What Is Fiduciary Out?
A fiduciary out is a critical provision found in definitive agreements for mergers and acquisitions (M&A) within the broader category of corporate law and deal protection measures. This clause permits a target company's board of directors to terminate an existing acquisition agreement or withdraw its recommendation for the transaction without incurring certain penalties, if failing to do so would breach their fiduciary duties to the shareholders. Typically, this provision is invoked when a genuinely superior proposal emerges from a third party or if unforeseen material events arise that make the original deal no longer in the best interest of the company's shareholders. The fiduciary out allows the board to uphold its primary obligation to maximize shareholder value.
History and Origin
The concept of a fiduciary out has evolved significantly through legal precedents, particularly in jurisdictions like Delaware, which is a leading state for corporate law. Its development is deeply intertwined with the establishment of directors' fiduciary duties. A pivotal moment in this evolution was the landmark 1986 Delaware Supreme Court decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.5. This ruling established what are often referred to as "Revlon duties," which mandate that when a sale or breakup of a company becomes inevitable, the board's primary duty shifts to obtaining the highest price available for the stockholders. This legal principle underscored the necessity for boards to retain flexibility, even after signing a merger agreement, to consider better offers to fulfill their obligations. Consequently, the fiduciary out became an essential tool for boards to navigate competitive bidding scenarios and ensure compliance with their overarching corporate governance responsibilities.
Key Takeaways
- A fiduciary out is a clause in an M&A agreement allowing a target company's board to withdraw its recommendation or terminate the deal under specific circumstances.
- Its primary purpose is to enable the board to fulfill its fiduciary duties to shareholders, especially the duty to maximize shareholder value.
- This provision is typically triggered by a superior proposal from a third party or a significant, unforeseen material adverse change affecting the deal.
- Exercise of a fiduciary out often involves negotiation, including potential break fee payments to the original buyer.
- It provides crucial flexibility for boards in dynamic M&A environments, ensuring they are not irrevocably bound to a deal that is no longer in the shareholders' best interest.
Interpreting the Fiduciary Out
A fiduciary out is interpreted within the context of the specific merger agreement and the prevailing corporate law, particularly in the jurisdiction of incorporation, such as Delaware law. The clause is generally drafted to provide objective criteria for its invocation, such as defining what constitutes a "superior proposal" (e.g., a written, bona fide offer that is fully financed and demonstrably more favorable to shareholders than the existing agreement, after giving the original buyer an opportunity to match).
Boards must exercise extreme care and conduct thorough due diligence when considering a fiduciary out. Their decision to invoke the clause must be made in good faith and based on the advice of legal counsel and financial advisors, demonstrating that they are acting in the best interest of the shareholders. The presence of a fiduciary out does not mean a board can arbitrarily abandon a deal; rather, it provides a defined pathway to do so when legal obligations demand it. This reflects Delaware's robust body of corporate case law, which frequently addresses the nuances of corporate fiduciary duties4.
Hypothetical Example
Imagine "TechInnovate Inc." (target company) has signed a definitive merger agreement to be acquired by "Global Holdings Corp." for $50 per share. The agreement includes a standard fiduciary out clause. Two weeks after signing, "Disruptor Ventures," an unexpected third party, submits an unsolicited, fully financed offer to acquire TechInnovate for $60 per share.
TechInnovate's board of directors, after consulting with its financial and legal advisors, determines that Disruptor Ventures' offer constitutes a superior proposal under the terms of the merger agreement. They notify Global Holdings, giving them the contractual "matching rights" period to revise their offer. Global Holdings declines to increase its offer. Based on their duty to maximize shareholder value, TechInnovate's board then formally exercises the fiduciary out, terminates the agreement with Global Holdings (paying an agreed-upon break fee), and enters into a new agreement with Disruptor Ventures. This action allows TechInnovate shareholders to receive a significantly higher valuation for their equity.
Practical Applications
The fiduciary out is primarily applied in public M&A transactions where the target company's board has a heightened duty to shareholders. It is a standard component of acquisition agreements, particularly for publicly traded companies. This provision enables boards to respond to competitive bids or unforeseen changes in circumstances, ensuring they are not locked into a transaction that becomes suboptimal. For instance, if, after signing, the financial outlook for the target company significantly improves, or a competitor offers a demonstrably better deal, the fiduciary out provides a mechanism for the board to pivot.
Furthermore, the Securities and Exchange Commission (SEC) regulates various aspects of M&A transactions, including the disclosure requirements related to such activities3. The SEC's interpretation of fiduciary duties also plays a role in how investment advisors and, by extension, corporate boards, must act in the best interests of their clients or shareholders2. The inclusion and careful wording of a fiduciary out provision are crucial during negotiations, as it balances the buyer's desire for deal certainty with the seller's board's legal obligations to its shareholder rights.
Limitations and Criticisms
While essential for fulfilling fiduciary duties, the fiduciary out is not without limitations or criticisms. One common critique is that it can introduce uncertainty into M&A deals, as it provides an avenue for the target board to walk away. This uncertainty can sometimes discourage potential buyers from investing significant time and resources in due diligence and negotiation.
Another limitation is the negotiation of deal protection measures, such as large break fees, which can make exercising a fiduciary out economically burdensome, effectively limiting the board's flexibility even when a superior offer exists. Critics also sometimes argue that boards might use the fiduciary out not solely for a superior proposal but for other reasons, though legal standards and judicial oversight aim to prevent such abuses. The Delaware Court of Chancery frequently addresses the nuances of corporate fiduciary duties, including disputes related to M&A agreements, highlighting the ongoing legal scrutiny applied to these clauses1. The precise circumstances under which a fiduciary out can be invoked are often subject to detailed contractual definitions and legal interpretations, designed to prevent arbitrary termination while safeguarding shareholder interests.
Fiduciary Out vs. No-Shop Clause
The fiduciary out and a no-shop clause are often discussed together in M&A agreements because they represent opposing forces. A no-shop clause is a covenant that restricts a target company from soliciting or entertaining alternative acquisition proposals from third parties once an agreement has been signed with an initial buyer. Its purpose is to provide deal certainty to the acquiring party.
In contrast, the fiduciary out acts as an exception to the no-shop clause. While the no-shop clause prevents the target from actively seeking other offers, the fiduciary out specifically allows the board to engage with, and potentially accept, an unsolicited superior proposal, even if it violates the no-shop covenant, provided the board determines that not doing so would breach its fiduciary duties. Essentially, the fiduciary out is a carve-out that preserves the board's ability to act in shareholders' best interests, even when a no-shop clause is in place.
FAQs
What triggers a fiduciary out?
A fiduciary out is typically triggered by the receipt of a superior proposal from another party that is demonstrably better for shareholders, or by an unforeseen material event that significantly alters the board's assessment of the original deal.
Can a board exercise a fiduciary out for any reason?
No. A board can only exercise a fiduciary out if it determines, in good faith and with the advice of legal counsel, that failing to do so would constitute a breach of its fiduciary duties to shareholders. The specific conditions are usually outlined in the merger agreement.
Is a break fee always involved with a fiduciary out?
Often, yes. Merger agreements usually stipulate that if the target company exercises a fiduciary out to accept a superior proposal, it must pay a predetermined break fee to the original buyer. This compensates the initial buyer for their time, effort, and expenses incurred during the negotiation process.
How does a fiduciary out protect shareholders?
The fiduciary out protects shareholders by ensuring that the board has the flexibility to pursue the best possible outcome for the company, even after a deal is initially signed. It prevents shareholders from being locked into a suboptimal transaction if a significantly better opportunity arises.