The negotiation of the “deal protection” package in a public company M&A transaction almost always involves the inevitable discussion as to the amount and percentage of the break-up fee. In general, the Delaware courts have upheld break-up fees within a range of 3% to 4% of equity value as reasonable and not preclusive. Delaware courts also have accepted somewhat higher break-up fees in certain deals (e.g., 4.3% in In re Topps Company Shareholder Litigation, and 4.4% in In re Answers Corporation Shareholder Litigation), depending on the circumstances.
Despite the contentious negotiations surrounding break-up fees and other deal protection devices, often the interests of an acquirer and a target are not dissimilar in fashioning reasonable and not excessive “deal protection”. In Delaware deals, if an acquirer successfully pushes for too high a break-up fee (or other deal protection devices that are too stringent), it can jeopardize the entire “deal protection” package. Delaware courts have gone so far as to throw out “deal protection” packages deemed preclusive, and have expressed a general reluctance to “blue pencil” contractual terms in merger agreements. Similarly, targets seek to avoid any excessive break-up fees or other deal protection devices that could be deemed to go “too far”, thereby opening the door to injunctive relief that halts the transaction.
The recent Delaware Chancery Court decision in In re Comverge, Inc. Shareholders Litigation highlights an additional risk to the target board for agreeing to a break-up fee that is seen to be extraordinarily excessive: the exculpatory provisions in a certificate of incorporation (that would otherwise insulate directors from personal liability for breaches of the duty of care) may not always apply.
Comverge involved the sale of a distressed company that agreed to a break-up fee and expense reimbursement in the amount of 5.5% to 7% of equity value. In Comverge, the Delaware Chancery Court stated that even at the low end, the 5.5% break-up fee tested the limit of what had been considered a reasonable break-up fee.
In addition, if the deal was terminated, Comverge was required to repay a bridge loan made by the acquirer. Although that bridge loan provided important liquidity to Comverge presumably in an effort to retain value for its stockholders, the court aggregated the full amount of the bridge loan repayment with the break-up fee and expense reimbursement, concluding that the total termination payments could have amounted to a 13% payment by Comverge. The Comverge court noted that a termination payment of 13% was “so far beyond the bounds of reasonable judgment that it seems inexplicable on any ground other than bad faith” by Comverge’s board of directors.
Comverge is a reminder that the Delaware courts tend to evaluate termination payments on an aggregate basis and do not necessarily discount or offset potential values derived from deal enhancements like bridge financing. These possibilities were understood by acquirers and targets when 19.9% new stock options were used as deal protection devices in “pooling of interests” stock mergers up through mid-2001, with the total notional profit under the stock option often being capped at a reasonable break-up fee level. After Comverge, target boards should be mindful that in some deals there are certain deal protection devices providing for payments (e.g., commercial agreements or licenses triggered upon termination) that, depending on the circumstances, might also be aggregated and evaluated as termination payments by the Delaware courts.
Targets and acquirers also should take note of the discussion in Comverge relating to a target board’s agreement to termination payments “so far beyond the bounds of reasonable judgment.” At some point beyond the bounds of reasonable judgment, the Chancery Court might find such payments amount to bad faith. Bad faith, if proven, is not entitled to the exculpatory provisions that most Delaware public companies have in their certificates of incorporation. While the Comverge decision came at the motion to dismiss stage, and may ultimately be decided differently on the merits, it is a reminder of some of the risks associated with termination payments that a court might see as “so far beyond the bounds of reasonable judgment.”
The full and original memorandum was published by O’Melveny & Myers on April 9, 2015 and is available here.