The High Court recently held that break fees [1] offered by UK public companies constitute unlawful financial assistance and, as such, are unenforceable. [2]

Paros plc was seeking to acquire Worldlink Group plc (a UK public company) and the parties signed Heads of Terms which provided for a break fee payable by Worldlink to Paros if Worldlink decided not to proceed with the acquisition. Negotiations broke down, Worldlink refused to proceed further and Paros sued Worldlink for the break fee.

Worldlink’s defence was that the obligation to pay the break fee was unenforceable because it contravened the rules prohibiting unlawful financial assistance [3] from a UK public company (Worldlink) to a person seeking to acquire its shares (Paros).

In a judgment handed down on 1 March 2012, Jonathan Hirst QC held that even though the break fee was only payable if the acquisition fell through, because the prohibition applies to cases where a person is proposing to acquire shares in a company as well as actually acquiring them, the break fee fell within the broader definition of unlawful financial assistance.

He concluded that the break fee was intended to ensure that, if Worldlink withdrew from the negotiations, Paros was certain to recover a minimum contribution towards its expenses. He held therefore that it was “smoothing the path to the acquisition of the shares” [4] because it enabled Paros to incur a certain level of expenditure in progressing the proposed acquisition secure in the knowledge that it would be reimbursed if the transaction failed.

On the facts of the case the break fee was payable as the parties varied the Heads of Terms from a share to an asset purchase which had the effect of taking the transaction outside the scope of the prohibition on unlawful financial assistance. This does not, however, affect the significance of the ruling as it relates to break fees constituting unlawful financial assistance in the context of share purchases.

The judgment is consistent with the new UK Takeover Code which prohibits a listed target company to which the Code applies from giving a break fee to a potential acquirer. However its effects go further as the prohibition on unlawful financial assistance applies to both listed and unlisted UK public companies and its infringement means that not only will the break fee be unenforceable, but also the company offering it and its directors will each have committed a criminal offence.

Finally, given the breadth of the words “smoothing the path to the acquisition of the shares” upon which the judge relied, it remains to be seen what other acts of a target company may be interpreted as unlawful financial assistance in the future.