Taking a Play out of the Financial Acquirer’s Playbook

Jamie Leigh and Eric Schwartzman are partners and Ian Nussbaum is an associate at Cooley LLP. This post is based on their Cooley memorandum and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice and Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here), both by John C. Coates, IV; and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

As the NFL season gets underway, it is interesting to see how certain plays go from fringe status to near-universal. A recent example is the “run-pass option” that, before finding a home in every NFL team’s playbook, was used only in high school and college football games. [1] Coaches survey plays to assess what works, and, over time, some version of a useful play finds its way into a coach’s playbook and then every coach’s playbook. That is an enduring aspect of the sport: if you see a game-changer, use it.

In public M&A, some provisions in merger agreements become near-universal as practitioners study precedents and react to case law. In the early 1990s, it was typical for financial acquirers to bargain for a financing condition with a walk-away right if it could not obtain the financing for the deal. This play proved to be a losing proposition—in competition for assets with strategic parties whose bids were backed by their balance sheets, the financing condition would usually render the financial buyer’s bid a non-starter as it was deemed too risky from a deal certainty perspective in the eyes of the seller. Financial buyers, wanting to compete against strategic parties, gradually developed a new play that has now become the market norm for public company deals. They have foregone the financing condition (although a few remain bold enough to ask for it from time to time) in favor of agreeing to pay a reverse termination fee to the seller in the event that there is a financing failure. Critically, as part of this framework, the reverse termination fee generally operates as a maximum liability cap for the financial buyer, such that, following full payment of the reverse termination fee (plus any expense reimbursement or interest that may be owed to the sellers), a financial buyer eliminates any further liability to the seller on any basis. [2]

Strategic parties, however, often do not escape with such a clean break. Not only do strategic parties rarely attain maximum liability caps, but a strategic party’s exclusive remedy provision for payment of a termination fee is often contingent on its compliance with other agreement provisions and not solely the receipt of the termination fee.

Genuine Parts Company v. Essendant Inc., a recent decision from the Delaware Court of Chancery, illustrates how important that distinction turns out to be for strategic parties. [3] In Genuine Parts, Essendant paid Genuine Parts a $12 million termination fee to accept a competing proposal that Essendant’s board of directors determined was a superior offer. After accepting payment of the termination fee, Genuine Parts then threw a yellow flag, suing Essendant for additional damages, alleging that the $12 million payment was an inadequate remedy because it failed to compensate Genuine Parts for Essendant’s material breaches of the merger agreement. Specifically, under the terms of the merger agreement, the $12 million fee would have been Genuine Parts’ “sole and exclusive remedy” in the event Essendant accepted a superior offer without having materially breached its non-solicitation obligations. But, because Genuine Parts alleged that Essendant had materially breached its non-solicit obligations, the Court of Chancery held, at the pleading stage, assuming such alleged facts were true, that Genuine Parts’ suit against Essendant could proceed despite the fact that Genuine Parts accepted the termination fee.

The Genuine Parts decision highlights why strategic parties would be wise to take a page out of the financial buyer’s exclusive remedies playbook. For a board of directors of the target company, the certainty of a clean break from a prior transaction is crucial and can raise questions that could factor into a board’s decision-making when evaluating competing bids. Should the board discount the financial terms of a competing bid for the risk attendant to possible litigation above and beyond the payment of the termination fee? [4] Will potential competing bidders be more reluctant to make competing offers if the potential cost is greater than the termination fee? Worst of all from the intervening buyer’s (and target company’s) perspective, when the payment and acceptance of the termination fee does not act as a bar to further claims, the intervening buyer essentially funds the aggrieved first buyer’s litigation case (which was never the intent of the termination fee).

While we are not advocating that a target company should have an unconditional right to accept a superior proposal in a situation where the target has materially breached its non-solicitation covenant, as the non-solicitation covenant is an important bargained-for protection of the original buyer, we are advocating an election of remedies approach. It would be preferable for all parties involved if a court could resolve the validity of the purported termination before the target company accepted another bid (however, this solution may not be practically feasible because a court would not be likely to make a ruling on a fact-based case without full discovery and a trial). But if the original buyer had to decide between acceptance of the termination fee or preservation of its claims that the merger agreement was not validly terminated for a superior proposal, the target company and intervening buyer would be better informed about the litigation risks and could investigate the alleged non-compliance of the merger agreement in connection with the termination and potentially negotiate a settlement with the original buyer. And, if the original buyer elected to accept the termination fee, the target company and intervening buyer would achieve the desired deal certainty. In fairness, the original buyer may accept the payment of the termination fee in circumstances where it was unaware that the target company breached its no-solicitation obligations. But we would submit that the appropriate solution in that case would be for the original buyer to bring a tortious interference contract claim against the intervening buyer if it were to become aware after the termination that the intervening buyer induced the target company to breach the non-solicitation or other covenants in the merger agreement in order to facilitate the making of the superior proposal. While there are relevant distinctions between strategic and financial acquirers that justify having different deal frameworks for the payment of a termination fee in respect of a superior proposal and a reverse termination fee in the event of a financing failure, an exclusive remedy provision that bars further claims with respect to the validity of the termination of the merger agreement itself after acceptance/payment of a termination fee is worth jotting down in the strategic party’s playbook.


1See Adam Kilgore, The run-pass option was born in high school and took over college. Now it’s the NFL’s favorite play (August 18. 2018), available at http://www.chicagotribune.com/sports/ct-spt-nfl-run-pass-option-20180818-story.html.(go back)

2While there are several variations on how this liability bar operates, including bifurcated caps or “uncapped” liability for material and willful breaches, the financial buyer’s limited guarantee is not an unlimited guarantee and, except in a rare case where a party can persuade a court to pierce the corporate veil, the limited guarantee acts indirectly as a cap on damages even if a party can obtain a larger judgment against the acquisition vehicle.(go back)

3C.A. No. 2018-0730-JRS (Sept. 9, 2019).(go back)

4While an argument can be made that the risk of the breach of contract claim will ultimately be the risk of the competing bidder, it wouldn’t be exclusively so in a situation where the competing bidder’s offer included a stock component or the subsequent transaction failed to close.(go back)

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