Takeover blog #3: breaking off negotiations

As a member of the Legal Persons & Contracts team, I am heavily involved in assisting in share transactions, both on the side of buyer(s) and seller(s). An acquisition process generally looks as follows:

• Orientation and introduction phase
• Signing confidentiality agreement ('Non Disclosure Agreement','NDA' or 'Confidentiality Agreement').
• Information Exchange
• Valuation and agreement on key points transaction
• Signing letter of intent ("Letter of Intent,""LOI," "Memorandum of understanding," "Heads of agreement" or "Term Sheet")
• Book examination ("Due Diligence Examination" or "DD").
• Signing purchase agreement ('Share Purchase Agreement' or 'SPA').
• Passage of deed of delivery ('Closing').

In a series of blogs over the next few weeks, I will focus on a lawyer's role in this process, highlighting the most important transaction documents. I pay attention to the place of the relevant transaction documents in the acquisition process, pointing out the main concerns and pitfalls.

Previously, I zoomed in on the non-disclosure agreement and the letter of intent. Next in line is the book review (vi), but given that I get a lot of questions about etiquette in ongoing negotiations during the COVID-19 crisis, in this blog I focus on the pre-contractual phase.

How are we doing?

Time will tell if, and if so to what extent, the COVID-19 crisis will have structural repercussions in takeover country. However, previous (global) crises do not bode well: unfortunately, in times of crises, certain acquisitions not infrequently turn out differently than previously hoped. Today the second quarter expires. The first quarter of 2020 marks the COVID-19 crisis in the global merger and acquisition market. Compared to the first quarter of 2019, globally not only the number of transactions declined (-16%) but also the total deal value (-18%).[1] The balance sheet for the second quarter will be taken in the near future.

Precontractual phase: breaking off negotiations

Negotiations in transactions can take a long time. During those negotiations, parties can break off negotiations. If that happens by agreement between buyer and seller, nothing is wrong. Things get more tense if either party breaks off negotiations while the other party is happy to continue negotiations. That scenario has been no exception since the outbreak of COVID-19. May negotiations be broken off without question as a result of the COVID-19 crisis?

The short answer is: no. Indeed, the Supreme Court has ruled on this point that each of the negotiating parties, who are obliged to have their conduct determined in part by each other's legitimate interests, is free to break off negotiations, unless this would be unacceptable on the basis of the other party's legitimate expectation of the conclusion of the agreement or in connection with the other circumstances of the case. In other words, in principle, parties may walk away from the negotiating table unless.... The latter is more likely if the parties had reached agreement on the essentials of the purchase agreement (think: purchase price and which shares are being sold). The further advanced the negotiations are, the sooner it is unacceptable to break off negotiations.

Consequences of aborted negotiations

What is the consequence of unauthorized interruption of negotiations? Roughly speaking, there are two flavors: (a) damages are due or (b) there is an obligation to continue negotiating in order to reach a final agreement. The first option may be interesting because in 1982 the Supreme Court opened the door to claim as damages not only the negative contract interest (the negotiation costs incurred) but also the positive contract interest (the lost profits). Precisely because of compensation for the positive contract interest, it may be interesting to sue the abortive party for damages. However, it should not be cheered too soon, because the award of damages in the form of lost profits has so far only been awarded in a handful of cases.

Damage can be mitigated at the front end

Proceedings over aborted negotiations can be costly. To avoid this, it is advisable to make agreements at the front end of the negotiation process about the (financial) consequences if either party breaks off negotiations. An effective instrument for this is thebreak-fee ortermination fee. From the buyer's point of view it can be interesting to agree that the target company must pay a fee to the buyer if the seller breaks off negotiations. First, because this compensates the buyer for (part of) his negotiation costs. Second, because this gives the seller an incentive to make a deal with the buyer. Thirdly, this construction has a deterrent effect for possible hijackers on the coast. After all, taking over a company with a (substantial) payment obligation on the balance sheet to a prospective buyer because negotiations have run aground is not very attractive, especially if the compensation is high enough (also called a "poison pill" ). Incidentally, even in this COVID-19 crisis, such clauses are in principle simply enforceable.

Are you facing an opposing party who wishes to break off negotiations or are you the party who wishes to break off negotiations? Do not hesitate to call to determine your legal position.

[1] Allen & Overy, M&A Insights Q1 2020, Confronting the Unknown, p. 2.