Summary

Perpetual’s proposed acquisition of Pendal for cash and scrip via scheme of arrangement took an interesting turn when Perpetual itself became the subject of a control proposal.  That brought into sharp focus the terms of the SID and saw many offer opinions on whether (and the consequences of) Perpetual walking. The parties couldn’t agree on that either so they asked the NSW Supreme Court to resolve it. The Court said the SID did not exclude Pendal’s right to specific performance or injunctive relief, even if Perpetual breached the SID to pursue a “Perpetual Major Transaction” or otherwise did not proceed with the scheme. The decision is a good reminder for bidders and targets to ensure they know what they’re getting with a reverse break fee – ie whether the fee is a monetary cap or the sole remedy for a particular breach by the bidder (including where the bidder walks, invalidly).  It also highlights the need to identify and negotiate upfront any off-ramps a bidder requires to be able to pursue an alternative opportunity, but we expect that will continue to only be entertained by targets on particular transactions like mergers of equals.

Background

Following months of engagement, Perpetual Limited (Perpetual) and Pendal Group Limited (Pendal) entered into a Scheme Implementation Deed (SID) in August under which Perpetual agreed to acquire Pendal for scrip and cash via a scheme of arrangement (Scheme). 

Concerns about the merits and terms of the deal became increasingly vocal after it was announced, as arbitrage funds piled into the stocks, and Perpetual’s share price continued to slide.

Then – as some stakeholders questioned whether the deal would proceed and others demanded that it didn’t – on 3 November, Perpetual itself received an all-cash control proposal from a consortium comprising Regal Partners and BPEA EQT (who had agreed to split Perpetual’s assets if successful).  That and a subsequent revised proposal from the Regal consortium, both conditional on the SID being terminated, were swiftly rebuffed by Perpetual.

Whether Perpetual could walk from the SID with Pendal, and the consequences if it did, became the subject of comment and speculation in the media, with some suggesting Perpetual could walk – it would just need to pay the $23m reverse break fee.

At the time this all took place, Perpetual had not yet signed the deed poll  in favour of Pendal shareholders (which a bidder is typically required to sign before the first court hearing) under which Perpetual undertakes to pay the scheme consideration to the Pendal shareholders upon the Scheme being implemented. 

Supreme court declaration

The parties disagreed on the answer to that question which – in the parlance of the SID – was what would happen if Perpetual breached the SID to pursue a “Perpetual Major Transaction” or otherwise did not proceed with the Scheme (even if that’s what Perpetual’s directors’ fiduciary duties were considered to require)? 

Pendal’s position was that it could seek specific performance or injunctive relief (eg, compel Perpetual to complete or prevent it from progressing another transaction).  Perpetual disagreed, believing Pendal could collect the $23m reverse break fee and terminate the SID and that all other legal remedies Pendal may have had were excluded.

The parties asked the NSW Supreme Court to resolve the matter by making a declaration, which turned on the construction of two clauses in the SID. 

First clause – consequences of pursuing a “Perpetual Major Transaction”

Perpetual was subject to exclusivity restrictions in the SID in respect of a “Perpetual Major Transaction”, a concept which could cover a broad range of transactions, from a person acquiring 20% of Perpetual to a transaction requiring Perpetual to abandon the Scheme. 

Perpetual had a “fiduciary-out” to the “no-talk” restriction, but it did not have the right to terminate the SID to pursue a “Perpetual Major Transaction”, even if that’s what the Perpetual directors’ duties were considered to require.

Clause 11.8(f) addressed the consequences of Perpetual breaching the SID in those circumstances:

“For the avoidance of doubt, Perpetual is not entitled to terminate this document in order to pursue, agree or implement a Perpetual Major Transaction. If Perpetual breaches this document in a manner which causes implementation of the Scheme to become impossible or impracticable, or otherwise materially breaches this document in order to pursue, agree or implement a Perpetual Major Transaction, Perpetual must pay to Pendal the Liquidated Damages Amount by way of liquidated damages, even if Perpetual’s Board determined that the breach was required in order to fulfil the fiduciary or statutory duties of the directors of Perpetual. The parties agree that the loss which would be incurred by Pendal as a result of that breach are of a nature that they cannot be accurately quantified and that the Liquidated Damages Amount is a genuine pre-estimate of that loss. Nothing in this clause limits Pendal’s right to terminate this document under clause 16 which might arise as a result of any breach to which this clause relates.”

Justice Black sided with Pendal finding that this clause did not exclude other legal relief (beyond the payment of the agreed reverse break fee) in the circumstances contemplated for the following reasons:

• The authorities show a liquidated damages clause will not ordinarily, without more, exclude other remedies. 
• The liquidated damages amount was $23m, the same as the reverse break fee, which per the ‘reverse reimbursement fee’ moniker given to it in the SID was designed to compensate Pendal for its transaction costs.  It was not intended to compensate Pendal shareholders for any loss of the opportunity afforded by the Scheme.
• Perpetual has no right to terminate the SID to pursue a “Perpetual Major Transaction”, even if its board formed the view that doing so is what their fiduciary duties required.
• An injunction (for instance) may be able to stop a breach from developing the characteristics required to trigger payment of the liquidated damages amount, so why would such relief be excluded under the SID? 

That is, the liquidated damages amount was only payable if Perpetual breached the SID to pursue a Perpetual Major Transaction, where the breach made implementing the Scheme “impossible or impracticable” or was otherwise “material”.  Justice Black reasoned that a breach could be prevented from having those characteristics by, for example, an injunction, so there was no reason for the clause to exclude interlocutory or other relief.

• The clause does not expressly exclude other relief, and the SID included a clause to the effect that the rights and remedies in the document were in addition to other rights and remedies at law.

Second clause – reverse break fee limitation of liability

The SID included a reverse break fee, which required Perpetual to pay Pendal $23m if Pendal terminated the SID due to a Perpetual material breach or a failure of Perpetual to pay the scheme consideration. 

There was a limitation of liability attached to the reverse break fee in clause 13.8:

“Notwithstanding any other provision of this document:

(a)   the maximum liability of Perpetual to Pendal under or in connection with this document including in respect of any breach of this document will be the amount of the Reverse Break Fee; and

(b)   the payment by Perpetual of the Reverse Break Fee represents the sole and absolute liability of Perpetual under or in connection with this document and no further damages, fees, expenses or breaks of any kind will be payable by Perpetual under or in connection with this document,

except that nothing in this clause limits Perpetual’s liability for fraud or following the Scheme becoming Effective, a breach of clause 4.1(c) or under the Deed Poll.”

On paragraph (a), Justice Black said the reference to “maximum liability” was a cap on the payment of money.

And on paragraph (b), his Honour reasoned that:

• The exclusion of “liability” did not, on its proper construction, exclude any other remedy or relief (ie it was not couched as an exclusion of other “obligations” or “remedies”); and the express exclusion of “further damages, fees, expenses or breaks” was not inconsistent with the grant of other relief.
• The limitation of liability is conditional on the reverse break fee being triggered and paid (though even if it were paid that would not exclude the possibility of other relief).
• The reverse break fee is about Perpetual’s liability to Pendal.  It is not intended to compensate and cannot extinguish any claim for relief for the benefit of Pendal shareholders if the Scheme did not proceed.

Declaration of the Court

The Court found that the SID did not exclude Pendal’s right to specific performance or injunctive relief.  That’s not to say that Pendal could obtain those remedies but rather that they are not contractually excluded.

It is important to remember that, while the Court sided with Pendal, its declaration made it easier for Perpetual to reconfirm its commitment to close the transaction.  Unless a transaction emerges which Perpetual finds more compelling, the Court’s decision does not stand in the way of Perpetual’s preferred outcome, being the Scheme to acquire Pendal.  It may also reduce the likelihood of that predicament eventuating, by deterring bidders for Perpetual who consider whether (and the cost at which) the transaction can be stopped too uncertain.

Even though the Court would confirm Pendal could seek orders compelling Perpetual to proceed with the Scheme on the agreed terms – to make the transaction more attractive to shareholders in both companies – the parties agreed to re-cut the terms to increase the scrip consideration and reduce the cash consideration, so the merged entity would have less leverage (but the overall implied value of the offer would be unchanged based on Perpetual’s undisturbed share price).  Accordingly, while the decision may be thought to show the sanctity of the SID, that’s not to the exclusion of the hearts and minds of shareholders.

Observations

A bidder will be legally bound to perform its obligations under a SID, unless it has a right to terminate.  For instance, because a condition has failed (eg a “MAC” or regulatory approval) or termination right has been engaged (eg target’s material breach of a SID restriction, financing condition or warranty).  That may seem an obvious observation, and it is, but one worth starting with given recent binding transactions that have been abandoned (eg Latitude and Humm “mutually agreed” to terminate the sale of Humm’s consumer finance business to Latitude due to disruption in financial markets), renegotiated (eg Dye & Durham’s proposed acquisition of Link) or in which the bidder has tried to walk (eg Elon Musk’s acquisition of Twitter).  

If those circumstances are not present, and they were not contended to be here (unlike in Elon Musk’s bid for Twitter), a bidder’s options to terminate are usually quite limited and need to have been specifically identified and negotiated upfront.

Fiduciary override

Can a bidder walk to pursue another deal if that’s what the bidder’s directors consider their fiduciary duties to require?  Only if the contract says so.  That is, there is no general principle of law (or requirement) that a company’s obligations under a contract are subject to what its directors consider to be their fiduciary duties.  When a company enters into a SID its directors are required to assess whether doing so complies with their duties, including whether securing the opportunity afforded by the contract is “worth” any restriction the SID places on them (including regarding their ability to pursue another opportunity). 

It is standard for a target to have the right to terminate a SID to pursue a superior rival proposal where required by its directors’ fiduciary duties (and the process in the SID has been followed, including any bidder matching rights being exhausted).  The bidder has put the target in play with a price to beat making the prospect of an interloper very real (as shown by the frequency of contested situations) and the target’s requirement for a mechanism to honour its duties in such a situation (and when it will have to pay a break fee) is the price to be paid to secure a recommended transaction.

It is much less common for the bidder to have a corresponding right.  Where the bidder is a financial sponsor bidding through an SPV, or the bidder is a materially larger corporate such that a control proposal for it will not necessarily be inconsistent with the acquisition it has agreed to make, the absence of a corresponding right will usually be uncontroversial.  It becomes more controversial where, for instance, the bid is for scrip (such that the transaction implies a value for the bidder to the market relative to the target) and the transaction is, or is close to being, a “merger of equals” (allowing the bidder to make a philosophical case for reciprocity).

Pendal and Perpetual shareholders were expected to own approximately 47% and 53% of the combined group (respectively) when the SID was signed, so the deal was certainly in the territory where whether Pepertual had a corresponding right to terminate based on its fiduciary duties would have been an important negotiating point (especially given Perpetual had received approaches).  The parties had clearly turned their minds to this exact scenario and had explicitly agreed the Perpetual would not be able to terminate the SID should a better deal for its shareholders eventuate.

Reverse break fee

A reverse break fee is designed to compensate the target for losses caused by the deal failing due to (usually) the bidder’s material breach and (sometimes) the failure of a particular condition or other matter.  It gives the target a clear and efficient mechanism to recover a fixed amount, rather than having to make a contractual claim for damages.  Remembering that, while damages are designed to put a person in the position they would have been had the contract been performed, the target’s shareholders are not party to the SID, and so the loss to be compensated for a breach is that of the target company (ie its transaction costs and expenses) rather than the target’s shareholders (ie the opportunity / transaction premium), who are likely to suffer significant loss.   

It may also be considered to enhance deal certainty by giving the bidder another reason to comply with its obligations.  The extent to which it does that will depend on the quantum of the fee (which need not comply with the 1% rule of thumb like a target break fee but does need to be set with regard to the law of penalties) – that is, whether it presents a real financial disincentive to the bidder, should the bidder decide it no longer wants to proceed with the deal. 

The trade-off for a reverse break fee is the corresponding limitation of liability/remedy, with the key question then being whether the limitation is a monetary cap or provides the sole remedy for a particular breach, as was tested in Perpetual/Pendal.  If, unlike in Perpetual/Pendal, the reverse break fee is accompanied by a clear sole remedy clause, the fee could be used as an option fee (especially if it’s around the 1% mark) to get out of the deal by breaching the SID.

While there are numerous combinations and the particular terms matter, key formulations of reverse break fees in SIDs, for simplicity, are as illustrated in the table below (with a quantum greater than 1% applying pressure to push to the left of that continuum). 

Reverse break fee in SID	“Bidder friendly” (ie ‘Option Fee’)	“Neutral”	“Target preferred”
Monetary cap?	Y	Y	Y
Sole remedy?	Y	N	N
Cap/sole remedy excludes intentional breach?	N	N	Y
	Capped fee. No other recourse.	Capped fee. But potential for specific performance.	Capped fee. But potential for specific performance and uncapped fee if breach is intentional.

Deed poll

The SID is an agreement between the bidder and the target.  Accordingly, any contractual claim for damages for breach of a SID by a bidder is one that a target would have to bring.  Damages for breach of contract are designed to put the non-breaching party in the position they would have been in had the contract been properly performed. 

In the context of a SID, the loss that a target (as opposed to target shareholders) suffers for breach of the SID is likely to be confined to the costs and expenses it has incurred in pursuing the proposed transaction.  That is because it is the target shareholders, rather than the target, that suffers the real financial harm if a bidder breaches a SID and the target’s share price falls materially.

The contractual exposure of the bidder to target shareholders changes once the bidder signs the deed poll in favour of target shareholders, which is usually required to be done just before the first court hearing.  The deed poll binds the bidder to the terms of the scheme of arrangement.  This means that the bidder’s obligations under the scheme – typically to pay the scheme consideration and take necessary steps to implement the scheme – are enforceable by target shareholders (as well as the target) once the conditions to the deed poll are met.  Those conditions are usually that the scheme has become effective, which requires target shareholders to have approved the scheme by vote at the scheme meeting and the Court to have made orders (then lodged with ASIC) approving the scheme at the second court hearing.  Where this has occurred, target shareholders would have direct contractual recourse against the bidder if it failed to perform its obligations under the scheme. 

For the target shareholders, they would have received the scheme consideration if the bidder had performed its obligations under the scheme.  Accordingly, their contractual loss for damages would be measured by the difference between the scheme consideration and the price at which they are able to sell their shares following them learning about the breach – which, presumably, would be at a material discount to the scheme consideration. 

Key takeaways

• If a bidder wants to be able to walk to pursue an alternative opportunity (including where it considers that to be in the best interests of its shareholders), then it needs to negotiate a clear pathway to do so.  That could be in the form of a termination right, or a sole remedy and limitation of liability clause the effect of which is that if the bidder breaches the SID to pursue an alternative opportunity its only liability will be to pay a monetary amount (with no exposure to any other remedies).
• We expect requests for this right will continue to only be entertained by targets where it is a merger of equals (or close to it), a reverse takeover or perhaps where the bidder has already been the subject of approaches.  
• On the other hand, a key focus for targets will continue to be ensuring the SID preserves their ability to seek specific performance or injunctive relief if the bidder breaches, and ideally to have uncapped recourse where the breach is wilful or intentional.  Of course, the rights a target has secured in a SID to recover loss from, and force the compliance of, a bidder will be of little utility if, as a practical matter, it won’t be able to pay, so funding certainty (and direct rights against funding sources) will remain paramount. 
• We may also begin to see requests for more express and tailored specific performance clauses, like those seen in the US, which prescribe pre-requisites to a grant of specific performance, like having funding secured.