Termination
Rights
and Fees

DEFINITIONS

A termination right is a provision in a main transaction agreement that, if exercisable, gives a party the opportunity to abandon a transaction by terminating the agreement.

 

A termination fee is an amount that may be payable by one party to another party if a transaction fails to close.

Each is only relevant to a staggered sign/close transaction.

GENERAL TERMINATION TRIGGERS

 

Most main transaction agreements can be terminated if: (i) all parties agree to terminate, (ii) the closing has not happened by the outside date, (iii) a law makes the transaction illegal or a governmental authority blocks it, or (iv) certain parties are in breach. Different parties hold different sets of termination rights.

 

Each termination trigger will often have nuanced exceptions and qualifications, like those: (i) granting breaching parties the opportunity to cure breaches before the other party can terminate and (ii) prohibiting breaching parties from exercising termination rights they may hold.

Parties may negotiate additional termination rights, like those related to the fee triggers described below.

EXERCISE OF TERMINATION RIGHTS

Other than in mutual terminations, a party exercises a termination right by sending notice of termination to the other parties.

However, in a typical leveraged buyout, a seller or target company cannot immediately terminate upon a buy-side financing failure. Instead, the termination prong relating to a financing failure (see below) usually requires the sell-side to deliver an advance notice—the ready, willing, and able notice—as a condition to exercising the actual termination right.

If an agreement is terminated, specific performance to force a closing will be unavailable.

TERMINATION FEES

Termination fees are designed to incentivize parties to complete transactions, and compensate them for opportunity costs (i.e., the time, money, and other resources spent on a failed transaction).

There are two types of breakup fees, categorized by payor: (i) sell-side fees and (ii) buy-side fees.

SELL-SIDE TERMINATION FEES & TRIGGERS

A seller or target company primarily pays a termination fee to a buyer when it accepts a superior proposal from another purchaser and abandons the original deal. Sell-side termination fees are most common in transactions with public companies.

• SUPERIOR PROPOSALS

Significant transactions require both board and equityholder approval. Typically, at signing, the target’s board of directors will approve the transaction and recommend that the equityholders also approve it. The equityholder vote takes place following board approval and during the interim period.

Companies cannot prevent inbound proposals. If the target’s board receives a proposal that is superior to the one with an existing buyer prior to the equityholder vote, the target might decide to exercise a fiduciary out.

• BOARD’S FIDUCIARY OUT

Fiduciary out provisions permit directors to cancel the original transaction or change the board’s original recommendation if doing so is required for the directors to carry out the fiduciary and other duties they owe to equityholders.

• CANCELLATION FEE TRIGGER

If the transaction is canceled, the target company will terminate the agreement and be required to pay a termination fee to the buyer. Payment is typically made concurrent with termination.

• CHANGE IN RECOMMENDATION FEE TRIGGERS

There are various outcomes for a change in recommendation, depending on the negotiated agreement.

A change in recommendation usually results in a choice for the buyer. The buyer either (i) terminates the agreement and collects a termination fee or (ii) lets the equityholder vote proceed despite the recommendation change. If the equityholders reject the transaction, a termination fee will be payable.

Though less common, some agreements provide that the buyer must exercise the termination right within a specified window of time following the change in recommendation or else the termination fee is waived. 

Other agreements specifically prevent the buyer from terminating before an equityholder vote, regardless of a recommendation change, in which case a termination fee is usually payable if the transaction fails.

• TAIL PERIODS

Finally, tail periods may be negotiated. These entitle the buyer to a termination fee where an agreement is terminated and then following the termination the target completes a qualifying transaction with another buyer.

• SUPERIOR PROPOSALS REQUIRED

It is worth noting that the above scenarios assume a superior proposal has been received. If equityholders simply reject a transaction the board approved, no termination fee is usually paid (though expense reimbursement may be negotiated).

BUY-SIDE TERMINATION FEES & TRIGGERS

There are two main types of buy-side breakup fees, or reverse termination fees: (i) financing failure RTFs and (ii) regulatory failure RTFs.

• FINANCING FAILURE RTFs

A financing failure occurs when a buyer’s equity and/or debt financing does not fund as expected, leaving the buyer without the proceeds required to close.

In this scenario, the sell-side can terminate the agreement and collect the RTF. The termination provision allowing the sell-side to terminate for a financing failure includes the ready, willing, and able notice.

This advance notice provides a brief cure window (e.g., two or three business days) for the buyer to obtain the funds to close. It requires the sell-side to certify that it is ready, willing, and able to close during the duration of the cure period. This puts the onus on the buy-side to either close the transaction or pay the RTF.

If closing has not occurred by the end of the cure period, the sell-side can then decide to terminate and collect the RTF by sending a termination notice.

Correctly drafted agreements expressly require the sell-side to terminate the agreement as a condition to collecting the reverse termination fee. This prevents a seller from suing for specific performance to force a closing if it believes the financing is available while at the same time trying to collect an RTF.

• REGULATORY FAILURE RTFs

A regulatory failure occurs when antitrust or other required regulatory approvals are not obtained. The most common scenario is failure to obtain by the outside date, in which case a seller could terminate and collect a fee negotiated for the failure.

It is theoretically possible for a regulatory approval to be denied prior to the outside date and for a seller to terminate at that time. However, usually there are appeal options available that must be exhausted before the denial will be considered definitive under the transaction agreement.

In addition, if a buyer has agreed to an efforts standard for obtaining regulatory approvals—like a HOHW provision—the buyer will be required to pursue appeals and other challenges to the denial.

In practice, the outside date will usually be reached before the denial is unappealable.

AMOUNT OF FEES

Parties are free to negotiate the amount of any termination fee.

However, sell-side fees are often limited by case law and buy-side fees usually conform to standard market practice.

When negotiating the size of a breakup fee, counsel should advise on whether any judicial precedents are relevant (like those relating to fiduciary outs).

Counsel can provide insight on what typical ranges would be for a given deal.

EFFECT OF TERMINATION

Termination provisions will describe the effect of the agreement having been terminated.

Various approaches exist, including: (i) no party is liable to any other party following termination (even for pre-closing breaches), (ii) the parties are only liable to each other following termination for willful and intentional pre-closing breaches (like purposefully violating pre-closing covenants), and (iii) the parties remain liable to each other following termination for other types of pre-closing breaches.

If a termination fee is paid, the payor will usually have no further liability under the agreement except for, in some cases, defense costs and specified expense reimbursement obligations.

The effect of termination provisions are among the most complex in a transaction agreement, requiring careful drafting, informed decision-making, and deal-specific carve-outs to preserve, among others, expense reimbursement and confidentiality commitments.

PITFALLS

• UNWRITTEN NOTICES

All termination notices and any other notices relating to termination—including cure notices and the ready, willing and able notice—should be required to be in writing.

• INCORRECT REFERENCES

Each termination provision is heavily intertwined with its sibling termination provisions and other clauses throughout the transaction agreement as a whole. While faulty cross-references in other sections of an agreement (like boilerplate miscellaneous sections) are certainly not ideal, bad or missing cross-references in termination provisions can cost real money and create real liability.

• IMPRACTICAL OUTSIDE DATES

If the negotiated outside date is scheduled to fall on a weekend, holiday, or other day money cannot move, the parties should consider moving it. It is never good to be working towards a last-minute closing, then to discover the closing cannot practically be completed.