Bare but not unfair: Court approves naked no vote break fee

In brief

• Naked no vote break fees are generally not seen in public M&A deals — according to our data, they have not featured in any deals in the last five years and only two deals in the last ten years.
• In the recent Ausmincon / Afry scheme, the Court reconfirmed that, as a matter of principle, naked no vote break fees are not necessarily coercive and need not be de minimis. A naked no vote break fee equal to the Takeover Panel’s 1% guidance is not, of itself, unfair if it is not so large as to have a coercive effect on shareholders.
• Importantly, the circumstances in which Ausmincon agreed to the naked no vote break fee (including that the deal was initially intended to be structured as an asset sale) were a key basis for the Court finding that it was not an impediment to convening the scheme meeting.

Background

A break fee is a fee payable by the target to the bidder if the transaction does not proceed due to an action or inaction by the target. A ‘naked no vote’ trigger is where the fee becomes payable if the transaction fails because target shareholders do not approve it.

Naked no vote break fees are not a traditional feature of public M&A deals. Even where agreed, they are often set below 1% of the target’s equity value. We attribute this to a few factors:

• target boards are mindful of the potential coercive effect on shareholders when voting on the transaction;
• scheme voting thresholds are tested against the number of votes actually cast, meaning a dissenting minority shareholder can influence the outcome of the vote (and therefore the break fee). Put another way, the break fee trigger is outside the target board’s control;
• Takeovers Panel guidance suggests that a 1% break fee may be unacceptable if triggered on a naked no vote; and
• the fact that naked no vote break fees are rarely agreed, together with the Panel’s guidance, has reinforced the perception that such fees are off-limits (or at least that there is little precedent supporting them).

In the recent Ausmincon / Afry scheme, AFRY AB (Afry), a Swedish listed engineering company, sought to acquire Ausmincon Holdings Limited (Ausmincon), an unlisted Australian mining consultancy.  Afry had expressed a strong preference to acquire Ausmincon by way of private sale with all the protections, warranties and indemnities that accompany a private M&A transaction.  When Ausmincon insisted on a scheme, Afry agreed on the condition that there was a naked no vote break fee.

The agreed fee was $1 million — just over 1% of Ausmincon’s equity value (based on total scheme consideration of $99,998,986).

Not an impediment to convening the scheme

When considering a scheme, Courts sometimes observe that a break fee that does not include a naked no vote trigger will not be coercive. But these comments, often made in passing to acknowledge that the issue does not warrant further consideration, do not mean that Courts will not entertain naked no vote break fees in appropriate cases.

In the Ausmincon / Afry scheme, the Court noted that, while naked no vote break fees are uncommon, the Court and the Panel have considered them in a few instances, identifying the key precedents as follows.

From these authorities, the Court distilled three key principles:

• naked no vote break fees are not necessarily coercive, but may be unacceptable if sufficiently large to be coercive; 
• a naked no vote break fee does not need to be de minimis. Relevant factors to consider when assessing the quantum include:
  • the bidder’s likely costs; 
  • the probability that shareholders will approve the deal;
  • whether the break fee can be easily funded by the target company’s cash reserves; and
  • whether the naked no trigger is essentially the price of buying the opportunity for the target shareholders to vote on the deal; and
• the absence of a reciprocal reverse break fee does not mean that a naked no vote break fee is unfair.

Applying the above, the Court concluded that the naked no vote break fee was not an impediment to convening the Ausmincon scheme meeting.

Where to from here?

The judgment reconfirmed the longstanding (but sometimes forgotten) position that Courts are open to naked no vote break fees in appropriate circumstances.

Here, a few key factors supported the Court’s conclusion:

• price of the opportunity: the deal was initially structured as an asset sale and only shifted to a scheme at the target’s insistence, making the fee effectively “the price of buying the opportunity” to put the proposal to shareholders. The Court acknowledged this scenario was “a little unusual”;
• bidder’s costs: the costs incurred by the bidder at the date of signing already exceeded the value of the break fee;
• risk of payment: the Ausmincon board considered shareholder approval likely, so the risk of paying the break fee was low; and
• cash on hand: Ausmincon had sufficient cash on hand to pay the fee without causing financial stress, limiting any coercive effect on shareholders.

The absence of a reciprocal naked no vote reverse break fee was not fatal.

Break fees are always a heavily negotiated feature of M&A deals. While this decision may embolden some bidders to revisit naked no vote triggers, our guess is that these sorts of break fees are unlikely to become widespread. However, it does serve as a good reminder that naked no vote fees are not entirely off-limits and can be appropriate in the right circumstances.