Financial advisors are often critical to the success of an M&A transaction. Often, but perhaps not always. Should the fees payable to a financial advisor be denied if, through no fault of its own, an M&A transaction is completed without any involvement of the advisor? This question is the subject matter of Crew Gold a decision of the Ontario Superior Court which was recently affirmed by the Ontario Court of Appeal.
In M&A sell-side roles, financial advisors are typically retained to advise boards on strategy, as well as perform a number of related tasks, including: preparing a timetable, identifying prospective purchasers, preparing a confidential information memorandum (CIM) and standstill agreement, providing a market check on any offers received, assisting in the due diligence process, providing an opinion as to the financial fairness of any offers, reviewing various deal documents and assisting with communications to, and at times interacting with, the public, key stakeholders, rating agencies and proxy advisory firms.
M&A advisory fees for sell-side roles are typically success-based, payable on completion of a transaction. Prior to completion, the advisor may receive a fee for the delivery of an opinion relating to financial fairness and periodic work fees, all of which are usually credited against the success fee. Work fees are typically modest compared to the success fee, as most issuers prefer not to run up huge advisory costs if no transaction is ultimately completed. Besides, it is often argued, any success fee is effectively for the account of the acquirer.
The decision in Crew Gold is clearly stated to be an exercise in contract interpretation, but there are nevertheless some key take-aways for advisors in drafting engagement letters. Given that the success fee as claimed by the financial advisor (Advisor) in Crew Gold amounted to US$7.2M, a significant quantum of money was at stake in the dispute. A brief summary of the facts is pertinent:
- In early December 2009, Crew Gold Corporation (Crew Gold), a TSX-and Oslo-listed mining company, concluded a debt restructuring pursuant to which debt holders were issued 95% of Crew Gold’s equity in consideration for cancelling their debt. GLG Partners, a London-based hedge fund, became the largest shareholder, holding 31.6% of the outstanding shares.
- In mid-December 2009, Crew Gold formally retained the Advisor pursuant to the terms of an engagement letter (Agreement) in connection with a potential transaction involving the direct or indirect sale of the company. The Advisor was to receive a monthly work fee and a success fee payable on completion of a “transaction”, which term was broadly defined to include a sale of all or a substantial portion of the shares of the company to a third party. The success fee was stated to be payable if a transaction were completed by any party, whether or not solicited by the Advisor, either during the term of the Agreement or during the 12 month period following termination.
- The Advisor prepared a detailed timetable for the sale process. The process, as envisaged, was to include a CIM prepared by the Advisor, the solicitation of expressions of interest, a due diligence process to be undertaken by prospective acquirers, the receipt of binding bids and the preparation of shareholder approval documentation.
- Throughout January 2010, GLG received several unsolicited offers for its block. The Advisor, at GLG’s request, provided GLG with a list of potential bidders for its block and prepared, jointly with GLG, a scripted sales pitch to facilitate the sale of the block.
- Subsequently, Endeavour Financial Corporation, a Vancouver-based investment bank, purchased the GLG block and another block of shares to hold 38% of Crew Gold’s shares, all without availing itself of the auction process contemplated by Crew Gold and the Advisor. Endeavour was not on the Advisor’s proposed list of potential purchasers for the GLG block and the Advisor played no role in brokering the share sales.
- Shortly following Endeavour’s share purchases, OAO Severstal, a Russian-based mining company, began to increase its holdings of Crew Gold shares, as did Endeavour.
- The Advisor offered to assist Crew Gold’s board in what appeared to be an imminent change of control transaction involving two competing bidders. Crew Gold declined the Advisor’s offer, retained the services of another financial advisor and terminated the Agreement.
- Severstal continued to increase its shareholdings and subsequently acquired Endeavour’s interest. Severstal ultimately acquired the balance of Crew Gold’s shares under a plan of arrangement in early 2012.
- The Advisor submitted various invoices to Crew Gold representing the success fee. Crew Gold refused payment principally on the basis that for the success fee to be payable, the Advisor had to have been involved in some manner with the completion of the transaction.
While the Court allowed that the Advisor was not required to be a “material cause” of the transaction, the Court ruled that the Advisor was not entitled to payment of the success fee “unless there was some causal link between its activities and the transaction that was completed”. The Ontario Court of Appeal, in affirming the Court’s judgment, concluded that the Court applied proper contract interpretation principles and that its interpretation of the Agreement was reasonable.
I will leave to others whether the Court’s interpretation of the Agreement was correct; however, in light of Crew Gold, advisors may wish to consider the following when preparing engagement letters in an M&A context. While the Court took pains to emphasize that its decision was based on the specific terms of the Agreement and the particulars of the factual matrix that played out, the terms of the Agreement are fairly standard in sell-side mandate engagement letters.
- The Court interpreted the Agreement to require that there be some causal link between the Advisor’s activities and the completion of a transaction. The Court may not have reached this conclusion if the Agreement had explicitly provided that no causal link was required. Going forward, M&A advisors may wish to consider adding to their engagement letters a statement that the success fee is payable, whether or not a transaction is completed as a result of, or in any way linked or related to, the advisor’s services or advice. Given that the events giving rise to an M&A transaction, as well as the outcome, are often difficult, if not impossible, to predict (especially at the stage where the terms of the engagement letter are being negotiated), this approach should be acceptable to issuers provided that it reflects the business deal.
- According to the Ontario Court of Appeal, the success fee was stated to be payable in consideration for the Advisor’s services. Again, given the often unpredictable nature of M&A outcomes, the engagement letter should not be drafted so as to directly link payment of the success fee to the actual provision of services.
- The Ontario Court of Appeal concluded that the provision of the success fee to be paid on completion of a transaction was presumably meant to reward the Advisor for “its success” in completing the transaction. Like beauty, success is in the eye of the beholder. In Crew Gold, the issuer may not have characterized the transaction as a success (as it was mostly a bystander in the process). A more neutral label for the fee, such as a “Completion Fee” or “Transaction Fee” may have been more helpful in defusing any argument that payment of the fee was somewhat dependent on the issuer’s view of the transaction or as a “reward” to the advisor for its services.