Reverse break fees payable upfront - The new name of the PRC M&A game

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14 January 2013

"THE PERSON WHO SAYS IT CANNOT BE DONE SHOULD NOT INTERRUPT THE PERSON DOING IT"

(Chinese proverb)

In the recently announced acquisition of Talison Lithium, Chinese bidder Chengdu Tianqi Industry Group has shown an astute appreciation of the competitiveness of the M&A game in gazumping the existing offer by US Rockwood Inc., and in agreeing to pay a reverse break fee as an upfront deposit. This innovative structure may be something to watch in 2013 as, faced with market unease about foreign government regulatory conditions and foreign court action, targets seek some form of protection against the risk of bidders walking away from a deal.

On 20 November 2012, private Chinese group Chengdu Tianqi Industry Group announced its bid for Talison Lithium Limited (a company incorporated in Australia and listed on TSX) – already the subject of a proposed scheme of arrangement with Rockwood Holdings Inc (see our previous Thinking Piece Chinese investment a new bolder approach).  On 6 December 2012, Talison announced that it had reached agreement with Tianqi to acquire Talison as Tianqi’s bid constituted a superior proposal to the Rockwood bid. 

In gazumping Rockwood’s existing offer for Talison, Tianqi has shown an astute appreciation of the competitiveness of the M&A game by:

  • a market raid of a 14.99% stake in Talison, with an option to purchase up to 19.99% subject to FIRB approval (rare since Chinalco’s raid on Rio but not as problematic since Tianqi was not an SOE);
  • offering a 15% premium to the consideration offered by Rockwood,
  • making a bid subject to minimal conditions (Tianqi had already obtained PRC regulatory and FIRB approvals when it went public with the proposal); and
  • agreeing a reverse break fee of US$25 million paid upfront into a trust account in Australia.

Under the Talison Scheme Implementation Agreement (attached to the Scheme Booklet, released to TSX on 7 January 2012):

  • a break fee of US$25 million will be paid by Tianqi to Talison, if Tianqi fails to obtain financing or fails to deliver payment to Talison security holders as required in accordance with the scheme; and
  • a break fee of CA$8.4 million will be paid by Tianqi to Talison, if Tianqi otherwise materially breaches an obligation under the Scheme Implementation Agreement 

In both cases the payment is required in circumstances where Tianqi has been directly or indirectly restrained by an order or direction of a court or PRC regulatory authority.

In obtaining PRC regulatory approval prior to approaching Talison, Tianqi had the necessary approvals in place to make this payment. 

In addition to the Tianqi bid, of the nine public M&A deals by PRC companies in 2012, two PRC transactions have included reverse break fees – Hanlong (Africa) Mining Investment’s bid for Sundance Resources and Linyi Mining Group’s bid for Rocklands Richfield Limited – both conditional on PRC regulatory approvals. Previously, there has been some question as to whether a PRC bidder is empowered to enter into binding agreements to pay a reverse break fee without PRC regulatory approval to do so – effectively making such a commitment worthless unless supported by some form of on-demand security.

In the protracted takeover of Sundance by Hanlong (Hanlong has been attempting a takeover of Sundance since July 2011) the renegotiated scheme implementation agreement, following the reduction in offer price from AUD0.57 per share to AUD0.45, provides for a reverse break fee.  Under the renegotiated scheme implementation agreement, Hanlong must pay a break fee (approximately 1% of the equity value of Sundance) to Sundance if Hanlong materially breaches the agreement or if Hanlong attempts to reduce the scheme price.  Given the uncertainty about the enforceability of a reverse break fee without PRC regulatory approval, Hanlong’s obligations under the scheme implementation agreement are supported by a parent company guarantee.  However, the parent company guarantee (which would also require PRC regulatory approval) is conditional on approval from the State Administration of Foreign Exchange (SAFE) – making the reverse break fee in this case somewhat illusory.

To deal with the uncertainty of a PRC company’s ability to give a guarantee (including a reverse break fee) in cases where PRC regulatory approval is still required, we have seen examples of targets seeking some form of on-demand security from a bank as support for the bidder’s obligations.  In Jinchuan’s bid for Metorex (a company listed on the JSE) in 2011 in which Jinchuan outbid Vale for the company, Jichuan’s reverse break fee (payable if PRC regulatory consents were not obtained by a longstop date) was supported by an irrevocable and unconditional bank guarantee in favour of Metorex from the Johannesburg branch of the Bank of China.

The Talison break fee / deposit is one step better. Clearly, funds in the bank means that Talison (depending on the terms of the Deposit Agreement which has not been disclosed) does not need to rely on enforcement of a contractual provision against a foreign entity which might have limited financial resources in the jurisdiction.

The deal structure also provides some protection in situations like those in the Flinders Mines proposed takeover offer by a Russian steel maker which fell through following legal action from a shareholder. Magnitogorsk Iron & Steel Works OJSC terminated its scheme implementation agreement in relation to the $554 million proposed takeover.

As noted in our 2011 M&A Year in Review (see M&A – Year in Review 2011), we are increasingly seeing targets seeking to allocate completion risk between the target and bidder. In 2011 nearly 30% of our deal sample included a reverse break fee (typically payable upon breach of the implementation by the bidder). In our 2012 M&A review (soon to be released) we have seen reverse break fees in 50% of deals where the bidder and target entered into an implementation agreement.  In the context of Hanlong’s bid for Sundance (and its difficulties in securing finance), the reverse break fee agreed by Tianqi must provide Talison with comfort against any potential risk of Tianqi not securing financing for the bid.  A reverse break fee is not as bidder friendly as a financing condition which would allow a bidder to walk away from the deal if financing could not be obtained – and for this reason, it is uncommon for targets to agree to such conditions. However, in this case the reverse break fee does provide Tianqi with a certain degree of optionality, in effect enabling it to walk away from the deal  - but for a price.

In a market where shareholders are becoming increasingly vocal about realising the gains of a takeover premium, a bidder may increase the likelihood of target board engagement where the board can point to tangible deal completion protections.  Obtaining PRC regulatory approvals prior to making a bid and agreeing to the payment of a reverse break fee upfront may provide PRC companies with the edge they need to compete in public M&A and provide comfort to target boards which are unwilling to risk heading down the same path as Sundance.  Clearly some private PRC companies can simply do it and get the deal done.

Further analysis on PRC deals for 2012 and what really matters to bidders and targets in doing an M&A deal will shortly be released as part of the Corrs 2012 M&A Year in Review – the deal survey with a difference. 




The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.


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