• A recent UK case has confirmed that there may be problems for companies that agree to pay break fees beyond the Takeover Panel rules. It is possible for a break fee to be unlawful and the consequences can be serious.
  • While financial assistance is only prohibited in Australia if it would result in material prejudice, the case underlines the fact that this is a complicated area that requires expert legal analysis, together with a degree of commercial judgment.
  • In particular, companies with limited cash flows or liquidity issues (such as exploration companies) should carefully consider whether agreeing to pay a break fee could constitute unlawful financial assistance.

For many years there have been concerns that the payment of a break fee by the target company could be construed as unlawful financial assistance.

A recent decision by the UK High Court held that a break fee may constitute financial assistance. The UK provisions are sufficiently like the Australian provisions that the case warrants serious consideration by any company contemplating agreeing to pay a break fee.  

The Corporations Act has always contained a prohibition against a company giving a person financial assistance to acquire shares in the company. The prohibition was designed to prevent transactions that might prejudice the interests of creditors and shareholders. These are very serious provisions and any person involved in contravening the financial assistance provisions, including a company’s directors and advisors may be liable for a pecuniary penalty of up to $200,000. If the contravention is found to be dishonest, the person may also be punished with up to five years in prison.  

The UK case arose out of a failed reverse takeover. The parties agreed that the target would indemnify the bidder for any expenses incurred in the course of the takeover. There was a concern that this indemnity would be viewed as financial assistance. In an attempt to avoid this possibility, the indemnity was structured as a break fee, requiring the target to pay £12,500 per week (capped at £150,000) if the transaction failed.  

Following the collapse of the deal, the target refused to pay the break fee claiming it contravened the financial assistance rules. The Court found that because the break fee “smooths the path” towards the acquisition, it was financial assistance. This is consistent with other UK decisions supporting the view that there can be unlawful financial assistance even where the acquisition does not take place, as the legislation applied to a proposal to acquire shares as well as an acquisition of shares.

The UK provisions are different to section 260A. The UK rules do not recognise situations where the giving of financial assistance does not result in a reduction of capital and are more like the pre-1998 provisions that existed in Australia.  

In Australia the key question is whether giving the assistance materially prejudices the interests of the company or its shareholders or the company’s ability to pay its debts. Despite the difference between the Australian and UK provisions, where a break fee is large enough to be considered materially prejudicial to the target, either because of its quantum or because of its impact on cash reserves, it may constitute unlawful financial assistance.  

The case underlines the fact that financial assistance is a complicated area that requires expert legal analysis, together with a degree of commercial judgment so as not to fall foul of these serious provisions.