Is a break fee the only remedy if you walk away from a scheme of arrangement?

A scheme of arrangement is by far the most common way of implementing a recommended takeover of a listed entity, but what if a bidder drops out? This is a particularly hot topic, in light of Elon Musk’s failed attempt to walk away from the acquisition of Twitter, and one which has so far been unclear.

A recent decision of the NSW Supreme Court has shed light on this important question for the first time: can a bidder walk away from a scheme, limiting its liability to a break fee amount, or would a court hold it to the transaction and force it to proceed? (Re Pendal Group Limited [2020] NSWSC 1575).

Why would a bidder abandon a takeover?

Although the transaction may commence with everyone intending it to complete, things might change unexpectedly along the way. For example, the bidder may decide that it no longer wishes to proceed with the transaction because it may be acquired or it is proposed to be acquired by a new owner who does not wish to proceed. Alternatively, the bidder may no longer have the funds necessary to complete the transaction. To address these possibilities, a Scheme Implementation Deed (SID) is often used to require a bidder to pay a liquidated sum (called a break fee or reimbursement fee) if it walks away from the transaction.

The Perpetual/Pendal transaction: just the break fee?

On 25 August 2022, Perpetual Limited announced that it had entered into a SID with Pendal Group according to which it would acquire all the shares in Pendal through a scheme of arrangement. The consideration to Pendal shareholders would be a combination of cash and Perpetual shares.

Between November 3 and November 10, the hunter became the hunted. Perpetual received unsolicited offers from a consortium to acquire all of its shares, first for $30 and then for $33 per share. The offers were conditional on the scheme of arrangement (by which Perpetual would acquire all Pendal shares) not proceeding. Both offers were rejected by Perpetual's Board.

Although rejected, the offers sparked understandable concern that Perpetual may walk away from the Pendal transaction. The SID required Perpetual to pay a break fee of $23 million to Pendal if it walked away, but clause 13.8 set “the maximum liability” for breach of the SID at the amount of the break fee. The question for the Court was whether the two clauses in the SID excluded the right of Pendal to specific performance or injunctive relief, if Perpetual had:

• breached the SID;
• indicated it would do so; or
• had otherwise determined not to proceed with the scheme.

Importantly, Justice Black found that clause 13.8 of the SID did not exclude Pendal’s right to seek specific performance, with the “maximum liability” contemplated in the provision relating to a "cap on a money payment" that could not be applied to exclude, for example, the grant of an injunction or an order for specific performance. While any such order is a remedy that may or may not be granted at the Court's discretion, this meant that if Perpetual walked away from the transaction, Pendal's remedies would not necessarily be limited to the break fee.

Reliance on market precedent clauses and inconsistent drafting

Following a record-breaking year of M&A activity, the ASX has been flooded with forms of SIDs from major law firms which are largely based on the same or similar terms. Accordingly, parties must ensure the SID reflects their intentions and objectives, and specifically negotiated clauses do not operate inconsistently with other standard terms in the agreement.

This can be seen from the Perpetual proceedings, where the outcome turned on the wording of inconsistent provisions. Had the parties negotiated a clear pathway for Perpetual to exit in the event of a “Perpetual Major Transaction”, then the outcome may have been different.

Scheme of arrangement had not yet become effective and a bidder’s liability

In the Perpetual/Pendal transaction, the deed poll (which allows the shareholders of the target to enforce the terms of the transaction against the bidder) had not been entered into by Perpetual and the scheme of arrangement had not yet become effective. In these circumstances, there is a common perception that a bidder’s liability until this point in time will be limited to payment of the break fee. However on this point, the Court noted that:

• the break fee may compensate Pendal but does not compensate its shareholders for missing the opportunity to receive cash and Perpetual shares in consideration for their Pendal shares;
• that loss to Pendal shareholders “can potentially be averted by an action by Pendal in specific performance or by injunctive relief, at least in an appropriate case”;
• the “academic commentary and the case law recognises that, in a case where one party has a contractual right (relevantly Pendal) and a third party (relevantly, Pendal shareholders) will suffer loss, that is more readily a situation where specific performance would be ordered”; and
• “[e]ven if were difficult to obtain specific performance, a narrower prohibitive injunction or a narrower mandatory injunction … may be available”. On this last point, his Honour gave the example of an order that Perpetual execute the deed poll for the transaction.

Although the Court here was not asked to consider whether such specific performance would be granted, it does open up the possibility of a scenario where a bidder is required to sign the deed poll, proceed with the transaction and then ultimately be liable for the entire scheme consideration should the scheme become effective. When a scheme becomes effective, a bidder unwilling to perform their obligations under the scheme may be exposed to liability for an amount in addition to the break fee and/or for the total scheme consideration via the following means:

• the target or the target shareholders may obtain an order for specific performance of the deed poll, thereby requiring payment of the entire scheme consideration; or
• alternatively, the target shareholders may be able to sue the bidder under the deed poll for the difference between the market value of their shares on the Implementation Date and the Scheme Consideration.

The outcome may be different where the bidder is unable – as opposed to unwilling – to proceed (where, for example, the bidder's finance arrangements fall through). In that case, the court may not be willing to approve the scheme or order specific performance as it may be futile to do so.

Making an unsolicited offer

The Perpetual decision also serves as a warning to a party who is seeking to intervene by making an unsolicited offer after a SID has been entered into. Prior to this decision, a party seeking to make an unsolicited offer in those circumstances may have believed the maximum liability they would face (as the potential new owner of the bidder company) would be the break fee specified in the SID. A consequence of this decision is that a person planning to make such an offer will now need to consider the possibility that their liability encompasses all of the bidder company's liabilities, which may include being subject to Court orders of specific performance or injunctive relief, along with liability to pay damages to the original target shareholders.

Fiduciary out clauses

The Perpetual/Pendal decision involved a bidder potentially walking away from a transaction, as opposed to a target. It is common for the SID to permit the target's board to withdraw its recommendation of the transaction in certain circumstances, including where a superior offer is made for the target's shares. It has also been well established by the Takeovers Panel that a target company should have a “fiduciary out” right in both pre-deal exclusivity arrangements and the SID. This is to allow the target directors to sufficiently respond to or accept a superior proposal, where required by their fiduciary duties.

The bidder does not usually have an equivalent right, raising the question of whether a fiduciary out clause should exist for the bidder. This is particularly the case where part or all of the consideration is for scrip and the transaction is, or is close to being, a “merger of equals” (which was the case in Perpetual/Pendal).