San Diego Mergers and Acquisitions: What is a Reasonable Termination Fee?
A typical merger purchase agreement will contain various termination rights and will also include termination fees (also called “breakup fees”). The idea behind termination fees is to protect both parties to the merger agreement if the merger is not consummated. Generally, a well-drafted merger agreement will specify the reasons or conditions that will trigger the termination fee and the triggering events are generally different for the target business versus the acquiring business. Retaining an experienced corporate attorney is essential to ensure the termination provisions are drafted properly.
There is a tension in the law with respect to such termination fees because of the law regarding liquidated damages. Here in San Diego, courts will not enforce penalty clauses. However, certain types of liquidated damages, like a merger termination fee, are enforceable if the fee is reasonable. The other requirement under California law for the enforceability of liquidated damages is that, at the time of contracting, it is “impracticable or extremely difficult to fix the actual damage.” See Cal. Civ. Code § 1671. A merger/acquisition scenario is a good example of when a liquidated damage provision is applicable and makes common sense. In general, if a merger/acquisition is not consummated, the aggrieved party has suffered various damages including out-of-pocket expenses and various expected benefits and profits had the merger/acquisition gone forward to completion. Those sorts of damages are difficult to calculate and are uncertain. Thus, termination fees are a good method of resolving the issue up front and of avoiding expensive post-breakup litigation.
What is considered reasonable? The answer depends on the circumstances, are deal-specific, and also depend on the party from whom the fee will be collected. But, in general, research and case law have demonstrated that fees in the range of 3% to 5% have been deemed reasonable and have been upheld by various courts. While often the parties negotiate a symmetrical termination fee, just as often the termination fees are lower for the target and higher for the acquiring firm. There is an interesting case pending in the Delaware courts where the breakup fees are 15.75% of the deal equity for the acquiring company and 3.1% for the target company. The court has not yet decided whether to enforce the termination fee against the target company but has signaled some doubts. See Vintage Rodeo Parent, LLC. v. Rent-A-Center, Inc., Case No. 2018-0927-SG (Court of Chancery of Delaware March 14, 2019).
As noted, there are generally differing events or conditions that trigger the respective termination fees. For the target, typically the termination fee is often triggered as follows:
- Board fails to vote for final approval or fails to make certain recommendations (such as that the shareholders vote in favor of the merger/acquisition)
- Failure to obtain shareholder approval
- Acceptance of a competing offer
- Some unknown problem or defect in the target company — a termination fee is particularly warranted if the problem/defect was known to the target company
For the acquiring company, the termination fee, often called a “reverse termination fee,” is generally triggered as follows:
- Failure to obtain regulatory or governmental approval such as antitrust waiver (where required) — some merger agreements will place this burden on the target company
- Board fails to vote for final approval or fails to make certain recommendations
- Failure to obtain shareholder approval
- Failure to obtain financing
Contact San Diego Corporate Law
For more information, contact attorney Michael Leonard of San Diego Corporate Law. Mr. Leonard provides a full array of legal services for San Diego businesses including contract review and drafting, mergers and acquisitions, corporate formations, private placement memorandums, and employment-related services like crafting employee handbooks. Mr. Leonard can be reached at (858) 483-9200 or via email. Like us on Facebook.