Break fees update: pushing the 1% guideline and the return of the naked no vote

Summary

• The traditional position of the Courts and the Takeovers Panel has been that a break fee not exceeding 1% of the target’s equity value is generally not unacceptable.
• Courts are demonstrating an increasingly pragmatic commercial approach to break fees in schemes which exceed the 1% guideline if it can be demonstrated that the fee is a genuine estimate of the costs that may be thrown away by the bidder.
• Despite a common misconception in the market, the Courts have shown that they are prepared to accept naked no vote break fees in schemes.

The traditional position

The Courts have said that break fees are justified due to:

• the costs and expenses incurred by the bidder in proceeding with the change of control transaction,
• the benefit that the bidder confers on target shareholders by increasing the target’s value, and
• the desirability, from the viewpoint of the target shareholders, that a change of control transaction be put to them.

One factor that is particularly relevant in determining whether a break fee is appropriate or not is its quantum.

The Takeovers Panel has stated that, in the absence of other factors, a break fee not exceeding 1% of the equity value of the target is generally not unacceptable. The Courts have also adopted this 1% guideline when considering the acceptability of break fees in the context of schemes of arrangement.

Increasing acceptance of break fees in excess of the 1% guideline

In the initial period following the publication of the Takeovers Panel’s 1% guideline, there was generally a rigid adherence to the 1% figure amongst merger participants.

However, the Courts have, in more recent times when considering schemes of arrangement, shown that they are prepared to accept break fees in excess of the 1% guideline if it can be demonstrated that the break fee is a genuine pre-estimate of the costs that will be thrown away by the bidder if the deal does not proceed.

Most of the recent examples of this happening involved transactions with lower deal values (for example, the current Spur Ventures/Atlantic Gold scheme where the break fee is 2.5% of deal value). However, there are some examples of the Courts adopting the same position on larger transactions as well (for example, the current Woolworths/David Jones scheme).

Recent examples of where the Courts have accepted break fees in excess of the 1% guideline include:

The position adopted by the Courts is a welcome and common sense approach to determining the acceptability of break fees, particularly in the case of smaller transactions where the costs and expenses of the bidder frequently exceed 1% of the deal value.

The return of 'naked no vote' break fees

A “naked no vote” break fee is a break fee that is payable if target shareholders do not vote in favour of a scheme of arrangement by the requisite majority.

Historically, there has been a stigma attached to naked no vote break fees as some consider them to be akin to holding the target shareholders to ransom in respect of their votes at the scheme meeting. This has fuelled a common misconception in the market that the Courts are unlikely to accept naked no vote break fees in schemes of arrangement.

Whilst naked no vote break fees are clearly not as commonplace as ordinary break fees, the Courts have accepted their existence in a number of schemes (including in the recent Murchison Metals/Mercantile Investment and USS Axle/Airtrain schemes).

The following table lists schemes of arrangement that have had naked vote break fees which have been specifically considered and accepted by the Courts:

The test that the Courts are applying in considering the appropriateness of a naked no vote is whether the quantum of the naked no vote break fee is so large as to be capable of coercing target shareholders into agreeing to the scheme rather than assessing it on its merits. In circumstances where the naked no vote break fee is not considered to be coercive (for example, because it is a small amount), the Courts have demonstrated a willingness to accept the break fee.

Herbert Smith Freehills acted for Spur Ventures Inc. in relation to its proposed acquisition of Atlantic Gold NL and David Jones Limited in relation to the proposed acquisition of David Jones Limited by Woolworths Holdings Limited.