I. Introduction

In Transactions related to Merger and Acquisition, a “break fee” Agreement is kind of an arrangement taking place between the target company of the transaction and the potential buyer or acquirer of the said company. In the [3]“Break Fee” arrangement, the target company agrees to make payment of any fee to the potential acquirer, when the offer from the acquirer cannot be potentially carried forward for any reason. These Agreements are generally looked as beneficial devices for deal protection. But, the quantum of such Agreements is governed and regulated in various jurisdictions having different approaches. Various other developed countries which are leading the world in the domain of corporate law have already well-established system governing rule and regulation of Break Fee Agreements, countries like U.S, U.K, Australia, Hong Kong and many others have a good and well-defined system and most of them are following UK’s de minimis limits.

The most important factors for the promotion and growth of merger and acquisition transactions in India are good government policies and the promotion of economic stability. M&A promote rationalisation which eventually benefits the economy and enhances the wealth of the shareholder. Although India does not have any written legislation governing the rules and regulations of how the Break Fee Agreements work, but various courts have laid down few landmark judgements in this context establishing the concept of Break Fee Agreements in the Indian legislation, although there is no specific mention of the term “Break-up free” under the Companies Act, 2013 or any of the other regulations enforceable in India to govern the Companies.[4] This is where higher bodies with authority like SEBI comes into play and assist in addressing the situation and fulfilling the gaps or the loopholes of Indian Legislation and assisting the need of the hour.[5]

II. How Break Fees Work?

In the transaction related to merger and acquisition, a Break Fee is considered as an instrument that is invariably negotiated and may prove out to be beneficial for providing some incentive for the target company for completion and execution of a deal and guarantees some monetary compensation to the acquirer of the target company if such deal is not executed. The sum of the amount of compensation in this Agreement is connected to an estimation related to the due diligence costs, acquiring companies time to review and negotiate the deal for the execution of the transaction of merger and acquisition. A Break Fee Agreement will come into force if there comes a situation that leads to a breach in a no-shop clause or in cases when the target company accepts another bid from another party to the contract. Break fees were first broadly disclosed in Form S-4, of the Securities and Exchange Commission (SEC) of the USA.[6] Break fees Agreements can also be used in other types of business transaction contracts to deal with non-performance and compensate a party if there is actually a non-performance.

In certain derivatives contracts, a Break Fee Agreement may be considered in a form of a termination clause which describes the procedures and actions which needs to be taken for the remedies available for one of the counterparties if any other counterparty makes any defaults or ends or break the contract by not following the terms and condition of the contract.[7] This generally includes any kind of payment for the damages to the injured counterparty but is not limited to this only. When there is an early termination then, both the parties will cease to be part of the contract, making payment of any contractually agreed upon payments and the party at fault will be required to make such payments. With respect to the current scenario, the companies to the contracts have now become more cautious when it comes to any transaction related to the merger and acquisition. Therefore, some necessary steps are to be taken as they are the need of the hour.

In the West, “Break Fee” is commonly used as a deal protective device. But it is not so common in India yet. But now, there are great chances that it will now be introduced in M&A transactions in India. With respect to the current circumstances of the global pandemic, many instances show that these devices should be given more recognition in Indian. As it guarantees a reasonable sum which the management of the target company is liable to pay to the company making an offer, for any already specified or contractually agreed terms and conditions based of possible circumstances, taking place before complete execution of the Agreement, which eventually leads to failure of completion of the contract.

III. Use of Break Fee Agreement in M&A

For target companies that are ready to be acquired or merged, a Break Fee arrangement works as an instrument that promotes competition among the bidders or the buyers interested in buying the target company.[8] It assures the potential acquirers that compensation will be given to them for any cost incurred prior to the completion of a transaction. It would promote bidders and buyers to spend more on assessments of the target company and make better bids for the M&A transaction. Due to the Break Fee Agreement, potential acquirers are now assured that they will be given proper compensation for the efforts they made, because of which more and more potential buyers will work for the offer, Hence, increasing the competition for acquisition and providing better options for the target company. However, break fees are considered as deal protection devices that work by choosing one bidder over the other.[9] Its impact on the asset of the target company is negligible, it is capable of potentially wiping out the annual revenue of the target company. This would eventually make the target company less attractive to subsequent bidders. Hence, if the compensation amount is high in Break Fee Agreement, it could serve to reduce competition.

Merger and Acquisition is a once in a lifetime event for most of companies, hence, in any transaction related to M&A, right from the very beginning from conceptualisation to execution of the term and conditions of the contract, the risk of paying a large sum of termination fee as compensation controls the parties from doing any unfair business practice and guarantees that the terms and conditions of the contract will be followed.

Use of Break Fee Agreements in M&A Transactions

Every transaction related to merger and acquisition will be different on their own depending on the situation and facts they are facing in the contract which is largely dependent on the negotiating power of the parties. But basic details which the buyer should keep in mind to claim a Break Fee are;

• That no one would like to be used as a “stalking horse”. Thus, the target company breaks the Agreement of the acquisition and then proceeds with someone else, then in such circumstances, the buyer can seek a break fee.
• If there is any failure to get the vote of approval of the shareholders, approving such transaction.
• If there is any breach of covenants and restrictions by the target company.
• If there is any breach of representation and warranties by the target company.
• If any event occurs resulting in any material adverse change.
• Failure to fulfil material conditions precedent.[10]

IV. Break Fee Agreements in the USA

A remarkable feature of the working of shareholders and shareholding in the US is its dispersed nature because of this the board and management act as  immediate agent for the shareholders and are empowered to take various decisions for determining the outcome of an offer.[11] They have to take these decisions in the best interest of the shareholders which should be in light of the interest of the company as well and should be subject to the owed duties of care and loyalty to the shareholders. The various standards of review according to rules and regulations made by U.S.’s legislative bodies should not be promptly applied in other jurisdictions because of the fact that the nature of shareholding in many other jurisdictions is concentrated and not dispersed and may vary. These jurisdictions are based on the rule of Board Neutrality, which basically finds its origin in the UK, according to which, the shareholders do have the authority of the primary decision-making regarding an offer. The management is supposed to have little to no leeway to enter into any kind of deal protection devices after an offer is made. This can only be done with prior approval of the shareholders, that the management can undertake any such necessary step. A judgment, which is based on the management’s power and freedom for taking decisions as they seem to be fit without shareholder approval, make no sense in these circumstances.[12]

V. Break Fee Agreement in Europe and Asia

The UK works on a system its board its neutrality rule which provides for a de minimis limit to deal with break fees. It works as the standard percentage value of the amount of transaction value against which all break fees are addressed. Apart from the UK, de minimis limits are now used as an accepted basic standards procedure in jurisdictions of Australia, Hong Kong, etc. for regulating rules and regulations in respect to Break Fee Agreements in such countries, however, this has multiple drawbacks and concerns.[13] As they work strictly based on rigidity and certainty over flexibility basis. Even though certainty leads to a more stable market in the economy, flexibility allows the managers to work on a structure that helps in assisting the fee to custom-fit the specific conditions their companies face in various circumstances and, according to the dual nature of break fees Agreements which are as inductive and anti-competitive, the quantitative standard of it is not to be used ideally to differentiate permissibility and acceptance of Break Fee arrangement.

Importing the conceptual basis of de minimis limits to Asia would be against the purpose for which they were introduced in the UK as it is a part of the larger Board Neutrality rule. This rule was created to be introduced in the dispersed shareholding context. In such context due to agency internal problems between managers and minority shareholders, making it affect the management and decision making it tends to take away powers of decision-making from the board’s hand over to the shareholders.  In the Asian market, the shareholding is concentrated on the rule causes concerns between the big and more powerful or the controlling shareholders and the minority shareholders. In various jurisdictions having concentrated shareholding, the managers and the controlling shareholders belong to the same interest group for which shareholders influence the managers. Eventually, this interest group runs against the demands of minority shareholders. Thus, this rule was introduced in the UK for the purpose of the protection of shareholders and has the potential of further benefiting the controlling shareholders’ by granting them greater decision-making power at the expense of minority shareholders.[14]

VI. Break Fee Agreement in India

The conception of a clear stage fee isn’t, for the most part, recognised in any Indian legislation or statute, hence, is being ruled by the terms of the contract of Break Fee Agreement entered into by the parties. Usually, these terms and conditions include:

• Its quantum is of penal nature, it’s seemingly been stricken down in Indian courts. Thus, many parties ought to cautiously with great attention look into this rope and take a look at it to maintain balance so the number of the Break Fee is high enough to act as a deterrent.
• The fee can be received by any non-resident, but in such circumstances, prior approval of the depository financial institution of the Asian nation could also be needed.

It is very important to see that very few of these social control issues are unconquerable and if the right skilled recommendation is used throughout the process of correction and drafting the Terms and conditions, then the parties to the contract will be able to overcome such difficulties easily. There is no Indian law that clearly prescribes the limit up to which the Break Fee compensation amount is permissible and the courts do not have the chance to lay down the law with regard to such Break Fee Agreements.[15]

However, this area has not prevented corporations from together with such clauses in their Agreements. Experts suggest that one of the explanations, the merger negotiations between Swiggy and UberEats failing is the result of the factor that the parties couldn’t agree on the break fee, associate tried acquisition of the US-based Cooper Tire and Rubber Co. by India-based Greek deity Tyres Ltd. concerned a clear stage fee and a reverse Break Fee amounting to $50 million and $112.5 million severally.[16]

When it comes to defensive techniques, the Asian nation follows a strict ‘no frustration rule’. This rule intends to go away the target’s Board engulfed within the wake of a takeover supply, and instead confers the only real decision-making power upon the shareholders. However, administrators have a legal duty towards the stakeholders of the corporate below Section 166 (2) of the Companies Act 2013 which regulates a lot of the part of the rule enforceable in India. It’s during this capability that administrators could introduce Break Fee clauses within the merger Agreement and induce the company to create a better bid.[17] However, this fee must not divest the shareholders of their decision-making power by nudging them towards the company bid.

Therefore, a balance must be stricken between the ‘board neutrality rule’ and a director’s fiduciary duties to see the validity of a clear stage fee. Additionally, the treatment of Break Fee clauses could vary betting on the character of the deal and therefore the styles of corporations concerned in case of a group action between non-public corporations, the character of the deal, being written Agreement, would be ruled by the Indian Contract Act 1872. Since Break Fee is simply owed once a contract is actually ‘breached’, Section seventy-four of the Contract Act is attracted in line with this provision, the courts are unconditional with the facility to grant an affordable compensation, that shall be determined supported the facts of the case.[18]

VII. Indian Regulation of Break Fee Agreements

New hurdles arise once listed entities embody Break Fee clauses in their acquisition Agreements. Such Agreements would return below the measuring system of the Securities and Exchange Board of Asian nation (SEBI) through the Draft Letter of supply (DLOF) filed. it’s so utterly potential for the market regulator to strike down such a fee, vide the comments offered on the DLOF, on the account of it being immoderately high and destitute of any rational nexus with the group action.

Moreover, immoderately high Break Fee might additionally represent ‘financial assistance’ as according to Section 67 of the Companies Act 2013. In line with this provision, it’s unlawful for any public company to grant monetary help in reference to the acquisition of shares. in an exceedingly case regarding Section 151 of Land Corporations Act 1985,[19] that’s equally worded, the court of England and Wales in Paros Plc v. World link cluster Plc, control that the Break Fee did represent monetary help because the fee was smoothing the trail to the acquisition of the shares.

There are 3 restrictions to a break-up fee clause in India:

• Once drafting the letter of supply that contains the break-up fees it should be sent to the SEBI.
• Once either of the parties fails to finish the group action, the opposite party is to indemnify the expenses that are incurred by the party.
• If a group action is to be between a distant entity and an Indian entity and if a foreign entity happens to be a non-breaching entity then the previous approval of the reserved bank is needed to pay the break-up fee to the foreign entity.

VIII. Judicial Pronouncements on Break Fee Agreements

• Apollo-Cooper Deal

Cooper Tire and Rubber Co., an associate company in June 2013 terminated its premature contract with Greek deity tyres Ltd., an associate Indian based mostly company that united to shop for it for $2.5 billion. The rationale Cooper Tire terminated its Agreement was that it absolutely was hip to by the Indian company that they didn’t have enough finance on the market with them to accumulate the corporate. The Indian company skilled that statement by stating that the Cooper tire company terminated the premature Agreement and additional they’d pursue legal actions. Once many months Greek deity united to shop for the corporate for the value of $35 per share. Whether either of the businesses is at risk of pay the break-up fee: it was answered that Cooper was at risk of $50 million and Greek deity was to pay $112.5 million a reverse termination fee.[20] Despite the threat of legal actions, the deal was welcomed by the Greek deity investors and that they purchased the Cooper Company $9 per share. On Gregorian calendar month, thirty Cooper had terminated the supply from the Greek deity before the expiration of the Agreement.

• Microsoft acquisition of LinkedIn

In 2016 the negotiations were created between Microsoft and LinkedIn wherever LinkedIn is to be non-heritable by Microsoft. The Agreement of each of the parties consisted of a “no search clause”. And just in case LinkedIn invited 3rd party emptor throughout the negotiations it’s to pay a break-up fee of $ 725 million to Microsoft. LinkedIn received an associate unsought bid from Salesforce, which is Microsoft’s biggest challenger. If the least bit LinkedIn accepted the Salesforce supply it’d be within the position to pay a break-up fee of $725 million to Microsoft.[21]

IX. Conclusion

Break Fee clause is structured in such the simplest way within the contract that either one in all the parties to the contract must pay to the opposite party all of the expenses that are incurred by the opposite party just in case the group action doesn’t become in. Due diligence ought to be taken whereas drafting a break-up fee clause by the parties to avoid unessential expenses and parties are to rigorously analyse on whether or not a selected group action is lawfully allowable whereas a scarcity of regulation of Break Fee isn’t apparently discouraging corporations from coming together with such devices. SEBI, within the on top of the matter, evaluated the raincoat clause. The courts could also be convinced by the yardstick coming in the way of the raincoat clause whereas decoding such a thing outside the proper space and jurisdiction of the Takeover Code, there exists a huge probability that the happening of such thing would not be satisfactory enough to satisfy the edge of a nonstarter.

This means that the bidder, World Health Organization still favour to stay out of so many such deals, this eventually brings in the risk of payment of the break fees compensation amount as the result. So, for anticipation of any kind of doubt arising in future, it will be considered as to give some important tips to the listed corporations which wish to bring in the Break Fee Agreement clause in their contract. SEBI could take into account announcing and bringing in some important safeguards as this could bring more aid, flexibility and establish a backbone in the regulation of the transactions related to merger and acquisition, hence, Break Fee Agreements needs to be properly addressed by the Indian law-making body as they are nothing else but to a source to give a boost and assist in the process of merger and acquisition in India market.

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[1] Author is a student at National Law University, Odisha, India.

[2] Author is a student at National Law University, Odisha, India.

[3] Break Fees and Broken M&A Deals, https://corpgov.law.harvard.edu/2017/11/15/break-fees-and-broken-ma-deals/ (last visited Apr 9, 2021).

[4] Ministry of Corporate Affairs – Government of India, https://www.mca.gov.in/MinistryV2/ (last visited Apr 9, 2021).

[5] Securities and Exchange Board of India, https://www.sebi.gov.in/ (last visited Apr 9, 2021).

[6] SEC Form S-4 Definition Investopedia, https://www.investopedia.com/terms/s/s4.asp (last visited Apr 9, 2021).

[7] Default Investopedia, https://www.investopedia.com/terms/d/default2.asp (last visited Apr 9, 2021).

[8] – HeinOnline.org, https://heinonline.org/HOL/Welcome?message=Please%20log%20in&url=%2FHOL%2FP age%3Fhandle%3Dhein.journals%2Fucollr70%26id%3D363 (last visited Apr 9, 2021).

[9] (PDF) Merger Agreements, Termination Fees, and the Contract-Corporate Tension | Judd F Sneirson – Academia.edu, https://www.academia.edu/21303170/Merger_Agreements_Termination_Fees_and_the_Contract_Corporate_Tension (last visited Apr 9, 2021).

[10] Acquisitions: The Process Can Be a Problem, https://hbr.org/1986/03/acquisitions-the-process-can-be-a-problem (last visited Apr 9, 2021).

[11] Julian Velasco, The Fundamental Rights of the Shareholder, 40 61 (last visited Apr 9, 2021).

[12] The arbitration epidemic: Mandatory arbitration deprives workers and consumers of their rights | Economic Policy Institute, https://www.epi.org/publication/the-arbitration-epidemic/ (last visited Apr 9, 2021).

[13] Reverse break fees in UK public takeovers Herbert Smith Freehills | Global law firm, https://www.herbertsm ithfreehills.com/latest-thinking/reverse-break-fees-in-uk-public-takeovers (last visited Apr 9, 2021).

[14] Ronald J. Gilson, Controlling Shareholders and Corporate Governance: Complicating the Comparative Taxonomy, 119 Harvard Law Review 1641–1679 (2006) (last visited Apr 9, 2021).

[15] Breakup Fee – Examples, Guide, Penalty for Backing Out of a Deal, https://corporatefinanceinstitute.com/ resources/ knowledge/deals/breakup-fee/ (last visited Apr 9, 2021).

[16] Swiggy UberEats deal: Swiggy, UberEats can’t tally numbers for a deal | Swiggy, https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/swiggy-ubereats-cant-tally-numbers-for-a-deal/articleshow/68731884.cms (last visited Apr 9, 2021).

[17] COMPANIES ACT sec. 166, cl. 2.

[18] INDIAN CONTRACT ACT sec. 74.

[19] LAND CORPORATIONS ACT sec. 151.

[20] Cooper Tire terminates $2.5 bln sale agreement with India’s Apollo CNBC, https://www.cnbc.com/2013 /12/30/cooper-tire-terminates-25-bln-sale-agreement-with-indias-apollo.html (last visited Apr 9, 2021).

[21] LinkedIn CEO Jeff Weiner is OK with Microsoft’s hands-off approach, https://www.cnbc.com/2019/12/27 /linkedin-ceo-jeff-weiner-is-ok-with-microsofts-hands-off-approach.html (last visited Apr 9, 2021).

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