the Offer, that is the particular Offer to the defendant’s shareholders which resulted in Palmary’s takeover of the defendant."
In general, the inclusion or exclusion of a pre-bid stake in the calculation of relevant transaction value could have a material impact on the size of an investment banks fees given that the pre-bid could represent up to 20% of the equity in the target. Mandate letters should therefore specifically refer to pre-bid stakes and other related transactions if they are to be included in the definition of "transaction value" for the purposes of calculating a percentage based fee.
What increase in value should the incentive fee relate to?
The mandate letter provided for a further incentive fee to be paid to the investment bank calculated as a percentage of "any increase in the Offer price ... above the initial Offer price"
The dispute between the parties was as to what the "initial Offer price" should be for the calculation of the increase in the context of the various competing offers which were made for Consolidated Minerals. The initial unsolicited offer from Pallinghurst was priced at approximately $2.08 per share. After a number of further offers were made by Pallinghurst and another competing bidder, Palmary made an initial offer at $3.95 per share. The final offer price under the successful Palmary bid was $5.00.
The investment bank argued that the incentive fee should be calculated by reference to the increase between Pallinghurst's initial offer price and Palmary's final offer price. Consolidated Minerals argued that it should be referable to the increase between Palmary's initial and final offer prices.
The Court of Appeal took a very technical interpretation of the mandate letter. It held that the use of the word "the" in "the Offer price" and "the initial Offer price" and the use of the capital "O" where Offer is referred to in both instances meant that the incentive fee must refer to an increase in the price of the same offer. As a result, the fee must refer to the difference between Palmary's initial offer price and Palmary's final offer price since the final Palmary offer was the offer which resulted in a completed takeover and therefore entitled the investment bank to its fee.
This is perhaps the most surprising conclusion reached by both the Court at first instance and confirmed by the Court of Appeal. It is relatively usual for a target and its advisers to seek competing bids and promote a competitive auction as a means of generating greater value for target shareholders. It is obviously in the interests of the target for its advisers to have an incentive to seek competing offers to extract the best possible offer price.
The structure of this incentive fee is common in defensive advisory agreements and commonly understood to be referable to any increase in the offer price between the initial and final offers, regardless of whether they are made by the same offeror.
Lessons for mandate letters
Counsel for the investment bank submitted in the appeal that the mandate letter was "written in the language of merchant bankers rather than lawyers". Of course it is preferable for investment banks and their clients that mandate letters remain readable and not full of lengthy, impenetrable legalese!
However, at the same time, plain English and clear drafting that have the intended legal effect is the only way to ensure all parties understand in advance what they are agreeing to and minimise the chance of any dispute.