In the wake of the continuing credit crunch, the use of “reverse termination” or “reverse break-up” fees has expanded beyond the ranks of private equity buyers and been adopted by strategic acquirors. This phenomena is still evolving, and questions remain as to the appropriate size of such a fee, as well as the basis upon which it will be triggered and a strategic buyer can exit a deal through its payment.
Reverse termination fees have in recent years become relatively common in private equity acquisitions. Sellers pushed such fees in order to enhance certainty of closing. Private equity buyers viewed such fees, when coupled with an exclusive remedy provision, as providing a ceiling to their exposure. When the credit crunch hit, some private equity buyers used such fees as a means to terminate transactions that they no longer found attractive. Jilted sellers, with their reputations tarnished, suddenly felt that rather than protecting them, reverse termination fees simply provided buyers with a relatively inexpensive option to buy the target company—or not. Historically, sellers have had less deal protection concerns with strategic buyers than with private equity buyers. In the current economic climate, however, that attitude has changed. In the $23 billion Mars-Wrigley deal in 2008, reverse termination fees became a more established part of the strategic acquisition lexicon, with Mars agreeing to pay $1 billion (4.35 percent of deal value) should the transaction fail to close, and retaining the ability to terminate at any time. Wrigley agreed to a standard 3 percent forward termination fee. The deal closed in October 2008. Since that transaction, no “standard” reverse termination fee model has emerged. As discussed below, the principal reported transactions, some of which are discussed below, reflect different deals, players and pricing.
In July 2008, Brocade Communication Systems agreed to purchase Foundry Networks for approximately $3 billion. Under the agreement, Brocade could exit the deal upon an uncured financing failure, with payment of only $85 million (2.8 percent of the purchase price) as a reverse termination fee. When the banks providing Brocade’s financing raised an issue as to the interpretation of the interest rate provisions in the $400 million bridge financing, Brocade used the relatively open-ended financing contingency to force a renegotiation of the purchase price. The relatively small termination fee and Foundry’s strong desire to close also facilitated Brocade’s re-pricing of the transaction. The transaction closed in December 2008.
The Pfizer-Wyeth transaction announced earlier in 2009 followed a different approach. Under the deal terms, Pfizer is permitted to exit the transaction if its lenders refuse to provide necessary financing, and if such refusal is primarily attributable to Pfizer’s failure to maintain its credit ratings. Under these limited circumstances, Pfizer would not be forced to consummate the transaction without financing, but would be subject to a reverse termination fee of $4.5 billion (6.6 percent of the purchase price). Notably, the banks’ conditions to closing are quite limited and in general allow the banks to terminate their commitment only upon a ratings drop. Additionally, Wyeth can sue Pfizer to force its lenders to specifically perform their credit agreement. This is a clear departure from the Brocade model. The financial conditions under which Pfizer has the ability to walk from the deal are much narrower.
In the more recently announced $41.1 billion Merck-Schering-Plough deal, the parties seem to have utilized a hybrid of the Brocade and the Pfizer models. The Merck deal provides for a reverse termination fee of $2.5 billion, plus expenses incurred up to $150 million (totaling approximately 6 percent of the purchase price), but it can refuse to close only if by a stipulated date “the proceeds of the Financing are not then available in full.” This broad language provides Merck with a wide array of circumstances under which it can refuse to close, but only upon payment of a fairly steep reverse termination fee.
Notably, in both the Pfizer and Merck deals, the reverse termination fees are two to four times the forward termination fee that the sellers would be required to pay. Wyeth agreed to pay $1.5 to $2 billion if it terminates, and Schering-Plough agreed to pay $1.25 billion if it walks. This is substantially different from the Brocade deal (and historically most private equity deals), where the forward termination fee and the reverse termination fees have generally been equivalent in amount.
However, some commentators have properly pointed out that forward and reverse termination fees serve very different functions and as a result should be analyzed differently. For example, courts have been reluctant to sanction forward termination fees greater than approximately 3 percent of the purchase price under a theory that higher forward termination fees would deter competing bidders and interfere with the Revlon duties of a sellers’ board to secure the highest price under the circumstances. This reasoning seems inapplicable to reverse termination fees, as such fees are intended to lock in the buyer, not the seller. So far, there is a dearth of case law addressing the upper bounds of allowable reverse termination fees.
How reverse termination fees may further evolve remains to be seen. That evolution may well be influenced by what if anything the Delaware courts have to say regarding the subject. In the interim, given the current credit crunch, it seems likely that buyers will more frequently become subject to asymmetrically higher termination fees. Also clear is that in today's challenging financing markets reverse termination fees are no longer limited to transactions involving private equity buyers.